Tim Graf (TG): This is Street Signals, a weekly conversation about markets and macro brought to you by State Street Global Markets, the Markets and Financing Division of State Street. I'm your host, Tim Graf, European Head of Macro Strategy.

Each week, we bring you the latest insights and thought leadership from our award-winning suite of research, as well as the current thinking from our strategists, our traders, our business leaders, and a wide array of external experts in the markets. If you listen to us and like what you're hearing, please do subscribe, leave us a good review, get in touch with us. It all helps us improve what we hope to bring to you.

And with that, here's what's on our minds this week.

TG: It's been a fascinating first month of the year, almost no matter what your view was on stocks and bonds. Broadly speaking, there are probably times where you will have thought, yep, I am nailing this. And then there are other times where the thinking might be more like, oh no, I have got this so wrong. And that might have all happened just this week.

Sticking with a long-term view seems the prudent thing to do for most investors, a thought that gets reinforced in this week's discussion with my friends and colleagues from the research team at State Street Global Advisors, the asset management business of State Street. Every year, the team publishes their global market outlook, and this week's podcast draws heavily from that. But of course, there are more recent developments in the macro and market environment that need attention, particularly the emergence of DeepSeek over the last week and what threats that presents to the US tech sector.

Joining me for what is a wide-ranging discussion are Simona Mocuta, Chief Economist of SSGA.

Simona Mocuta (SM): Always great to be here.

TG: Altaf Kassam, the EMEA Head of Investment Strategy and Research.

Altaf Kassam (AK): Thanks, Tim. Good to be here.

TG: And Jenn Bender, Global Chief Investment Strategist and Head of Investment Strategy and Research.

Jenn Bender (JB): Thanks, Tim, for having us.

TG: Great, guys. Well, it's so good to have you on, but I should say, at first, I appreciate we're probably doing this a little bit later than I would have hoped, and scheduling things got in the way, but better late than never. And we're going to do this podcast in three different stages.

We're going to start with Simona on the economic and fundamental outlook for the global economy. We're then going to go to Altaf for the more market-based outlook and think about some granular views in equities and fixed income. And then, Jenn, you're going to finish things up, bring it all together with some very high level questions on asset allocation.

But Simona, we're going to give you the floor to start with. You are the Chief Economist of State Street Global Advisors (SSGA), and as Chief Economist, I think probably the US economy is chief in those thoughts for you, I would think. You have an outlook for this year of a continuation of the soft landing that has been in place in the US, really for at least two years, maybe more two and a half years now since inflation has peaked.

We're looking at rates potentially being in territory that the Fed would consider restrictive or tight for another year. How concerned are you that that represents too tight a policy for too long for the US economy to bear?

SM: Well, certainly not as concerned as I was a year ago. You know, all of 2024, that was probably the top risk in my mind that we, the Fed would end up being too high for too long. And, you know, that soft landing had a lot of downside risks.

I would say today, I see the risk to the outlook as actually being evenly distributed, right? So for every downside risk, there is a scenario you can construe, legitimate scenario, that would speak to upside risks. So still a soft landing, but with the wider dispersion of risk and not that concern necessarily about, you know, the Fed is no longer the big crux of the matter. You know, the story was very much around Fed policy.

Now, this year in 2025, the story is around all the other policies that I like to call the known unknowns. We know things are happening. We kind of know the direction from which they are coming from. But we still lack the details. And you know, the devil is in the details, certainly. That's where I am.

TG: Of the potential upside risks, actually, that's an interesting way to frame it, because I can come up with any number of downside risks. But I wanted to think about those upside risks a little bit more.

What do you think are the strongest drivers for this pretty robust outlook for the US that you have, that I think the market has kind of come to, that will see a continuation of growth, not just at trend, but maybe above trend for another year? Where does that come from in your mind?

SM: So this idea that you are in a place where household balance sheets, by and large, are strong, the labor market is strong. So there is a resilient beginning. And that sets you up for, you know, you would say at least a trend type of growth. And then you have to ask, you know, what derails the, what shifts it higher, what shifts it lower?

