2 / Outlook and changes

Here is our base scenario for 2025. We expect it to be a good year for investors overall, as inflation eases, growth returns to normal and central bank interest rate cuts help many asset classes. But the amount of international speculation, even before Donald Trump’s inauguration, on the nature, quantity and extent of the import tariffs he is proposing is immediately a good guide to the big uncertainties the world faces in the year ahead. Trump has promised to “end inflation” but tariff rises are liable to put it up. Many economists are also worried about the medium-term effects on U.S. growth potential of tighter labor markets stemming from stricter immigration laws. In addition, the wealth effect from the gains in U.S. capital markets this year have reduced recession risk in the U.S. but create a vulnerability should markets struggle. Then there is China, where it remains to be seen how consumers’ mood will develop after the biggest stimulus program since 2009 failed to create lasting euphoria. In Europe, meanwhile, the macro numbers, especially in Germany and France, have been rather depressing in the second half of the year. These are the risks to an overall macroeconomic backdrop that is still broadly positive, with no recession in sight, labor markets still strong and major central bank interest rates declining.

 

2.1 Fixed Income

We expect yield curves to steepen further in 2025 as central banks' interest rate cuts leave their mark on two-year bond yields in particular. At the end of 2025 we see the Fed Funds rate at 3.75-4.00% and the ECB deposit rate at 2.0%. Corporate bonds should remain attractive in 2025 due to their high current interest yield and overall robust economy. However, we do not expect yield spreads to narrow further. We prefer bonds with investment grade status to those without.

 

Government Bonds

We expect government bond yields to trade in a similar manner to 2024 — sideways, but with high volatility. This volatility also means that we expect yield curve steepening for U.S. Treasuries to be fed by slightly declining 2-year yields and slightly increasing 10-year yields over the next 12 months. For German Bunds we also expect the shorter end to fall faster than the longer end, given lower expected economic growth. We have reduced our expectation for the terminal ECB deposit rate for this cycle to around 1.50%. For the UK we expect more rate cuts by the Bank of England than the market does and forecast a 2.75% rate by the end of 2025 (they now stand at 4.30%^[3]). This helps to explain our yield outlook: We see 2-year Gilts ending 2025 at 3.75% and 10-years at 4%. This makes 10-year Gilts look attractive from a total return perspective. For Italy we have changed our spread forecast and do not expect a material spread widening of Buoni del Tesoro Poliennali (BTPs) versus Bunds in our main scenario. Despite the high debt-to-GDP level and quantitative tightening by the ECB the market (and rating agencies) do not seem to be overly concerned about Italy’s debt sustainability. The right-wing government looks comparably stable. The economy is doing ok so far. Valuations are rather tight, but we do not expect a material pick-up in Italy’s credit risk compared to German government bonds. In Japan, given the expectations for higher interest rates, we believe the market will reprice yields higher in the coming months. We expect the short and medium part of the curve to do more upward repricing during the current hiking cycle than the long end, i.e. curves will flatten. Hence, we are negative on the short- to medium- end, and more positive on the long end of the curve. We leave our one-year forecasts almost unchanged.

Sovereign bond yields in November: first up then down

^{Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 12/2/24}

  

Corporate Bonds

In U.S. Investment Grade (IG) Credit, we will look for clarity over the next two quarters on whether Trump keeps his promises on tariffs, tax policy and immigration. If inflationary pressures reignite, this could cause some weakness in spreads. For U.S. high yield Credit, we see an elevated risk of a correction as spreads are priced for no room for errors and default rates are expected to increase over the next 12 months. Euro IG Credit, however, remains a fundamentally sound and technically well supported asset class, with an attractive all-in yield. EUR High Yield looks more vulnerable to corrections given how low credit spreads are and the economic headwinds causing stress in some sectors, with automobiles and parts as one example. Default rates are expected to be manageable and stay historically low.

