In the time since the US election, the collective reaction of financial markets has been one of optimism. US stock markets have moved significantly higher and are beginning to expand beyond the Great Seven. Fixed income credit spreads remain at historically narrow levels.
The Republican election and tight margins in Congress raise the prospect of a wide range of fiscal outcomes, creating potential upside risks to growth, though they also raise the likelihood that inflation could stabilize at higher rates, if not accelerate. That could change the pace of the Fed's path, which markets have priced at two rate cuts through 2025.
Of course, the economic and market background remains dynamic, but generally positive. Consumer spending is back to normal. When prices go up, the consumer trades down. The average consumer has accumulated debt, very similar to normal types of behavior before the pandemic, but remains generally healthy and supportive of growth.
There is a surplus of energy and oil capacity remains high. In our view, the shocks would have to be significant enough to affect the global economy.
Enthusiasm is high for a potential increase in M&A activity and continued AI-related spending. We believe that general secular trends will continue, such as replenishment and diversification of supply chains, investment in technology and climate transition with a move towards more sustainable energy.
However, with huge increases in asset values and US stock market concentrations near historic highs, there is now less room for error. We believe that the US stock market remains the most attractive in the world, due to sustained economic growth and corporate earnings. Even with rich valuations and policy unknowns, we are still bullish and expect the stock market return structure to continue to widen in 2025.
However, for investors sitting on large equity portfolio gains, 2025 should be a year to diversify their portfolios with an income focus.
However, as attractive yields from money market funds fade, investors will need to consider different ways to generate that income. This could mean buying fixed income at higher rates now to lock in yield or looking for income opportunities in global capital markets.
Nominal fixed income rates are higher than terminal levels and serve as a dampening mechanism on demand. If, due to shocks, the economy slows down, lower rates should follow. This can develop into relative or total return opportunities that can also diversify overall portfolios.
However, rate cycles may look different across jurisdictions – bond markets are ultimately global and influence each other in finding rate equilibrium. This can open up relative value opportunities to provide returns based on global duration markets.
It's still early in the cycle for many fixed income products, so we believe the spread income is good. Investors can receive premiums in relation to other assets, such as investment-grade credit, where there has been a shortage of supply.
Securitized loans offer attractive income, particularly in collateralized loan obligations and mortgage-backed commercial securities. However, investors may not be able to achieve the excess income of the previous year. And high-yield bonds, including tax-free US municipal bonds, offer an attractive source of income generation. Healthy yields remain in municipal bonds further down the curve.
Within equity markets, non-US exposure often offers higher dividend yields. With European pay-out ratios below average, there is an opportunity for them to move higher. Buy-write strategies provide exposure to stocks while selling call options to earn income unrelated to fixed income. For investors willing to tolerate stock market volatility, covered call strategies can provide an income boost.
We emphasize the importance of staying invested and focusing on tax-efficient returns as clients seek to build long-term wealth. Income and profits generated in investors' portfolios can be reinvested in the next growing opportunity, an important but sometimes underappreciated strategy.
Attractive income options are available for investors willing to look at them more broadly. They should look to use multiple strategies in fixed income and equity markets – combining stocks with bond-like characteristics and bonds with stock-like characteristics. This mix allows for the construction of portfolios with the potential to generate attractive income from return risk.
Ashish Shah is Chief Investment Officer of Public Investments, Goldman Sachs Asset Management