In my mind, you know, there is already some, you know, data releases since the election. If you're looking at the small business sentiment, if you're looking at the Philly Fed survey, that, you know, some of the surveys have been vertical lines higher. And you have to ask yourself, what do they mean? Is this hope? Is it hype? Is it reality? Would this translate into, you know, that, you know, increase in hiring or increase in capex?

That's where, in my mind, the upside risk come from. And then, of course, all of this is related to a large extent, I believe, expectations around policy deregulation, energy. So a little bit here, a little bit there can get you, you know, a little over the 2 percent line, which is exactly where we are right now.

But again, we need to see what we actually get, because on a number of these fronts, you can do policies in the right way, and you can do policies in the wrong way and end up hurting yourself. So I'm very wary of not allowing myself to get too caught into upside optimism.

TG: Well, thinking about maybe the potential for downside risk, and going back really to the first question I asked about the tightness of policy and it potentially extending for another year, I wanted to ask one final question about the US, and it's to do with the Fed trajectory for rates. The market and your view are effectively aligned, small differences between the two, but pretty modest.

But there's this notion that policy might be restrictive, and that is to do with where the Fed sees neutral rates, or what is otherwise known as R-star, the rate that balances the economy. And my question is, we've seen upward revisions to this as this cycle has stretched out and the US recovery has extended and the soft landing continues to be in place. Have we seen the peak of these revisions to R-star, or do you think the Fed will continue to assess that it is higher if the soft landing continues?

SM: Well, actually, it appeared as though the peak of the revisions was behind us and then very, very recently we got another slight uptick higher. I think the bulk of the changes is behind us and I think at the end of the day, of course, you are concerned at the moment around tariff implications for inflation, but at the end of the day, tariffs from an inflation standpoint are a one-time shock. It should not really speak to the neutral rate in a fundamental sense.

What else you do in terms of policy that maybe encourages capex on a sustained basis that may raise new questions that are what the neutral rate is? But I think it's now really at the margin, the changes from here onward.

TG: Well, moving from an economy that seems to have a consensus rosy outlook, or at least a trend growth outlook, I wanted to shift to Europe, where we are a week after the World Economic Forum in Davos. And if there was a consensus view to come out of that, it is that the US is pulling away, Europe needs to catch up. And I don't know if I can find anyone right now who was upbeat about the prospects for the eurozone economy. As a starting point, do you think the consensus is now almost too gloomy for the European economic outlook?

SM: I wish I could say that, but I think there is always room for some disappointment here. And why do I say that? I mean, I love Europe and I'm looking for the upside scenario here. But I have to say, especially in the aftermath of the US election, I would argue the message to the rest of the world is a very strong help yourselves. Help yourselves. And I'm not sure that Europe is ready to do that, right?

I think the moment in time, and especially to me, one of the most depressing charts in all of Macro is the German industrial production. If this is not the moment that calls for bold action, I'm not sure what we are awaiting to see happen. So I think for my part, I'm actually looking at the German elections to see, do we get something a little more dramatic, not just a temporary put aside the death limit, but something more substantive to reignite, regain competitiveness.

I think in a way, it's fair to say Europe has homework. It's the Draghi report. The solution for Europe, especially in 2025, is not coming from the ECB. It has to come from national and supranational policies that speak to improving competitiveness. And the unfortunate reality is, you don't know that you will truly move in that direction in a meaningful way.

TG: You mentioned the German industrial situation and the weakness there, and that clearly has links to China through the export channel. And China is where I wanted to finish your section, Simona. Particularly the evidence you are seeing or hope to see, as far as a reflation or a continued recovery from the post-COVID era in the Chinese economy.

Do you expect to see greater evidence of reflation this year?

Should we expect further news of stimulus to provide that reflation? Or have we seen all the stimulus we're going to see, and we should just hope for the best at this point?

SM: I think there is room for more stimulus, but I think it's going to be in response to US policy change. So sort of await and see what happens and respond accordingly. But at the same time, I would also say that just as the solution for Europe does not lay with the ECB, I think the solution for China from a sustainable macro solution is not in stimulus, right?

