Franklin Templeton’s 2025 Outlooks for Equities and Fixed Income Sectors

SAN MATEO, CA, December 5, 2024 – Five of Franklin Templeton’s specialist investment managers provide their annual outlooks for the global economy and key asset classes, including global equities; global fixed income; global infrastructure; the macro fixed income environment; municipal bond market; high yield bond market; small cap equities; U.S. dollar; U.S. economy; and U.S. equities.

Their outlooks include the following insights:

Brandywine Global says fixed income investors will face elevated macroeconomic uncertainty in 2025 due to possible policy shifts under the Trump administration. Nevertheless, after 15 years of low to negative returns from sovereign bonds, allocators are now favoring high yield credit over sovereigns. When it comes to currencies, the theme for 2025 is the “reflation force.”

ClearBridge Investments says the pace of expansion is likely to stay buoyant in 2025 as the U.S. economy rides the tailwinds of both a fiscal impulse, courtesy of Donald Trump’s election win and a Republican sweep of Congress, and a monetary impulse from the Federal Reserve’s pivot to a rate-cutting cycle. In terms of U.S. equities, although near-term ebullient sentiment could create some volatility, the markets’ long-term outlook remains healthy. Global infrastructure is a particularly bright spot since it has historically outperformed global equities as rate hikes end. Moreover, infrastructure’s inflation pass-through mechanism will likely be more valuable in 2025.

Martin Currie sees opportunities from the global equities that are being driven by three thematic trends – the energy transition, ageing populations and, most importantly, artificial intelligence (AI), which continues to bring about seismic shifts. On the emerging market side, it believes the long-term investment outlook remains robust due to a powerful synergy of technology adoption, urbanization and services sector growth prevalent in these regions.

While history seldom repeats itself, Royce Investment Partners comments on the persistence of small cap equities’ advantage over large cap following both rate cuts and elections.

Western Asset says the U.S. economy remains resilient and only a moderate slowdown is anticipated. Following a record supply year that buoyed municipal yields and tax-exempt income opportunities, it expects 2025 issuance to remain robust to fund new infrastructure initiatives.

Emerging market equities by Paul Desoisa, Portfolio Manager, Martin Currie

Despite significant variation in individual performance, share prices of emerging market (EM) equities have responded logically to considerable changes in investment conditions, both nationally and sectorally. We firmly believe that the long-term investment outlook for emerging markets remains robust.

The market persistently undervalues high-quality, sustainable growth EM companies. We are excited by the powerful synergy of the technology adoption, urbanization and services sector growth prevalent in EM. In the current market, strong sustainability characteristics are vital to obtaining long-term value creation.

Strong economic growth, an improving inflationary environment and easing interest rates should be supportive of EM equities in 2025. We think markets will refocus on company fundamentals. The key building blocks for growth are those operating in the following areas:

Information technology: EM companies are at the heart of AI innovation.
India: We expect a return to fundamentals.
China: We expect to see policy support and valuation opportunities.

Global equities by Zehrid Osmani, Portfolio Manager, Martin Currie

Both tax cuts and trade tensions could fuel a more inflationary trend which could impact – or slow down – the U.S. Federal Reserve’s rate cutting runway. China’s government has recently taken some effective policy initiatives to boost growth and the economy seems to be showing early signs of benefits from that; we hope this continues. And, of course, China’s relationship with the U.S. and President-elect Donald Trump is critical. The potential risk of introducing tariffs and the impact on global trade will be critically important for markets in the year ahead. Investors will need to keep a close eye on both the Trump administration’s policy actions and on any further Chinese policy actions.

Out of our three thematic trends (which also includes the energy transition and ageing populations), artificial intelligence (AI) continues to bring a seismic shift to the disruption rate faced by companies throughout the world. At the same time, AI is likely to lead to a significant acceleration in innovation potential and breakthroughs across many fields of the economy. We continue to see more support for companies that can monetize the significant investment cycle brought by this AI revolution. In our view, we favor the enablers of AI to generate long-term growth, specifically those involved in the design and production of semiconductors, not to mention the cloud hyperscalers.

For long-term investors, this opens up good areas of opportunities. But it also highlights the need to be vigilant in terms of disruption risk on established business models, and to ensure disruption risk is assessed in a detailed and structured analytical approach. Equally, at times like this, a strict valuation discipline is vital to see through the froth that is appearing in some areas of the market.

Global fixed income by Michael Buchanan, Chief Investment Officer, Western Asset

As we approach 2025, Western Asset’s base case investment thesis appears to be coming to fruition: the U.S. economy remains resilient and only a moderate slow-down is anticipated without a recession, aligning with the global disinflation trend. However, a unified government under Trump could drive higher bond issuance and might put upward pressure on bond yields.

In 2025, we anticipate developed market central banks will reduce rates further due to diminishing inflation concerns. The U.S. Federal Reserve (Fed), European Central Bank and Bank of England are expected to continue easing, while Japan may tighten further. However, potential inflation from new Trump policies could lead the Fed to pause or move at a slower pace.

