SEI Forward

Hi, I'm Jim Smigiel, SEI's chief investment officer, here with this quarter's installment of "SEI Forward," where I'll be covering the road ahead for 2025. This time last year, we expressed our contrarian view that stubborn inflation would persist and that long-term interest rates were more likely to increase rather than follow central bank policy rates lower. This year, we find ourselves in consensus with market expectations, at least in part. While many strategists are predicting another strong year for performance, our view is slightly more nuanced. 

We're broadly positive on both equities and credit, but we are also keenly aware of potential challenges to come. We believe, given the relatively robust state of the global economy, particularly here in the U.S., that the combination of global stimulus measures, the high likelihood of less regulation, and the prospect of lower corporate taxes will be enough to keep the rally going well into the new year. However, it will require a delicate balancing act. Investors will need to weigh pros and cons on several fronts, including higher earnings from less regulation versus higher inflation from potential tariffs, lower corporate taxes boosting profits versus immigration policies that result in labor shortages and higher labor costs, easy monetary and fiscal policies boosting risk assets in underperforming economies particularly versus stimulus measures leading to higher interest rates in outperforming countries, austerity efforts leading to meaningful long-term reform versus tax cuts and inertia failing to address rising government debt, policy changes easing pressures on commodity prices versus escalating global conflicts and trade wars keeping prices and volatility high, and finally, a broadening earnings picture supporting higher equity valuations in the U.S. versus lofty expectations setting the bar just too high for multiples to expand much further. 

Our caution arises from what we see as too many potential outcomes leading to a reacceleration in inflation and higher long-term interest rates. The bond market seems to share our concern. Long-term U.S. yields have risen roughly 90 basis points since the Federal Reserve pivoted to lower interest rates after a surprising 50-basis-point cut in September. Equity markets began to pay attention into year end as yields rebounded from a post-election rally. In short, we think inflationary pressures and higher interest rates can potentially spoil this party. The yield on the 10-year U.S. Treasury note is our guide for '25. We will get concerned about equity markets once the yield reaches 5%, as tighter financial conditions may begin to weigh on growth. Within equities, we continue to expect a broadening of participation. 

Earnings have surprised to the upside and have shown strength outside of just big tech, while lower taxes and less regulation should provide a bigger boost to smaller and mid-sized companies. In addition, markets outside of the U.S. appear undervalued, as both earnings expectations and valuation multiples have room to grow. We expect additional stimulus from the European Central Bank given the weakness in the core of Europe and further efforts from China to find that right mix of fiscal and monetary stimulus. Not surprisingly, we maintain our strategic recommendations for investors to stay diversified globally and focus on profitable companies with strong earnings momentum trading at reasonable prices. Given our views on the likelihood of higher interest rates and heightened volatility, within equity markets, we continue to lean into value and active management, favoring sectors such as financials, industrials, and staples. 

Within fixed-income markets, we remain cautious on interest rates and somewhat sanguine on credit. We're paying particular attention to inflation. We believe the Federal Reserve is still biased towards lower rates despite core consumer prices remaining above 3%. While inflation did move lower in 2024, it has started to rise. We suspect that tariffs and immigration reforms may add fuel to this inflation fire. 

Given our outlook for higher long-term interest rates again, we see headwinds for fixed-income returns, but on a more positive note, while credit spreads have limited room to tighten, absolute yields do remain attractive, defaults do remain low, and maturities have been extended. This suggests that carry strategies such as high-yield bonds and collateralized loan obligations, or CLOs, should perform well. As we begin 2025 with a mixture of hope and caution, we thank you for your trust and confidence and wish you a prosperous and happy new year.