I think it's in the re-energizing of the private sector, is the reorientation of demand, and I think unfortunately domestic demand is not strong enough to offset the shortfall in external demand. So I think in a sense it's kind of, your hands are a little bit tied, you know, the trajectory for growth can only be lower, I think.

TG: What sort of things would you look for in terms of spurring that reallocation toward domestic demand? And maybe over what time horizon do you think that needs to take place?

SM: I think if you're looking short-term, it will have to be some form of stimulus generated or induce, you know, positive hit to confidence. But over the medium term, it really, I think, has to speak more to innovation, market forces, productivity gains, with the understanding that one of your two big factors of production, which is labor, is shrinking. There is no turning that around, right?

So in a sense, you need the gains in productivity just to, you know, running to stand still is the same. And I think in a sense, you can apply that to Chinese growth in the next decade.

TG: That's perfect, Simona. Thank you so much for all those thoughts.

Altaf, we're going to turn to you now. You are the head of investment strategy and research for EMEA, and thinking about how asset markets will behave this year, and reading the GMO for 2025. There's a mixed message we have on growth, the US doing probably pretty well, Europe and China maybe not so well. But overall, the outlook you've put out appears to be decent years for both equities and bonds.

I just wanted to ask as a starting point to that.

Which do you think, especially considering valuation, I suppose, in equities? We're going to talk a little bit more about that in a moment as well. But which do you prefer for this year on a risk-adjusted basis?

AK: I still think on a risk-adjusted basis that it's going to be a better year for equities. And you mentioned valuation, and we should go into that. And the classic thing for a strategist to say is that this is now a great year for fixed income because we have this higher level of starting yields.

But it feels like there are still a few too many risks on the fixed income side, whereas if we were to stick with US large cap equities, which I know everyone hates and everyone wants to hear another story, but we still think that they're going to work. Clearly, there's a huge amount of political risk out there.

But right now, given what we know, and all the known unknowns that Simona has talked about, it still feels like we stick with what's winning, and that's US large cap equity. On the fixed income side, there's still quite a lot of uncertainty, and we can talk about how we might finesse the fixed income view. But if you were to ask me straight up, binary choice, equities, fixed income, I would stick with that.

TG: Okay. Well, let's delve deeper then and let's talk about US equities, because this really did stand out from reading the piece. I wanted to ask you really where you see the further returns coming from in US equities. We've of course had significant multiple expansion. There are significant earnings growth from the big market cap weights within the US equity market.

Do you have a sense of what is the source of those returns for what would be a third strong year in a row for US equities?

AK: There's a few graphs of the GMO if you have a chance to read it. One of them that's burned in my brain is that the US has basically just been consistently delivering a higher return on equity than other global equity markets over the last several years. That's what you're paying for. Valuations matter. But frankly, you're buying something that we think has delivered, has definitely delivered in the past and will keep continuing to deliver.

Now, I wouldn't like valuations to go higher. They're already at pretty elevated levels, both relative to their own history and relative to other markets. But frankly, as my children remind me, if just because something's expensive doesn't mean you can't buy it.

We feel like the US equity market is expensive for a reason, just like Europe and China might be cheap for a reason. So when you ask me where the growth is going to come from, we're moving through earning season. Results have been decent. They've been completely overshadowed by the presidential inauguration and all the executive orders. But people have missed, I think, that earning season is actually progressing pretty well.

I don't think we'll see much more in the way of multiple expansion. I think what we're going to see is continued earnings growth, but much more importantly, we're going to see a broadening of the rally from this incredible focus on US large cap tech and into other sectors.

TG: That's perfect. In fact, that was exactly what I wanted to ask next, because whether you want to put it in the guise of thinking about the US equity market in terms of thinking about equally weighted versus market cap weighted indices or small- and mid-caps versus those large caps, particularly the mega cap tech sector.

Where do you see some of the more interesting opportunities coming at a sector level within the US equity market?

AK: Yeah, I think within the US in particular, what feels like a sure hit is moving into financials. We've got a steeper yield curve now. It feels like with all the deregulation, that might be coming down the pipe from the Trump presidency. And frankly, the people that he surrounded himself with in this cabinet, it feels like financials are in a much better place than they were, say, two years ago. So in terms of sectors, we're liking financials a bit more.