Europe may see lackluster growth and fiscal retrenchment in 2025. China's recent stimulus could temper cyclical headwinds, but structural issues in the property sector and local government debt persist. In emerging markets (EM), opportunities are selective; India and Brazil are demonstrating strong fundamentals, though political risks may still affect performance.

We expect fixed income to perform positively in 2025, and see opportunities across various sectors, including top-quality global banks, select EM sovereign debt and agency mortgage-backed securities (MBS) as well as opportunities in commercial mortgage-backed securities (CMBS). In addition, fundamentals in corporate credit should remain supportive and allow for reasonably stable spreads.

Global infrastructure by Nick Langley, Shane Hurst and Charles Hamieh, Portfolio Managers, ClearBridge Investments

With 2024 returns dominated by the Magnificent Seven, and more recently cyclical stocks surrounding the U.S. presidential election, infrastructure’s differentiated returns offer some diversification away from the risks of concentrated trades. And with Trump’s policies potentially leading to a second round of inflation, infrastructure’s inflation pass-through mechanism will likely be more valuable in 2025.

Infrastructure has historically outperformed global equities as rate hikes end. With global central banks easing policy, breadth has improved with the market beginning to recognize infrastructure’s strong fundamentals and secular themes. These include decarbonization, growing power demand from artificial intelligence (AI) and data growth, and significant network investments to replace aging assets, improve resiliency and meet the needs of realigning supply chains and onshoring trends.

We think the earnings stability of utilities will be sought after in a more unpredictable and volatile market going forward. Add structural tailwinds from AI, decarbonization and network investment, and utility asset bases and earnings are set to grow at some of the fastest levels we have seen in many years. User-pays infrastructure assets are more tied to gross domestic product (GDP) growth, which is projected to rise slightly to 3.2% in 2025, per the International Monetary Fund (IMF). This bodes well for economically sensitive assets such as toll roads, airports and ports.

High yield by Bill Zox, Portfolio Manager; Brandywine Global

After a difficult first half in 2022, high yield has generated double-digit annualized returns for almost two-and-a-half years. The high yield spread was above historical averages during the last half of 2022 and much of 2023. In 2024, the spread has been well below historical averages, even approaching historical lows, but the high yield market has continued to perform well.

While the tight credit spread is a risk that must be managed, the yield at 7.3% and dollar price below 96 cents continue to be attractive. And the fundamentals are strong with a default rate that has been in steady decline down to 1.3%, compared to a long-term average above 3.6%.

However, the most important positive factor is the sea change in demand for the asset class. Traditionally, sovereign bonds were the core while credit was the periphery of the fixed income universe. After 15 years of low to negative returns from sovereign bonds, a fair amount of volatility and a large drawdown in 2021 to 2022 that has not yet been recovered, allocators are now favoring credit over sovereign bonds.

High yield inflows in 2024, even with low credit spreads, are comparable to 2020 when credit spreads were well above average for much of the year. That suggests these allocations are strategic rather than tactical. Credit is now the core and sovereign bonds have moved to the periphery, a shift we expect to support high yield in 2025.

Macro fixed income by Paul Mielczarski, Head of Global Macro Strategy, Brandywine Global

In 2025, fixed income investors will face elevated macroeconomic uncertainty. Possible policy shifts under the Trump administration are expected to heavily influence bond market performance. The global growth and inflation mix in 2025 and beyond can be significantly affected by the timing and degree of changes in U.S. trade, immigration and fiscal policies.

The U.S. economy could benefit in the short term from the removal of election uncertainty and the reduction of regulatory burdens for certain industries. However, a combination of high tariffs and restrictive immigration policies would be a significant headwind to growth. Additionally, we are skeptical that the Trump administration will deliver a large net fiscal stimulus.

While G10 central banks are likely to cut policy rates gradually next year given elevated macroeconomic uncertainty, we expect both the Fed and Bank of England to reduce rates more than markets currently anticipate.

We find the U.S. and U.K. bond markets relatively attractive after the sharp sell-off in the past two months. This is especially true given the historically high valuations of U.S. equities. Ultimately, we see more downside risks to global growth from Trump’s policy priorities with smaller upside risks to global inflation.

Municipal bonds by Rob Amodeo, Head of Municipals, Western Asset

Western Asset anticipates positive fixed income tailwinds of declining inflation and slower U.S. economic growth will drive favorable outcomes for the municipal market in 2025. Generationally high tax-exempt income levels, robust supply conditions and resilient fundamentals have improved the long-term value proposition of the municipal asset class and provided an attractive entry point for taxable investors as the Federal Reserve embarks on a rate-cutting cycle.

Following a record supply year that buoyed municipal yields and tax-exempt income opportunities, we expect 2025 issuance to remain robust to fund new infrastructure initiatives. Meanwhile, improved demand levels should absorb this supply. As the Fed eases front-end rates, we anticipate investors will shift from cash allocations in favor of higher after-tax income opportunities offered by the muni market. The new administration will likely extend the individual income tax provisions of the Tax Cuts and Jobs Act, but we expect marginal tax rates to remain at or near current levels and do not expect municipal relative valuations or demand to diminish.

