In the time since the U.S. election, the collective response of the financial markets has been one of optimism. Equity markets in the U.S. have moved notably higher and have started to broaden out beyond the Magnificent Seven. Credit spreads in fixed income remain at historically tight levels.
The Republican election sweep and narrow margins in Congress raise prospects of a wide set of fiscal outcomes, creating potential upside risks to growth, although also increasing probabilities that inflation may stabilize at higher rates, if not accelerate. That could change the pace of the Fed’s path, which markets have priced at two cuts through 2025.
To be sure, the economic and market backdrop remains dynamic, but generally positive. Consumer spending is back to normal. When prices go up, the consumer is trading down. The average consumer has been accumulating debt, very similar to normal pre-pandemic types of behavior, but in general remains healthy and supportive for growth.
An excess amount of energy is available, and oil capacity remains high. In our view, shocks will have to be quite meaningful to impact the global economy.
Enthusiasm is high for a potential pick up in M&A activity and continued artificial intelligence-related spending. We believe general secular trends will continue, such as re-shoring and diversification of supply chains, investment in technology and climate transition with moves to more sustainable energy.
However, with the big run-up in asset values and U.S. equity market concentrations near historical highs, there is now less room for error. We believe the U.S. equity market remains the most attractive in the world, owing to resilient economic and corporate earnings growth. Even with rich valuations and policy unknowns, we are still bullish, and we expect the stock market's return structure to continue to broaden in 2025.
Nonetheless, for investors sitting on large equity portfolio gains, 2025 should be a year to diversify their portfolios with a focus on income.
Yet as the attractive yields from money market funds fade, investors will need to consider different ways to generate that income. That could mean buying fixed income at higher rates now to lock in yield or seeking income opportunities in global equity markets.
Nominal fixed income rates are higher than terminal levels and serve as braking mechanisms to demand. If, because of shocks, the economy slows down, lower rates should follow. That may develop into relative or outright return opportunities that can also diversify overall portfolios.
Yet rate cycles can look different across jurisdictions—bond markets ultimately are global and influence each other in finding rate equilibrium. That may open relative value opportunities to deliver returns based on global duration markets.
It is still early in the cycle for many fixed income products, so we believe spread income is good. Investors can get premiums relative to other assets, like investment-grade credit, where there has been a dearth of supply.
Securitized loans offer attractive income, particularly in collateralized loan obligations and commercial mortgage-backed securities. Yet investors may not be able to achieve the excess returns of the last year. And high yielding bonds, including tax-free U.S. municipal bonds, offer an attractive source of income generation. Healthy yields remain in municipal bonds farther out on the curve.
Within the equity markets, non-U.S. exposure often provides higher dividend yields. With European equity payout ratios below average, there is an opportunity for them to move higher. Buy-write strategies offer exposure to equities while selling call options to earn income that is uncorrelated to fixed income. For investors willing to tolerate equity market volatility, covered call strategies can provide an income boost.
We stress the importance of staying invested and focusing on tax-efficient returns as clients seek to create long-term wealth. Income and gains generated in investor portfolios can be reinvested in the next incremental opportunity, an important but sometimes underappreciated strategy.
Attractive income options are available for investors willing to look more broadly for them. They should look to utilize multiple strategies across fixed-income and equity markets—combining stocks with bond-like characteristics and bonds with stock-like characteristics. That mix allows for the construction of portfolios with the potential to generate attractive risk-return income.
Ashish Shah is Chief Investment Officer of Public Investing, Goldman Sachs Asset Management
