We think investors should no longer think in terms of business cycles, with short-term fluctuations in activity leading to expansion or recession. Instead, mega forces are driving an economic transformation that could keep shifting the long-term trend, making a wide range of very different outcomes possible – on the upside and downside. Building the transformation – such as with AI data centers – requires a major infrastructure buildout. Financing the transformation given constrained public finances means that capital markets, including private markets, will be key. Markets are starting to reflect these shifts: The “magnificent 7” of mostly mega-cap tech shares now make up almost a third of the S&P 500’s market capitalization. See the chart. We think this calls for rethinking investing, and challenges investment strategies based on valuations converging back to historical trends.
We follow that playbook as we stay pro-risk headed into 2025. We increase our overweight to U.S. stocks as we expect AI beneficiaries to broaden out beyond tech. We’re also confident U.S. equities can keep outpacing global peers given the ability to better capitalize on mega forces, a favorable growth outlook, potential tax cuts and regulatory easing. Signposts for changing our view include any surge in long-term bond yields or an escalation in trade protectionism. Pricey U.S. equity valuations, based on price-to-earnings ratios and equity risk premiums, don’t yet change our view. Why? We find valuations affect near-term returns less than long-term returns. The equity risk premium – a common valuation gauge – for the equal-weighted S&P 500 is near its long-term average, according to LSEG data, and thus looks less affected by the transformation.
Harnessing the transformation
U.S. outperformance is unlikely to extend to government bonds. We go tactically underweight long-term Treasuries as we expect investors to demand more compensation for the risk of holding them given persistent budget deficits, sticky inflation and greater bond market volatility. We favor government bonds in other developed markets. Globally, Japanese equities stand out due to corporate reforms and the return of mild inflation that are driving corporate pricing power and earnings growth.
More broadly, we think investors can find opportunities by tapping into the transformation we expect in the real economy. AI and the low-carbon transition require investment potentially on par with the Industrial Revolution. Major tech companies are starting to rival the U.S. government on research and development spending. Plus, meeting growing energy demand will generate US$3.5 trillion of investment per year this decade, according to the BlackRock Investment Institute Transition Scenario. We see private markets playing a vital role in financing the future. Big spending on AI and the low-carbon transition plus rising geopolitical fragmentation is likely to cause persistent U.S. inflation pressures. And an aging workforce could start to bite as immigration slows, likely keeping wage growth too high for inflation to return to the Fed’s 2% target. We think that means the Fed will keep rates well above pre-pandemic levels even after cutting some in 2025.
Our bottom line
Mega forces are reshaping economies and markets. That requires a new playbook challenging old investment rules. We stay pro-risk to kick off 2025 but stand ready to dial down risk as catalysts emerge. Read our 2025 Global Outlook.
