A fresh look at macro conditions, portfolio drivers and the role of private markets
Today, the case for allocating to private equity is particularly strong, given current valuations of public markets and projected long-term returns
A YEAR ago, we retired the 10 surprises. It was an annual tradition started by my late colleague and friend, Byron Wien, in 1985.
After 38 years and 473 Surprises and also-rans, one thing clear to me is that they were all distinctly Byron. His was a voice that resonated, and collaborating with him for six years’ worth of 10 Surprises was an honour and an education.
As we start 2025, I continue to think about what surprises we may face.
US President Donald Trump’s return to the White House will bring both surprises and a familiar set of considerations. The interplay of tariffs, deregulation and tax reform, set against a global backdrop of coordinated interest rate cuts and moderating inflation, is likely to define the year ahead.
Lofty valuations in certain corners of the markets are another consideration for investors.
US uncertainties: a new boss or same old boss?
The US is at a fascinating inflection point. The retirement of the hard landing scenario, rather than providing clarity, introduces a more pronounced set of uncertainties around the interest rate trajectory.
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Today’s narrative encompasses a broader spectrum of outcomes – soft landing (with or without a gradual loosening of the labour market), no landing, or growth reacceleration.
Each one carries distinct implications for the depth and duration of the cutting cycle, the timing of potential pauses and the prospect of renewed tightening.
Fiscal policy adds another layer of complexity to the US Federal Reserve’s calculus. The first Trump administration executed a distinctive economic vision – blending supply-side economics, protectionism and deregulation, with a focus on American businesses.
While these themes likely remain priorities, there is a markedly different economic landscape.
Today’s inflation dynamics and concerns over spending present a more challenging environment for implementing pro-growth policies centred on deregulation, tax reduction and America-first trade negotiations.
These concerns may be valid, but they arguably miss the bigger picture: That instead of being mired in the vicious cycle of weak demand, low interest rates and hibernating animal spirits, the second Trump administration comes to power at a time when the full strength of the US economy is becoming clear for all the world to see.
Productivity growth is the long-run driver of higher living standards and budget sustainability. The US is a clear leader in productivity growth across the developed world right now.
The recent bounce may have been driven by a period of rapid business investment and epic churn in the labour market.
However, we anticipate a hand-off to artificial intelligence (AI) over the horizon and believe the US economy will continue to grow faster than its developed market counterparts.
Balancing act: global stimulus gains amid trade uncertainty
Chinese fiscal expansion dovetails with a coordinated global monetary easing cycle, creating a potent combination of fiscal and monetary stimulus.
In our experience analysing markets through multiple cycles, the combination of synchronised global rate cuts and substantial fiscal stimulus has proven consistently effective at reinvigorating economic growth.
The transmission mechanisms are well-established: Lower borrowing costs facilitate investment while fiscal spending provides direct economic support, creating a multiplier effect that ripples through the global economy.
Liquidity conditions could improve further if European policy rates decline as much as the market expects.
As at Jan 7, the market was expecting a 2 per cent deposit rate by December 2025. With Japanese policy rates rising, the euro may become a global funding currency in 2025, an outcome that could boost markets with strong underlying fundamentals and higher yields relative to the single currency, such as the US.
Yet, this optimistic outlook must be tempered by acknowledging potential headwinds, particularly the spectre of renewed trade tensions.
The return of America-first trade policies introduces uncertainty into global supply chains and trade relationships that have only recently stabilised. History suggests that trading partners are likely to respond in kind to new tariffs.
As countries calibrate their responses to protect domestic industries, there is potential for trade tensions to broaden beyond their initial scope, pulling more countries and sectors into the fray.
Strategic investment implications
The macroeconomic environment has always determined optimal asset allocation, but we believe that today’s landscape, which is vastly different from prior cycles, demands a fundamental reassessment of the traditional allocation framework.
With an unreliable stock-bond correlation, higher interest rates and stretched public equity valuations, portfolios require a distinct set of alpha drivers to achieve outperformance while also controlling for risks. In our view, private market assets can be a potential solution.
Nowhere is the need for new thinking more apparent than in fixed income allocations.
For 40 years, investors benefited from a fixed income bull market, as yields fell from elevated levels in the early 1980s to their bottom during the pandemic in 2020 – a period nicknamed the Great Moderation for its dormant inflation.
Today, a long decline in yields has given way to a range-bound market, with yields higher than the post-global financial crisis era, but still low compared to post-war history.
This market will likely provide lower fixed income returns – both in the absolute sense and when adjusted for risk – than investors enjoyed in the Great Moderation.
Government bonds have also lost attractiveness as a method for hedging equity drawdown risk. In only a few quarters over the last two-and-a-half years have government bond returns moved in the opposite direction to equity returns.
Also, for investors concerned about the federal debt position, long-duration core fixed income is not the place to be.
An allocation to private credit can help mitigate some of these challenges, as it offers an attractive high-yielding, shorter-duration option for portfolios.
This diverse asset class includes corporate direct lending and asset-backed finance, which is usually investment-grade in quality, with amortising loans secured on physical assets or a stream of cash flows.
In terms of the equity bucket, the relative positioning of public and private equity markets offers an excellent entry point into the private space – particularly for investors with no exposure.
Historically, private equity outperforms public markets over the long term, and designating an allocation within an equity mandate improves a portfolio’s Sharpe and information ratio.
Today, the case for allocating to private equity is particularly strong, given current valuations of public markets and projected long-term returns.
As at Jan 7, the S&P 500 Index traded at 27 times its trailing 12-month earnings.
In hindsight, an investor entering the market at these multiples can expect a forward 10-year annualised return in the mid-to-low single digits, less than the 13 per cent average annual return investors have become accustomed to over the past decade.
Investors could move to small and mid-cap stocks, where current valuations are lower both in absolute terms and relative to their own history.
However, swopping some large-cap exposure into a private equity allocation could be more impactful. Historically, private equity offers an attractive spread of 750 to 800 basis points above large-cap public equities in these types of environments.
Whether looking at public or private markets, high-quality companies with strong cash flow generation and robust balance sheets should command investors’ attention in this environment.
In our view, those companies with prudent capital allocation strategies, strong operating margins and sustainable free cash flow yield are positioned to outperform.
The writer is the chief investment strategist at Blackstone’s Private Wealth Solutions group. The views expressed in this commentary are his personal views and do not necessarily reflect the views of Blackstone.
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