Also industrials, I think one topic that is really important is that US large cap tech has benefited in the last few years because everyone has got really excited about AI. And it's been kind of anti-destructive. It's been the big names that have profited more from this theme. What we do think is going to happen now is this theme is going to percolate more into other sectors, smaller companies.

Industrials, we think, will benefit from that because when you think about robotics, it's basically the blend of AI and industrial machinery. And that's exactly kind of where we think the next phase is going to be. And then there's other interesting topics like health care and so on.

TG: Well, we do need to take a little bit of a side trip here, Altaf. We are recording this on Monday, the 27th of January. We are in the midst of a bit of a risk reduction episode, particularly in large cap tech over the weekend. Really the explosion of news about DeepSeek, this China-based large language model that is producing very strong results with, apparently, lower cost of input in terms of the demand for tech needed to produce these results. This is creating all sorts of havoc in asset markets today.

NVIDIA is the big loser so far as it's seen as reducing the potential for future cap ex, i.e. chip demand, for the use of large language models. I wanted to just get a quick thought from you. How does this news, does it influence your views for the sector over the medium and long term? Let's forget about what might be short term position adjustment. Does this represent a long term threat or game changer for that sector?

AK: So I would say not in the long term, but I think it reinforces what I was just talking about, that these gains so far on AI have been limited to a few companies that have been able to shell out hundreds of billions of cap ex and have the entrenched user bases to capitalize on the theme. This is now going to spread, and DeepSeek is a great example of how this can spread with something that's open source, relatively cheap, widely available. And I think that is going to be the trend.

So it might be time to allocate away, which is what we've been saying, from the Mag-7 into other sectors of the economy, but the underlying theme of AI over the medium to long term is actually going to actually, I would say, gain. So change in allocation rather than a reversal of a trend.

TG: Well, let's now spend some time thinking about fixed income markets. You mentioned possibly not seeing them perform as well on a risk-adjusted basis relative to equities. That, I think, is probably, if I'm putting words in your mouth, maybe still more of a positive equity story rather than, say, a negative fixed income story.

Because I think the outlook I took from the piece was that it will be a different, or a better year for fixed income. And you mentioned we've reset to higher yield levels. But I was curious, thinking about this more tactically, we still have concerns over deficits and large debt burdens that are potentially going to grow even further in the coming year. We haven't really talked about inflation that much, but we're not quite back to target inflation in a lot of the major economies yet.

Do you see this maybe better view for fixed income this year as a right now opportunity, or is it something that you still want to wait for maybe better levels before you start to allocate there?

AK: That's the big question, is how much more could yields back up? And I think if we look at our kind of base case for the US economy, which is a soft landing, then I think I'm more comfortable taking risk at the short end. So I'd rather be in the twos than the tens, should we say. And I think, unless something drastic happens, and the market is starting to put a small price, a non-zero price at least, on a rate hike from the Fed. But frankly, that feels like it's a long way away.

So I feel like taking some risk in the US at the short end makes sense. Rather, though, I would think about looking outside of the US, and I think European government bonds look like a lot more attractive if you want to take a duration view. And people have talked about the UK. I think the UK unfortunately suffers from this massive credibility loss that happened with the Truss mini-budget debacle. And it's going to take a long time for the market to get over their PTSD after that event. And so I don't think people are going to trust UK yields in the near term.

So we'd rather say take risk at the short end in the US duration in Europe for now. Maybe look at emerging market debt, a hard currency, you know, peg to the dollar, because that should also benefit from the Fed's easing cycle, which is what we see. And then wait for better entry for the US duration.

TG: Thinking about it, we started the conversation with a thought on valuation. And that's where I wanted to finish with.

Out of all of these markets we've covered, and we've covered quite a lot in a short span of time, which one do you think faces the most realistic challenge from valuations being elevated this year?

AK: I mean, it still has to be the US large cap. I just think in the balance of risk, we're still going to see that US large cap that meant to carry us forward. It should spread, but still, I'm talking about spreading within like the S&P 500, maybe into mid and small caps, but we're not talking about it going away completely from the larger names, just spreading out.

