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OUR VIEW

A look ahead: First quarter 2025 outlook

10/12/2021

01/14/2025

10/12/2021

A look ahead: First quarter 2025 outlook

Looking ahead, there are good reasons to believe robust growth can continue. Interest rates are likely to fall further, and we are encouraged by rising productivity.

Our base remains that the U.S. economy is sufficiently robust and diversified to withstand political and economic uncertainty. With time and a little help from the U.S. Federal Reserve (Fed) if needed, it can adapt to even dramatic policy changes.

Inflation measures have come down but remain above the Fed’s long-term average target of 2%, and the most recent data suggests the downward trend in inflation could be stalling. Service price inflation, in particular, has been notably sticky.

The bond market’s reaction to higher inflation expectations has been to price in fewer interest rate cuts in the year ahead. While we agree there will likely be less need for lower interest rates, we also believe the Fed would like to return rates to a more “neutral” (neither stimulative nor restrictive) level estimated around 3.5%, as the data allows.

While there are many potential headwinds, we expect 2025 will confirm that the economy had a soft landing in 2024 and should see sustained and possibly accelerating growth in the year ahead. There are risks to this view, foremost of which is the lack of clarity about the incoming administration’s domestic and foreign policies.

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Capital Markets Perspective
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Asset allocation views: Current outlook

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Fixed income vs. equity

As we begin a new year, the market and economic conditions present a generally favorable environment for equities, at least from a longer-term perspective.

The manufacturing sector continues to stagnate, while capacity utilization has persisted in its negative trend. Signals from the housing market also remain mixed. However, we believe the potential for economic expansion exceeds the threats to further growth.

Regarding the immediate prospects for equities, we have a few concerns. The meaningfully different experience of the average stock, and that of the highly concentrated mega cap leadership, leaves the market vulnerable to relatively rapid contractions.

Equities

Equities

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U.S. vs. Int’l.

We remain overweight domestic over international equities.

The S&P 500 Index’s 20% outperformance over MSCI EAFE Index in 2024 was the largest win since 1997 and marked the 12th year of superior performance in the last 15.

Relative valuations in the U.S. continued to rise on account of higher earnings growth and industry composition, supported by a higher degree of innovation and a more favorable business climate.

The Magnificent Seven tech stocks remain crucial drivers of U.S. equity performance, and we remain optimistic about their collective long-term outlook, but acknowledge the potential for some give-back of significant 2024 gains.

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Market cap

Domestically, we are overweight both large- and mid-caps, while being roughly benchmark-neutral in small-caps.

For the eighth calendar year in the last 10, the S&P 500 outperformed mid- and small-caps in 2024, this time by a material 9.5% and 16.5%, respectively. Much, but not all, of the outperformance was driven by mega cap tech.

Small caps were expected to benefit from falling rates, but with rates rising in Q4 and now fewer cuts by the Fed expected in 2025, that is at risk. However, with the potential of lower taxes and lower regulation from the incoming Trump administration, we moved from an underweight to a neutral stance in small-caps.

Fixed income

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Duration

The Federal Reserve continued to lower its target interest rate in Q4 with two 0.25% rate cuts, lowering the upper end of its target band to 4.5%.

We expect the Fed to gradually lower the Fed Funds rate with the pace dependent on incoming economic and inflation data. Short-term Treasury rates should follow Fed Funds lower, while long-term rates face upward pressures from large deficits, heavy issuance of Treasury bonds, solid economic growth, and sticky inflation.

While we expect inflation to continue to moderate over time, the path is likely to be uneven and slow.

Tariffs and an expected push to limit illegal immigration both could create inflationary pressures but also slow growth.

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Credit quality1

Yields remain relatively high, which has attracted both retail and institutional buyers, keeping spreads tight, as any widening has been met with buying.

Looking ahead, we expect increased volatility in spreads with income from coupon payments driving returns outside of interest rate moves.

We expect defaults to remain at relatively moderate levels. However, with spreads historically narrow with limited room to tighten further, the risks are skewed toward episodic volatility and wider spreads should unexpected economic or market developments spark repricing of credit.

Any indexes shown are unmanaged and do not reflect the typical costs of investing. Investors cannot invest directly in an index.

The S&P 500® Index is a market-cap weighted index that represents the average performance of a group of 500 large-capitalization stocks.

MSCI EAFE Index tracks the performance of developed-economy stocks in Europe, Australasia and the Far East.

This article refers to specific securities which Thrivent Mutual Funds may own. A complete listing of the holdings for each of the Thrivent Mutual Funds is available on thriventfunds.com.

1 Credit Quality ratings are determined by credit rating agencies Moody’s Investor Services, Inc. or Standard & Poor’s Financial Services, LLC.

The Senior Investment Team is discussing the asset classes, sectors and portfolios they oversee at a macroeconomic level. The views expressed are as of the date given unless otherwise noted and may change as market or other conditions change, and may differ from views expressed by other Thrivent Asset Management, LLC associates. Actual investment decisions made by Thrivent Asset Management, LLC will not necessarily reflect the views expressed. This information should not be considered investment advice or recommendations of any particular security, strategy or product.

Past performance is not necessarily indicative of future results.

Investing involves risks, including the possible loss of principal.

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