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Macro outlook
Five themes for 2025
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Section 4: Five themes for 2025
- Relative spreads and credit selection, not risk-free rates, will drive returns in public and private debt markets.
- Municipals are still the borrower of choice for investors in it for the duration.
- Real estate reality: the trends are favorable.
- The world may be decoupling; markets are not.
- Energy demand charges ahead of capacity, creating opportunities amid political changes.
If someone had ignored markets for the last six months, they may be asking, “What did I miss?” As of mid-June, the S&P 500 Index is only slightly higher from the start of the year and the 10-year Treasury yield only slightly lower. But beyond those benchmarks, it’s clear for global, multi-asset investors that the path has unfolded quite differently from initial 2025 expectations. Consider:
- The U.S. dollar (DXY Index) saw the largest decline to start the year since 1973, when the OPEC oil embargo caused a 9% inflation surge. While the greenback came into this year overvalued, its rapid depreciation is causing investors to rethink their allocations. Is trade policy uncertainty and the U.S. fiscal trajectory causing global investors to lose faith in U.S. dollar assets?
- Developed non-U.S. equities are outperforming U.S. large cap equities by the largest margin since 1993 on a U.S. dollar basis and are also performing well in local currency terms for non-U.S. investors. Are U.S. equities headed for a prolonged period of underperformance?
- Municipal bonds have underperformed the core bond market by their second largest margin in history (behind only 2020) and have struggled to regain their footing after April’s spike in interest rate volatility. Do these lower prices reflect fundamental weakness, or are municipal bonds undervalued?
To answer questions 1 and 2, we direct readers to theme 4. Despite 2025’s headwinds and Moody’s recent downgrade of U.S. credit, the U.S. dollar is still the leading reserve currency due to high marks across several metrics, including share of foreign exchange volume, size and liquidity of capital markets, and depth and openness of markets. While 2025 highlights the importance of global diversification, investors should resist the urge to dramatically change U.S. vs non-U.S. allocation splits.
We upgraded U.S. large cap equities this quarter to reflect this view. While index-level valuations are far from “cheap,” expected earnings growth has been revised down from a peak of 15% earlier this year to a more achievable 10% (Figure 2). This earnings growth expectation still exceeds that of Europe and China, despite their growth rates moving more positive this year.
As for the third question, our conviction in theme 2 remains strong. We attribute municipal market’s performance weakness primarily to increased new issuance compared to history, as well as shifting tax policy discussions. This creates an opportunity for long-term municipal investors: Starting yields are in the 97% percentile versus their 10-year history (Figure 3). While we still believe allocations should balance interest rate risk versus credit risk in their overall fixed income portfolios, municipals are adequately compensating investors for extending duration exposure. With that said, current and potential federal policy changes are impacting certain sectors (higher education, for example), meaning credit research and active management are critical to capitalize on these yield opportunities.
Endnotes
All market and economic data from Bloomberg, FactSet and Morningstar.
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Important information on risk
All investments carry a certain degree of risk and there is no assurance that an investment will provide positive performance over any period of time. Equity investing involves risk. Investments are also subject to political, currency and regulatory risks. These risks may be magnified in emerging markets. Diversification is a technique to help reduce risk. There is no guarantee that diversification will protect against a loss of income. Debt or fixed income securities are subject to market risk, credit risk, interest rate risk, call risk, tax risk, political and economic risk, and income risk. As interest rates rise, bond prices fall. Investing in municipal bonds involves risks such as interest rate risk, credit risk and market risk, including the possible loss of principal. The value of the portfolio will fluctuate based on the value of the underlying securities. There are special risks associated with investments in high yield bonds, hedging activities and the potential use of leverage. Portfolios that include lower rated municipal bonds, commonly referred to as “high yield” or “junk” bonds, which are considered to be speculative, the credit and investment risk is heightened for the portfolio. Credit ratings are subject to change. AAA, AA, A, and BBB are investment grade ratings; BB, B, CCC/CC/C and D are below-investment grade ratings. As an asset class, real assets are less developed, more illiquid, and less transparent compared to traditional asset classes. Investments will be subject to risks generally associated with the ownership of real estate-related assets and foreign investing, including changes in economic conditions, currency values, environmental risks, the cost of and ability to obtain insurance, and risks related to leasing of properties. Investors should be aware that alternative investments including private equity and private debt are speculative, subject to substantial risks including the risks associated with limited liquidity, the use of leverage, short sales and concentrated investments and may involve complex tax structures and investment strategies. Alternative investments may be illiquid, there may be no liquid secondary market or ready purchasers for such securities, they may not be required to provide periodic pricing or valuation information to investors, there may be delays in distributing tax information to investors, they are not subject to the same regulatory requirements as other types of pooled investment vehicles, and they may be subject to high fees and expenses, which will reduce profits. Alternative investments are not appropriate for all investors and should not constitute an entire investment program. Investors may lose all or substantially all of the capital invested. The historical returns achieved by alternative asset vehicles is not a prediction of future performance or a guarantee of future results, and there can be no assurance that comparable returns will be achieved by any strategy. Responsible investing incorporates Environmental Social Governance (ESG) factors that may affect exposure to issuers, sectors, industries, limiting the type and number of investment opportunities available, which could result in excluding investments that perform well.
This information should not replace an investor’s consultation with a financial professional regarding their tax situation. Nuveen is not a tax advisor. Investors should contact a tax professional regarding the appropriateness of tax-exempt investments in their portfolio. If sold prior to maturity, municipal securities are subject to gain/ losses based on the level of interest rates, market conditions and the credit quality of the issuer. Income may be subject to the alternative minimum tax (AMT) and/or state and local taxes, based on the state of residence. Income from municipal bonds held by a portfolio could be declared taxable because of unfavorable changes in tax laws, adverse interpretations by the Internal Revenue Service or state tax authorities, or noncompliant conduct of a bond issuer. It is important to review your investment objectives, risk tolerance and liquidity needs before choosing an investment style or manager.
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