 

Corporate Bonds: spread compression in the U.S., not so in Europe

^{EUR IG All Sectors OAS: Option adjusted spread (weighted by market value) of Euro IG cover All Cash Bonds Sector.}

^{EUR HY All Sectors OAS: Option adjusted spread (weighted by market value) of Euro HY cover All Cash Bonds Sector.}

^{US IG All Sectors OAS: Option adjusted spread (weighted by market value) of the U.S. dollar IG cover All Cash Bonds Sector.}

^{US HY All Sectors OAS: Option adjusted spread (weighted by market value) of U.S. dollar HY cover All Cash Bonds Sector.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 12/2/24}

 

 

Emerging Markets

After falling to multi-year lows the pricing of Emerging Markets (EM) Sovereign hard currency debt looks tight as there are many risk factors. The presidency of Donald Trump might result in higher tariffs, tax cuts and less immigration, all potentially leading to higher inflation and as consequence to higher U.S. rates and a stronger dollar. On top of this, a more protectionist global trade environment might be detrimental to the fundamental outlook for small and open emerging markets. Nevertheless, in the absence of a recession, an escalation of geopolitical risks or a fully-fledged trade war, tight spreads might prevail for now. EM high yield issuers are so far somewhat insulated from the global economic cycle and benefiting from their own fundamental recovery story. In Asia Credit we remain positive given technical support, high saving rates, decent corporate balance sheets and, importantly, slightly softer U.S. monetary policy.

 

Currencies

Two factors will likely determine the direction of G10 currencies versus the dollar in the coming months: whether or not the U.S. imposes tariffs on G10 countries; and to what degree current Fed policy will be impacted. The U.S. economic outlook has brightened lately, and so some Fed rate cuts have been priced out: The market no longer expects as much easing as it did before. As a result, the dollar strengthened ahead of the U.S. election. We expect the growth outlook outside the U.S. to suffer, leading to an expectation that most G10 currencies will underperform the dollar. Major central banks, other than the Fed and the Bank of Japan (BoJ), will potentially have to cut more to support the growth outlook. The BoJ is an exception in that it is seeking to normalize policy after years of ultra-low rates. This is why we expect the yen to appreciate versus the dollar toward end of the forecast horizon. Nevertheless, the yen remains a funding currency; as the BoJ gradually raises rates, there will be some structural unwind in these trades. Commodity currencies such as the Australian dollar are still struggling because at present there is no reflation yet globally.

 

2.2 Equities

After 2 years with returns in excess of 20%, the prospect of a seemingly business-friendly president leading the U.S. next year, no recession in sight and interest yields moving sideways, global equities have momentum on their side. At the same time, valuations are historically high, market leadership is concentrated in a handful of mega-cap U.S.-tech companies and global trade might again be harmed by potential trade policies of the new U.S. administration. What do we make of this? Our core scenario is that the economic outlook and earnings growth are too robust for us to turn negative on equities. Furthermore, the significant wealth effect from equities continues to push markets higher as investors are driven by the fear of missing out (FOMO). This also creates the risk that the market will overshoot fundamentals in the first half of 2025. What this is likely to mean is that equity returns over the next decade are likely to be far below those in the recent past: We forecast 5% per annum for the MSCI AC world, only half that of the average realized return of 10% per annum over the past two decades. Our preferred sectors are software, the most attractive segment within IT in our view, followed by Asian semiconductor companies. We believe Health Care is the most attractive defensive sector, although we might see some volatility here as a result of potential policies of the new U.S. administration. In terms of regional preferences, we have no strong conviction but believe in the merits of a diversified global equity portfolio.

 

U.S. Market

It has been another very strong year for U.S. equities in 2024 and, once more, it was Big Tech that drove most of the gains. The ten biggest companies in the U.S. (nine of which are closely related to tech) account for 36%^[4] of the market cap of the broader market – a historical high. In our most positive scenario, the Trump momentum would mean: Pro-business initiatives would be quick to deliver tax cuts, deregulation, and reshoring.  Apart from political issues, we see the biggest risks as being disappointment with AI and 10-year-Treasury yields climbing above 4.5%, or valuations mean-reverting, as all positive developments have already been priced in. Our preferred sectors are Health Care, Financials, Utilities, Energy and Communication Services. Our S&P 500 target for end 2025 is 6,500 points.  

 

European Market

While we expect Europe to show robust mid-single digit EPS growth and superior dividend pay-out profiles, the region has less intrinsic momentum than the U.S. and there are fewer positive earnings revisions. Thus, even the record high discount to the S&P 500 might be a poor timing indicator: European stocks may not close the gap while the exaggerated "America First" euphoria continues. Our preferred sectors are European banks and small and midcaps. Our target for the Stoxx 600 is 525 points.

 

German Market

Shareholders in German stocks can’t complain that the depressing political and economic environment is weighing on their assets: The Dax is trading close to its historic high. One reason for this is Dax companies generate at present some 80% of their sales abroad. A further positive we currently identify for the market is the upcoming snap election in February 2025. It might mean that we have seen sentiment trough, as a more business-friendly government might take over. Furthermore, real wage growth should support consumer spending. On the negative side, global manufacturing purchasing manager indices (PMIs) remain weak. New trade barriers might be erected by the next U.S. administration and Chinese demand remains weak. Our target price for the Dax is 20,500.