Favorable municipal credit fundamentals will likely remain supported by strong labor and real estate markets that drive tax collections. While we expect much of the upgrade activity following pandemic era credit drawdowns is behind us, we anticipate diligent credit selection across investment grade and high yield municipals segments will contribute to favorable after-tax outcomes.

Small cap equity by Francis Gannon, Co-Chief Investment Officer, Royce Investment Partners

Our outlook for small-cap stocks is constructive and is rooted in a few key developments that took place near the end of 2024. First, we note that small cap stocks have a robust and remarkably consistent record following elections: the asset class has experienced strong returns regardless of which party or policy goals were ascendant. This tells us that small cap’s post-election strength has been driven more by psychology than ideology. Once elections are decided, investors feel as though they can see a more certain course ahead than was the case before ballots were cast.

The second is the even longer-term trend of small cap stocks beating their large cap siblings following interest rate reductions. We went back to November 1957 (federal funds rate data goes back to July 1954, with the first cut in 1957), and our research shows that small caps beat large caps in the 3-, 6- and 12-month periods following fed rate reductions, averaging double-digit returns in each period.

There are concerns, of course. The most important centers on tariffs, which have historically been inflationary, tamping down demand. The timing and reach of tariffs are developments we’ll be watching closely—and the management teams of many holdings have been surveying as best they can the possibility of an altered global trading landscape.

However obvious, it’s also worth pointing out that history seldom repeats itself. Yet we find the persistence of the small cap advantage over large cap following both rate cuts and elections quite striking. So, while recent events in politics, the economy, monetary policy and the markets offer timeless lessons in the importance of patience and caution, we are hopeful that small cap investors will find plenty to cheer about in the years ahead.

U.S. dollar by Jack McIntyre, Portfolio Manager, Brandywine Global

Markets are still actively digesting the impact of the new Trump administration and mini-red wave it rode into power in the U.S. In currency markets, the U.S. dollar started this process in mid-September by beginning to discount a Trump win and his proposed tariff regime. A sizable portion of that regime has been priced into currency markets.

What has not been priced – and will be the theme for 2025 in currency markets – is the “reflation force.” This theme involves pro-growth economic policies, led by global monetary policy, turning less hawkish via more rate cuts as well as China doing “whatever it takes” to boost its economy. With both massive fiscal and monetary policies, it is a process that will carry deep into 2025. And unlike prior stimulative episodes, this one in China will have legs.

Furthermore, it will have two distinct negative impacts on the dollar. First, the global economy will benefit. Second, relative economic growth will shift in favor of the rest of the world and away from the U.S., even with the Trump administration’s new policies, which likely won’t have an impact until 2026.

For a 2025 road map, investors should look back to 2017. It was an extraordinarily strong and balanced global growth environment with most countries participating. China’s stimulus in 2015 and 2016 caught traction in 2017. And it took a year to fully feel the impact of the first Trump administration’s tariffs and tax cuts. Sound familiar? No one is talking about it yet, but an underperforming dollar may be the surprise for 2025.

U.S. equities by Scott Glasser, Chief Investment Officer, ClearBridge Investments

The S&P 500’s advance of 28% year to date (through November) is the second strongest 11-month start to a calendar year since 1997 and one of the best of all time. With a trailing 12-month return of 34% – the 95th percentile of one-year rolling returns since 1989 – it’s hard to describe this run as anything but spectacular.

With Donald Trump expected to bring a potentially lower tax and lighter regulatory touch to his presidential second term, the market expects a rise in productivity and unleashing of capital investment over the next several years. In our view, the initial impacts of Trump’s victory are likely to be directionally consistent with 2016, favoring value, small capitalization and cyclical stocks, albeit to a lesser degree given a more mature economic backdrop and current lofty valuations.

Nonetheless, liquidity – the primary driver of bull and bear markets, in our opinion – continues to be plentiful with credit spreads near all-time lows, capital markets funding wide open (corporate high yield issuance is +44% year to date through October) and the yield curve positively sloped for the first time in two years. Therefore, although near-term ebullient sentiment could create some volatility, the markets’ long-term outlook remains healthy.

U.S. economic outlook by Jeff Schulze, Head of Economic and Market Strategy, ClearBridge Investments

The pace of expansion is likely to stay buoyant in 2025 as the economy rides the tailwinds of both a fiscal impulse, courtesy of Donald Trump’s election win and a Republican sweep of Congress, and a monetary impulse from the Federal Reserve’s pivot to a rate-cutting cycle.

Over the past several years, the U.S. economy’s resilience has distinguished it from other developed economies. A key question for investors is whether this trend can continue, as stronger economic gains have translated into healthy corporate profits and outsize stock market gains. Our starting point for such analysis continues to be the ClearBridge Recession Risk Dashboard. Encouragingly, the dashboard’s overall signal is currently in green/expansionary territory, and it has been consistently improving over the course of 2024.

We believe there have been four key components of exceptional relative U.S. economic growth over the past few years: the strength of the U.S. consumer, productivity gains, growing labor supply and a solid fiscal impulse. Looking ahead, three of these are likely to remain intact in 2025, while the fourth — growing labor supply — should be less of a benefit, but not so much less that it could derail the U.S. economy.

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