TG: Yeah. Okay, well, thanks so much, Altaf.

Jenn, we're going to finish with you, and we've kind of zoomed in a little bit, and now I want to zoom back out. And you sit at the top of the investment strategy process as the global chief investment strategist, the head of investment strategy and research for SSGA.

And I wanted to start very, very big picture with you about your approach to asset allocation. How do you think about it? How do you go about it at SSGA, particularly from the strategy perspective?

JB: So, I mean, the most important thing we don't do is we have, we don't have a one size fits all approach. So investors really have different return goals, risk appetites, cash flow needs, etc. And even within the institutional space, there's a wide range of what types of investment goals our clients have. So when you start thinking about solving a specific investor's needs, you start to move away from traditional portfolios, whether they be 60-40, the endowment model, and you start crafting solutions.

And these days, we have so many building blocks to choose from, to craft solutions. So we have private assets, including private equity and private credit. Real assets, including gold, infrastructure, real estate, crypto, and digital assets. There's hedge fund strategies and other alternative strategies, some using option overlays, some using leverage.

As a practical example, you can take a look at our model portfolio range. We have eight off-the-shelf models right now, everything from sort of a short-term tactical global portfolio to an income-focused one to a tax-sufficient one. And we even have a real return multi-asset portfolio which uses only ETFs. So it speaks to an evolution in what we think of as active management.

When I was first entering this industry three decades ago, the most glamorous job you could get was to be a stock picker. And active management was very much about beating the S&P. But these days, the opportunity set for generating alpha has expanded sort of well beyond publicly traded equities. And it's really multi-asset managers that have the most interesting jobs.

You know, in this new world, we can sort of think of asset classes as building blocks. I like to think of them as LEGOs, right? So as allocators, you want these LEGOs, these bricks to be efficient. You want them to be reasonably priced in terms of fees. You want them to have reliable, consistent exposure to that source of return you're looking for. And it's just so much more possible these days with our huge advances in technology. It's made everything easier to trade, to settle, even to digitize going forward.

TG: There are aspects to what you just said that I want to talk about almost all of them. But I want to start with some of the asset classes you mentioned that are the sort of non-traditional ones. And I wanted to see if you could draw on your discussions that you're having with asset owners and allocators in thinking about their current interest level in sizing allocations to, I want to start with private markets actually, because this is something we've talked a lot about on the podcast with other guests.

I'm starting to get the sense that there's some skepticism building, particularly around private debt.

    And I wanted to see if you could talk about the current themes and experiences you have with your clients and what they're thinking in these private markets, both equity and debt.

JB: Yeah, I mean, it's safe to say that this has been, this has exploded in sort of our news media attention and within the financial services industry over the last few years. And I think it's important to point out that part of this is just sort of the higher levels of movement between stocks and bonds in recent years, and also the feeling that ordinary investors can't eke out quite the same premia that they've gotten from stocks and bonds and need to look elsewhere. And also, investors are worried about the extreme concentration in US large caps.

So it means going beyond our standard asset classes. With respect to private assets, particularly private equity and private credit, they have the promise. And we've seen mixed performance with respect to private equity and some pretty strong performance recently with respect to private credit. So there's obviously the promise of higher returns, lower volatility, and then there's diversification.

And there's this intuition that because information on private market investments isn't as widely available as in public markets, that there's more potential for market inefficiencies that you can capture. But there's sort of two points that we talk about with our clients.

And these are very important points, which is first, private equity and private credit do have commonalities with their public market counterparts. So private equity, for instance, has a market beta of around 0.9 when you control for the smooth nature of their returns. And similarly, private credit, though we don't quite have a robust estimate yet, has a pretty high correlation with high yield corporate bonds. So when you're allocating to these seemingly new assets, it's important to understand that there are commonalities with the things that are already in the portfolio.

And then the second point I want to highlight with respect to private equity, private credit and other alternatives is if you look at what we call the global market portfolio, and that's the universe of investible assets weighted by their available market cap, they're very small, right? So equities is still the bulk of the opportunities set at 45 percent of this total investible universe. And government bonds takes up a pretty good chunk of the next size of 21 percent. So all of the alts categories are tiny comparatively. So private equity is around 5 percent, real estate itself is around 4 percent, gold is around 3 percent.

