Market fundamentals remain supportive

Video : CIO strategist Jon Gordon on the January effect and US equities (2:01)

Video replay: Ask Kelvin Live – Predictions for 2025 (36:51)

US equities and Treasuries fell on Tuesday following the release of stronger-than-expected economic data. The S&P 500 slid 1.1%, the Nasdaq dropped 1.9%, and the yield on the 10-year US Treasury jumped 7 basis points to 4.68%, the highest level since April last year.

US job openings in November rose to a six-month-high, with available positions increasing to 8.1 million, from an upwardly revised 7.8 million in October, according to the Job Opening and Labor Turnover Survey (JOLTS) from the Bureau of Labor Statistics. In addition, the ISM services index for December rose to 54.1, with the sub-index for prices paid surging to the highest level since early 2023. Markets took these data points as an indication of a resilient labor market and inflationary pressures within the service sector, and further scaled back expectations for how much the Federal Reserve will lower rates this year.

But while risk sentiment is likely to remain fragile, we continue to see a favorable macro backdrop for equities and bonds, and believe that market fundamentals should benefit these asset classes.

Further Fed cuts remain in store this year. The labor report for December due this Friday and inflation data next week will provide more details on the state of the US economy. While the Fed is unlikely to cut interest rates at its first policy meetings of 2025, we expect data in the coming months to show slowing inflation and a softening labor market, allowing the US central bank to start cutting again by the June policy meeting. In line with the Fed’s latest economic projections, we expect a second rate reduction to follow later this year, most likely in the third quarter.

Healthy corporate profit growth should continue to support equities. While US equity valuations are higher than the historical average, we think they reflect the current positive economic conditions. Valuations historically have also had little correlation with returns over the next 12 months. Instead, with lower borrowing costs, resilient US economic activity, further AI monetization, and the potential for greater capital market activity under a second Trump administration, we expect healthy profit growth of 9% for S&P 500 companies in 2025. This should help equities gain further ground.

The secular AI story should drive further growth but at a slower pace. NVIDIA Chief Jensen Huang this week revealed a suite of new tools, chips, and model frameworks aimed at speeding up the adoption of AI across robotics, autos, the industrial sector, and the enterprise workforce. On a broad level, we remain bullish on the AI investment theme, favoring AI semiconductors and leading cloud platforms. We expect big tech’s combined capital spending to grow another 25% this year to USD 280bn, after an estimated 51% increase in 2024, while monetization continues to pick up.

So, while volatility is likely to persist in the year ahead, potentially driven by tariffs, fiscal battles in Congress, inflation trends, Fed actions, and the outlook for economic growth, we think the fundamentals should continue to support equities and bonds. Our year-end S&P 500 price target of 6,600 would represent a near 12% gain versus Tuesday's index close. We also believe quality bonds and diversified fixed income strategies remain valuable in a portfolio context as cash returns fall.