2025 Multi-Asset Strategies Outlook
First Quarter
Key Takeaways
Investors should be prepared for a roller-coaster year of economic, market and geopolitical tension in 2025.
In a potentially volatile environment, diversification spreads risk among different assets and potentially improves overall risk-adjusted return.
Navigate Economic Volatility in 2025 with Diversification
Amid economic and geopolitical uncertainty, U.S. stocks are at historic highs as we enter the new year. So, we believe now might be the time to take some winnings off the table and for investors to revisit their portfolios’ diversification.
This may seem counterintuitive, given that many pundits are talking about “U.S. exceptionalism.” Stocks are at record highs. We hear clients arguing that they’ve been rewarded for betting on the Magnificent 7 and corporate America, so why change now?
To that argument, we acknowledge that momentum and risk-taking are working. The Federal Reserve (Fed) is cutting rates, and the new Trump administration will likely cut taxes and regulations. Seen in that light, we think the conclusion seems obvious: Be bullish.
But we think the counterpoints are stronger. Stock valuations are high even when we use aggressive forward earnings estimates. Inflation refuses to go away, so bond yields are stubbornly high. U.S. growth stocks have outperformed value by a historic amount, as have large versus small stocks. It’s a similar story for U.S. versus non-U.S. stocks, both developed and emerging markets (EM) equities.
Elsewhere, the difference between high-yield and investment-grade bond yields is very low by historical standards. This means you’re getting little reward for taking on the additional credit risk of high-yield bonds.
The upshot is that across financial markets, risks and valuations are heightened.
2025: A Year of Economic and Geopolitical Uncertainty
Moreover, we think 2025 is likely to be a roller coaster year of economic, market and geopolitical tensions. The Fed is cutting interest rates, but how low can they go? Inflation is proving to be sticky, and any potential tax cuts will likely expand the deficit, pushing up Treasury yields. The new administration takes office amid escalating wars in Ukraine and the Middle East.
Another big unknown is whether we will see more moderate or more aggressive policies from the new administration. The former would involve corporate tax cuts, lighter tariffs and immigration policies, and less regulation/more stimulative fiscal measures. This scenario might be beneficial for stocks because lower taxes and less regulation mean higher corporate profits and minimal disruption to the labor force and trade.
More aggressive policies might be less favorable for financial markets. Higher tariffs, trade conflicts, and significant changes to the labor force could impact economic growth, hurt productivity, and promote inflation.
We don’t want to lose sight of the macroeconomic forest for the policy trees. Suffice it to say that nonpartisan research on the economic effects of proposed tariffs and immigration restrictions shows negative effects on U.S. growth.1 Setting aside the question of the social or political desirability of such policies, our takeaway is that the risks to economic growth are heightened going forward.
Strategic Portfolio Rebalancing: Taking Some Profits Off the Table
Portfolio diversification and rebalancing offer a way to address these risks. Diversification spreads assets among different assets to mitigate risk in any single asset class. This also improves overall potential risk-adjusted returns. Diversification is particularly well-suited to times like these when uncertainty is high. It doesn’t eliminate exposure to the best-performing asset classes. Instead, it reduces exposure in line with an investor’s original financial plan.
Rebalancing is the mechanism to keep intended asset class weightings and relationships in line. It’s a process that systematically sells expensive assets, buys cheap ones, trims leaders and adds to laggards. As a result, investors are not making wholesale trades into and out of asset classes. Instead, we’re talking about marginal changes to take off some risk and potentially lock in some gains. So, it’s not a question of abandoning the Magnificent 7, but of taking some profits investors may have earned from owning them.
In our portfolios, we have focused on redeploying into arguably undervalued — but certainly underperforming — areas of the financial markets. Whether it's emerging markets, non-U.S. equities, bonds or small-cap and value-oriented stocks, we think these “ignored” asset classes look compelling from a diversification and risk/reward point of view.