So we kind of have to ask ourselves, if we all decide we want to be invested in these asset classes, how much can we really allocate to them?

TG: The one that then comes to mind, given the new cycle and the new administration and what will supposedly be a more friendly environment for it will be crypto assets, digital assets. I spoke about this with Ron O’Hanley, our CEO a couple of weeks ago, and he's very clear to make distinctions between digital assets and crypto, particularly cryptocurrency. I wanted to see what your thoughts are on this in terms of whether this will be a meaningful allocation beyond, say, sort of token half percent, one percent in asset owner portfolios over the coming, say, five to ten years.

JB: Okay, so I'll start by saying that, you know, at SSGA, we're great believers in blockchain technology and the potential for it to transform access to assets just across the board. So when it comes to crypto, though, in its current state, we believe to solely incorporate direct crypto exposure still adds more volatility than what it might be worth. We recommend a risk-adjusted approach to capturing that beta exposure to crypto via equity allocations with overweight or concentrations to the companies that are involved or aligned with digital assets. Now, this is in the short term.

You know, we're going to be keeping an eye out on how crypto as an industry, and particularly the regulations around it, involves. But even apart from crypto, I mean, we think it's early days yet, with a lot of promise for what we call asset tokenization. So tokenization is basically just taking financial instruments as they are today and making them digitally native, right? So where the digital token becomes the instrument with all the legal and financial implications.

One thing like our digital assets experts like to say is, like, imagine being able to pay for your morning coffee directly using funds from your investment account, right? Just like tap your phone and there you go. So, you know, we've been so caught up in these singular instances of digital assets such as crypto and NFTs. But if you think about the power of the technology to change the access that we all have to the asset classes that are out there today, I mean, everything from private equity, private capital, venture capital funds, it's actually kind of mind blowing.

So, you hear about the term the democratization of investing. I mean, ETFs were the first wave. They opened up such a broad range of investment styles, strategies, asset classes to ordinary investors. And we think that tokenization is going to be the next wave.

TG: Thinking about all of these asset classes and the mix of them within the portfolio and the construction process that you talked about at the very beginning of your section, I wanted to finish with your outlook on asset market volatility and particularly how tactical do you think these asset owners and allocators need to be this year?

JB: So we're pretty much aligned with the rest of the street that volatility in general is likely to be higher this year. This isn't as problematic if you are a truly long term set it and forget it investor. It's really only a problem if you're an active investor with a very short time horizon. And if that's the case, then volatility just increases the difficulty of success.

And I want to say like in an almost unintuitive way, we would argue that the more volatile markets are, the riskier it is to be very tactical, right? So if you miss selling at the peak, that incurs much greater losses. And if you miss buying at the trough, it means it's harder to keep up with just a buy and hold position.

So I would challenge our listeners, so taking a step back, right? This might actually be a good time for many investors, both individual and institutional to ask themselves, well, what really is my investment horizon? If I can be patient and afford short-term losses, then maybe this is not a great time to be taking short-term bets and to not be tactical.

I just want to leave you with that.

TG: Very good. I think it's the perfect note to finish on, Jenn. There's so much to think about more generally. And again, if you haven't already, please check out the 2025 Global Market Outlook from State Street Global Advisors. I think it's public and free to anyone who wants to have a look on their website.

And just as a final note, thank you so much to the panelists who joined me today, Simona Mocuta, Altaf Kassam and Jenn Bender.

Really appreciate it, guys. Thank you so much.

Thanks for listening to this week's edition of Street Signals from the research team at State Street Global Markets. This podcast and all of our research can be found at our web portal Insights. There you'll be able to find all of our latest thinking on macroeconomics and markets, where we leverage our deep experience in research on investor behavior, inflation, risk, and media sentiment. All of which goes into building an award-winning strategy product.

If you're a client of State Street, hit us up there at globalmarkets.statestreet.com. Again, if you like what you've heard, subscribe and leave a review. We'll see you next time.