 

Emerging Markets

With the case for rate cuts becoming less clear in the U.S. after the presidential elections, Global Emerging Markets (GEM) face some more headwinds due to the stronger dollar. That will likely make it hard for markets to perform. Those less exposed to the U.S. could fare relatively better but are too small to turn around the whole GEM universe. A stabilization in Chinese earnings would be the strongest galvanizing factor but, due to the lack of meaningful reforms and soft consumer spending, we prefer to await more details before buying into any kind of China optimism. In the meantime, China is expected to remain a range-bound market, as it has been in the recent past. We assume that valuations will not get “dirt cheap” due to the government’s stimulus measures but investors are likely to fade rallies given the high geopolitical risks, unless the government does more. Indian companies have recently underdelivered, making valuations look even more expensive. We find valuations more reasonable among Indian mega-caps; some of these companies have been able to differentiate themselves positively.

 

Japan

The Japanese equity market has performed well over the past year in yen terms. The weak yen is supporting corporate earnings, real wages are growing, and corporate reforms and improvements in shareholder returns are driving the market. Shorter-term weakness in selected names seem appropriate to build positions for the long term, aiming for a balanced portfolio of export-oriented and domestic names.

U.S. stocks expanded their lead in November

^{Source: Bloomberg Finance L.P., DWS Investment GmbH as of 12/2/24}

 

 

2.3 Alternatives

Demand concerns remain a headwind for global commodity prices. Stronger U.S. economic data and reduced fear of recession in the U.S. has reduced the need for the Fed to be more aggressive in cutting rates. The Chinese government has continued to provide monetary and fiscal support at a gradual pace. On the supply side, producers’ Capex spending has remained limited. Possible Trump tariffs may ignite further negative sentiment on global growth and commodity demand in the short term, but the long-term case for commodities remains intact.

 

Real Estate

Global real estate investors remain cautiously optimistic as interest rate cuts and robust fundamentals support the return of positive total returns in Europe and the U.S. While fundraising remains difficult, in general improving investor sentiment is supporting a gradual return of liquidity. With occupier fundamentals likely to strengthen further amid a sharp fall in construction activity, this could be an exceptional period for real estate investment, with both strong rental growth and tightening yields. The European recovery is expected to broaden as investor sentiment improves. Our preferred sectors are Residential and Industrial (logistics). Besides these, real estate debt remains attractive across most sectors apart from U.S. office space which is seeing rising delinquencies. We like most residential, industrial and real estate debt.

 

Infrastructure

We remain focused on relative valuations and companies that can maintain and grow cash flows. Inflation has eased, but the labor market and economic growth have begun to show some weakness, and markets expect to see 50 to 75 basis points (bps) of rate cuts before 2025 in the U.S. Infrastructure should benefit as a need-based asset with a good ability to pass on inflation; a reduced cost of capital in the form of lower long-duration bond yields would also be a positive for the sector. We expect performance dispersion to continue, potentially affording active managers alpha opportunities.

 

Gold

We raise our gold forecast for end-2025 to USD 2,800 per ounze, given that expectations on the Fed’s terminal rate have risen by almost 1% since the low water mark after the September rate cut. Additionally, the dollar has gained against other currencies, and the market has priced in higher inflation expectations after the Trump election victory. Though there are price concerns in the short term, some factors could support the gold price in the long run. Central bank buying should continue, albeit at a slower pace and uncertainty generated by the new administration’s policies on the economy and trade should bolster interest in gold as well.

 

Oil

Our target price for end-2025 is USD 69 per barrel, little different to their current level. Our forecast reflects ample near-term supply, with additional OPEC+ barrels entering the market in 2025. Our base case assumes a gradual increase in OPEC+ volumes, matching moderate growth in crude demand and in the global economy. Recent events in the Middle East have heightened geopolitical risk premiums, leading to increased volatility in global crude oil prices. OPEC’s decision to increase its output in January is based on expected stronger demand growth in 2025. However, persistent weakness in China creates downside risk for prices, which we see stagnating in 2025.

Sideways trading for gold and oil

^{Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 12/2/24}

 

3 / Past performance of major financial assets

 

Total return of major financial assets year-to-date and past month

 

 

 

 

 

4 / Tactical and strategic signals

 

The following exhibit depicts our short-term and long-term positioning.

 

 

4.4 Legend