¹Erica York, “How Will Trump’s Universal and China Tariffs Impact the Economy?” Tax Foundation, November 8, 2024; Diana Roy, “How Does Immigration Affect the U.S. Economy?” Council on Foreign Relations, October 30, 2024.
Asset Class
U.S. Equity | U.S. Fixed Income & Cash
Uncertainty is high, and historical relationships between asset classes are stretched or at extremes. This presents challenges for some asset classes and opportunities for others. In this environment, we prefer to maximize our diversification benefit and position at our long-term strategic allocations.
Equity Region
U.S. | Developed Markets
In both developed and EM equities, momentum is strongly on the side of U.S. stocks, reflecting their strong outperformance. And if you’re in the “American exceptionalism” camp, you’d continue to favor U.S. stocks. Or if you’re focused on reversion to historical relationships, you’d be inclined toward non-U.S. stocks. But our tactical models have a much shorter horizon, so we remain neutral on U.S. versus developed market equities for now.
U.S. | Emerging Markets
As with developed markets, there are arguments for and against U.S. and EM stocks based on recent performance in contrast with long-term trends. But here, too, we prefer to adhere to our carefully constructed long-term allocation targets. It’s also worth reiterating that “neutral” doesn’t mean passive. Our EM equity managers actively work to identify what they believe are the best opportunities in their markets.
U.S. Equity Size & Style
Large Cap | Small Cap
This is another area beset by uncertainty, as “America first” policies could impair the profits of large multinational corporations and benefit the relative performance of smaller, more U.S.-focused firms. Similarly, large has outperformed small by a historic margin, so mean-reversion arguments should favor small. Nevertheless, our short-term quantitative models argue for hugging our neutral strategic weights.
Growth | Value
Similar to positioning by style, short-term momentum arguments favor one asset class, while long-term mean reversion arguments favor the other. In the short run, we’re glad to rebalance to our neutral asset allocation targets. Rather than make a broad asset allocation call for the next few months, we prefer to allow our managers to navigate the considerable opportunities in their respective markets.
Fixed Income
U.S. | Non-U.S.
Our Fixed Income team is positioned for economic, market and policy uncertainty to dominate in the near term. As a result, they are emphasizing short- and intermediate-term bonds, with a particular focus on higher-quality sectors and issues. Examples are mortgage- and other asset-backed securities. In terms of credit quality, our models prefer investment-grade over high-yield bonds because of relative valuations.
Alternatives
REITs | Core Assets
The decline in year-over-year mortgage rates is positive for real estate investment trusts (REITs). REIT yields relative to other asset classes are neutral to negative, in our view, canceling the positive effect of falling mortgage rates. This is another area where we prefer to maintain a neutral strategic allocation and allow the managers of this highly diverse, global slice to pick the individual securities they deem most attractive.
References to specific securities are for illustrative purposes only and are not intended as recommendations to purchase or sell securities. Opinions and estimates offered constitute our judgment and, along with other portfolio data, are subject to change without notice.
International investing involves special risks, such as political instability and currency fluctuations. Investing in emerging markets may accentuate these risks.
Investment return and principal value of security investments will fluctuate. The value at the time of redemption may be more or less than the original cost. Past performance is no guarantee of future results.
Historically, small- and/or mid-cap stocks have been more volatile than the stock of larger, more-established companies. Smaller companies may have limited resources, product lines and markets, and their securities may trade less frequently and in more limited volumes than the securities of larger companies.
Diversification does not assure a profit nor does it protect against loss of principal.
Rebalancing allows you to keep your asset allocation in line with your goals. It does not guarantee investment returns and does not eliminate risk.
Generally, as interest rates rise, bond prices fall. The opposite is true when interest rates decline.
Past performance is no guarantee of future results. Investment returns will fluctuate and it is possible to lose money.
The opinions expressed are those of American Century Investments (or the portfolio manager) and are no guarantee of the future performance of any American Century Investments' portfolio. This material has been prepared for educational purposes only. It is not intended to provide, and should not be relied upon for, investment, accounting, legal or tax advice.