2025 enforces tactical shift towards themes over asset classes

The investment landscape has seen a tactical shift towards thematic investing due to the rise of artificial intelligence (AI) and well-positioned “mega forces” such as the Magnificent Seven, according to the BlackRock Investment Institute.

The institute’s latest commentary said these “mega forces” have driven recent bouts of economic transformation and thus have called for re-evaluating investment strategies, given that the Magnificent Seven now make up close to one-third of the S&P 500’s market capitalisation.

“We think investors should no longer think in terms of business cycles, with short-term fluctuations in activity leading to expansion or recession. Instead, mega forces are driving an economic transformation that could keep shifting the long-term trend, making a wide range of very different outcomes possible – on the upside and downside,” the institute said in its report.

“Building the transformation – such as with AI data centres – requires a major infrastructure buildout. Financing the transformation given constrained public finances means that capital markets, including private markets, will be key.

“We follow that playbook as we stay pro-risk headed into 2025. We increase our overweight to U.S. stocks as we expect AI beneficiaries to broaden out beyond tech. We’re also confident U.S. equities can keep outpacing global peers given the ability to better capitalise on mega forces, a favourable growth outlook, potential tax cuts and regulatory easing. Signposts for changing our view include any surge in long-term bond yields or an escalation in trade protectionism.

“Pricey U.S. equity valuations, based on price-to-earnings ratios and equity risk premiums, don’t yet change our view. Why? We find valuations affect near-term returns less than long-term returns. The equity risk premium – a common valuation gauge – for the equal-weighted S&P 500 is near its long-term average, according to LSEG data, and thus looks less affected by the transformation.”

The institute also encouraged investors to leverage opportunities found among those expected to spearhead transformation across various areas.

“AI and the low-carbon transition require investment potentially on par with the Industrial Revolution,” the commentary stated.

“Major tech companies are starting to rival the U.S. government on research and development spending. Plus, meeting growing energy demand will generate US$3.5 trillion of investment per year this decade, according to the BlackRock Investment Institute Transition
Scenario.

“We see private markets playing a vital role in financing the future. Big spending on AI and the low-carbon transition plus rising geopolitical fragmentation is likely to cause persistent U.S. inflation pressures. And an aging workforce could start to bite as immigration slows, likely keeping wage growth too high for inflation to return to the Fed’s 2% target.

“We think that means the Fed will keep rates well above pre-pandemic levels even after cutting some in 2025.”

The institute’s latest commentary also identified five main “mega forces” it believed would contribute greatly to the “new regime of greater macroeconomic and market volatility”, the “long-term growth and inflation outlook”, and the “big shifts in profitability across economies and sectors”.

These included:

• Demographic divergence: The world is split between aging advanced economies and younger emerging markets – with different implications.
• Digital disruption and artificial intelligence (AI): Technologies are transforming how we live and work.
• Geopolitical fragmentation and economic competition: Globalization is being rewired as the world splits into competing blocs.
• Future of finance: A fast-evolving financial architecture is changing how households and companies use cash, borrow, transact and seek returns.
• Transition to a low-carbon economy: The transition is set to spur a massive capital reallocation as energy systems are rewired