THE PAST YEAR BROUGHT much for investors to like. Inflation — and interest rates — fell, corporate earnings remained high, the three major stock indexes broke records, and despite volatility along the way, the stock market moved toward its second consecutive year of double-digit returns.

Amid that surge came a national election that brought GOP control to Washington, and along with it an expected shift in a number of policies that could affect the economy and the markets. “The new administration is looking to achieve a higher level of growth,” says Chris Hyzy, Chief Investment Officer for Merrill and Bank of America Private Bank. “If successful, we could see a job market that stays healthy, stable consumer spending and corporate profits that have the potential to be higher than expected.” But there are larger forces at play as well.

Looking ahead

 “Taking a longer view, we expect 2025 to be a launchpad for an expanding era of innovation that is likely to affect every corner of the market and the economy,” says Hyzy, who believes 2025 could bring continued strong corporate profits, broader participation in equity market gains, a normalization of bond markets and disruptive innovation that brings measurable productivity gains. 

There are risks that could upend those expectations, however. Depending on the targets and levels of new tariffs that have been proposed by the incoming administration, inflation might tick higher again; global tensions and a growing government deficit could also cloud the outlook. Below, Hyzy and members of the Chief Investment Office (CIO) team discuss what they think will be the key drivers of — and risks to — growth in 2025 and share ideas to help you navigate both.

For more on the CIO’s outlook for the year ahead, read the December Viewpoint, “2025 year ahead: The advancement of the asset-light era” And be sure to tune in to the 2025 Year-Ahead Outlook webcast, “Get ready for what’s next.”

How to prepare for the opportunities — and risks — ahead

Diversify, diversify, diversify. Hyzy’s view of 2025 as a launchpad foresees a continuing shift toward an “asset-light” economy in which companies in technology, healthcare and other sectors are less burdened by heavy infrastructure and more focused on intellectual property, leading to a nimbler workforce and greater flexibility to respond to opportunities and risks.

The small number of large technology stocks that have dominated returns for the overall equity market during the past two years epitomizes what asset-light companies can achieve, says Marci McGregor, head of Portfolio Strategy for the Chief Investment Office, Merrill and Bank of America Private Bank. Now, however, their dominant performance has begun to be shared by the broader market, with the "S&P 493" — the S&P 500 minus those seven high-flying stocks — posting positive earnings growth, and McGregor expects 2025 to continue the trend toward broader participation by a range of stocks. "It will be difficult to match the performance of the recent past, and equity returns are likely to be roughly in line with the rise in corporate profits," she says. “Still, with earnings growth that may be in the low double digits, equity investors should find opportunities across many market categories.”

Things to consider: Being well-diversified could include an allocation to large-cap financial stocks, which may benefit from a rising demand for lending as manufacturing and other industries increasingly return to the U.S., according to McGregor.

As interest rates come down, small-cap stocks could also be helped by a lower cost of capital and attractive valuations. Lower interest rates and the regulatory relief promised by the incoming administration may also lead to an increase in mergers and acquisition (M&A) activity, which has been largely dormant for several years. "Pent-up demand for M&A could help small- and mid-cap stocks," McGregor says.

Get ready for a return to a more traditional bond market. Even as inflation came down and the Federal Reserve pivoted to cutting interest rates, bond yields in 2024 followed an uncertain path. During the year, the yield on the 10-year Treasury rose, fell and rose again, while yields on the shortest-term Treasurys sometimes were higher than those on 30-year government bonds.

That situation, known as an inverted yield curve, is likely to change in the coming year, providing a return to a more traditional bond market, such as that of the 1990s, says Matthew Diczok, head of Fixed Income Strategy for the Chief Investment Office, Merrill and Bank of America Private Bank. “We should see a bond market that rewards investors with higher interest rates when they buy longer-term bonds and that lets fixed income do what it’s supposed to — provide reliable income to investors,” he adds.

Things to consider: The Federal Reserve would like short-term interest rates to drop to a neutral range of around 2.5% to 3%, according to Diczok. “The question is how quickly we can get there,” he says. And while he expects longer-term rates to be higher than short-term rates, those longer-term yields could also rise because of fears that inflation may return, causing economic growth to falter. In this environment, active management of bond portfolios makes sense, notes Diczok, and investors may want to consider laddering. With a bond ladder, investors hold bonds with a range of maturity dates. As one bond matures, the proceeds can be reinvested at then-prevailing interest rates.

Keep an eye on inflation and interest rates. “The mostly positive outlook for stocks and bonds could face risks if, as some believe, high tariffs and broad tax cuts lead to higher inflation and drive the Federal Reserve to stop cutting rates,” Hyzy says. Many provisions of the 2017 Tax Cuts and Jobs Act, which reduced tax rates for individuals and corporations, are set to expire at the end of 2025, and extending some or all of that law’s provisions is a top priority for the president-elect and the Republican majority in Congress. That extension, however, would come with a $4 trillion price tag and raise the federal budget deficit to levels that could unsettle some investors. 

Things to consider: The size of the national debt matters less in absolute terms than how it compares to the rate of economic growth, and one way to reduce the debt-to-GDP ratio is to increase the pace of the economy’s growth. “In previous periods when the debt burden for the government was problematic, economic growth accelerated faster than the rise in debt levels,” Hyzy says. That could happen again today, and indeed that’s what the new administration hopes to see, with pro-business policies producing GDP growth that would outpace inflation and the increase in the deficit.

For investors, broad diversification in equities and owning bonds with a range of maturities could help prepare for potentially higher growth while hedging against the risk of other scenarios.

Invest with an eye toward the future. As much as investors may be focused on what the new year will bring, many trends extend far beyond that time frame. “Companies don’t look just one year ahead; they think three, four, five or even 10 years ahead,” Hyzy says. “They’re thinking about how they can be more productive, with a business model that consistently creates innovation. The more widespread adoption of generative artificial intelligence, in particular, could help increase productivity — and in the process reduce costs and boost profit margins,” he says. Hyzy expects manufacturers to automate more and more processes, increasing productivity while freeing workers from high-stress, physically taxing jobs.

Things to consider: The factors discussed here could help propel investment markets this year and beyond, Hyzy says. Strong corporate profits, broadening market participation, clarity on interest rates and a more normal yield curve all are reasons for optimism.

No matter what, keep your goals in sight

“As you look ahead to 2025 and beyond, the opportunities we’ve described, as well as the risks, should create an environment in which a steady, measured approach works well,” Hyzy says. “Stay in the market, be diversified and be prepared for a range of policy changes that could be broadly positive but that may also bring surprises and risks.” Through it all, he says, remember why you’re investing, and keep your investments aligned with your current and future financial goals.