Top Five Surprises for 2025

History shows us that the biggest surprises in a typical year aren't usually from out of left field (although that sometimes happens, as it did in 2020 with the COVID-19 outbreak). Rather, they are often hiding in plain sight. As goes one of my favorite quotes often attributed to Mark Twain: "It ain't what you don't know that gets you in trouble, it's what you know for sure that just ain't so." Surprises most often appear when there is a very high degree of confidence among market participants in a specific outcome that doesn't pan out—for better or worse. So, by identifying the unexpected, here are our top global upside and downside surprises to our base case outlook for next year, in no particular order:

1. Tariffs quickly come and go
2. Shifts from rate cuts to rate hikes
3. Sentiment in Europe rebounds
4. Supply chains could be disrupted
5. China recovers

Since the election, currency markets seem to have priced in a moderate rise in U.S. import tariffs for major trading partners. But volatility could ensue if markets are surprised by the imposed tariffs being much higher and then abruptly dropped or sharply reduced. There is some reason to believe that this could occur in 2025.

During his first presidential term, President-elect Trump threatened implementing large across-the-board tariffs on China and ending a trade agreement with Mexico and Canada. However, Trump not only forged a Phase One trade deal with China but also successfully renegotiated the United States-Mexico-Canada Agreement (USMCA), formerly the North American Free Trade Agreement (NAFTA). He also renegotiated existing free trade agreements with South Korea and Japan. If history is any indication, the extreme tariff threats may simply be negotiation tools leading toward agreements with China and other countries, making the prospect potentially much less disruptive to economic growth, inflation, sales, and operations of multi-national corporations. These agreements could come quickly on the heels of new tariffs.

This negotiating tactic is not unique to the U.S. On October 29 in Europe, an eye-popping 45% tariff was imposed on some Chinese made electric vehicles (EVs). This was rapidly followed by rounds of talks between European and Chinese trade representatives. While there is not yet a final agreement, the negotiations have led to a technical consensus which scraps the tariffs in exchange for a minimum selling price on imported EVs, according to comments by the chairman of the European Parliament's trade committee.

An even more recent example is the late November announcement of 25% tariffs on Mexico and Canada and an additional 10% tariff on China to be implemented on Trump's first day in office unless these nations take further steps to address drug trafficking and illegal border crossings. The threat echoes the one in May 2019, when President Trump announced 25% tariffs on Mexico, with 5% to be imposed on June 10 and 5% increases each month until reaching 25%, unless Mexico stopped the flow of illegal immigration into the United States. That threat was never imposed. It was dropped by Trump less than a month later after Mexico agreed to pursue an enforcement surge to curb irregular migration. In response to the November announcement, Canadian President Trudeau met with Trump and Mexican President Sheinbaum sent a letter, both seeking to cooperate on the stated issues of drug trafficking and illegal border crossings.

Tariffs may still rise, but it seems that extreme tariff announcements may be used by Trump as a tool of statecraft to extract actions or concessions, rather than tools of economic policy. It is worth noting that Trump doesn't have a mandate on implementing tariffs, based on polling data of voters' intentions. Polling data shows voters expect Trump to focus on inflation (35%)—which tariffs might bring if implemented at the level they were proposed—not on implementing tariffs (only 1%). The uncertainty over tariffs being announced and then potentially dropped or reduced following negotiations could create market volatility.

The market seems highly confident in rate cuts by major central banks throughout the first half of 2025. As inflation rose across most major countries in the fourth quarter, markets have reduced the amount of additional rate cuts expected over the coming two years. It is possible that by the middle of 2025, the market may anticipate a rise in policy interest rates over the coming two years, which would be a big shift from the major cuts priced in during 2024.

It is worth noting that Brazil's central bank has shifted to hiking rates in recent months. Over the past few years, Brazil has been leading other central banks—initially as the first to hike in 2021, about a year ahead of the Fed and many other central banks. And then they were the first to cut in 2023, also about a year ahead of the Federal Reserve. Recently they have started to hike once again. Inflation in Brazil bottomed in mid-2023 at 3.2% but has since climbed back up to 4.8%. Brazil may be signaling what could come if inflation creeps higher—that cutting cycles get cut short. The potential for a shift from forecasting rate cuts or even the expectation for rate hikes on the horizon as 2026 comes into view in developed market economies could result in stocks selling off.

Economic growth in the eurozone has been below average during the last two years, led by softness in its largest economy, Germany. Germany may post the second straight year of contraction in 2024 amid weaker global demand for manufactured goods, especially autos tied to higher interest rates, as well as the slowdown in demand from China—one of Europe's largest export destinations. As a result, sentiment by business leaders and investors has been weak.

Sentiment may be poised to shift. While on an absolute basis, sentiment remains below average, the November Ifo Business Climate survey for Germany shows that expectations for the future have climbed relative to the assessment of the current situation similar to those seen during the rebounds from both the pandemic of 2020 and Eurozone Debt Crisis of 2011. Both instances preceded a strong rebound in overall sentiment, economic growth, and stock market performance.

While recent headlines may seem worrisome with France's government collapsing over a budget impasse and Germany's minority government unable to pass a budget, each struggle may lead to fewer budget cuts that originally planned and act as less of a drag on Europe's growth in 2025.

Energy costs could also be poised to fall. The poll-leading Christian Democratic Union of Germany (CDU) party is moving away from its opposition to nuclear energy, which could provide a longer-term benefit to the German economy in terms of lower costs. In the near term, Europe's access to low-cost energy is set to surge as liquified natural gas (LNG) import capacity is set to outpace demand growth in 2025, according to the U.S. Department of Energy. Additionally, the Trump administration may lift the pause on LNG export permits that was put in place during the Biden administration as way to rebalance trade between Europe and the U.S., further boosting natural gas supply to Europe. This increase in supply could reduce overall energy prices in the continent.

Valuations for eurozone stocks remain depressed, trading at a price-to-earnings ratio of 13 times next 12 months consensus expected earnings and at a 40% discount to the S&P 500. This is a much bigger discount than the historical average. Any rebound in sentiment could boost valuations, with each one point of increase estimated to boosting returns by 7%.

The supply shortages experienced during the pandemic were a lesson in the interconnectedness of the global economy and how disruptions in one part of the supply chain can ripple through to other areas. Supply chain disruptions no longer dominate the headlines but have crept up from time to time. In the past couple of years, shipments in the Panama Canal were slashed due to a drought that reduced the necessary water to move ships through the locks. Droughts in Europe disrupted trade on the German Rhine River. Houthi attacks on ships in the Red Sea have diverted trade. Not to mention the collapse of the Key Bridge in the Baltimore port causing shipments to be redirected. Other weather impacts have included excessive rain, freezing cold, and fires. While none of these caused rebounding inflation or materially impacted production, a more significant supply disruption would be an unwelcome surprise.

Supply chain disruptions are most often unpredictable, but there are some signs of vulnerability.

• Policy risks - Deportation of Mexican-born population from the U.S. could disrupt supply chains on labor shortages in some industries and global increases in tariffs could result in diversions in trade.
• Weather risks - Hurricane Helene flooded Spruce Pine, NC in September 2024, the location of nearly the entire global supply of high-purity quartz—the kind needed to make the crucibles that hold the molten silicon as it is formed into a silicon wafer.  Luckily the mines were brought back online after just four weeks and the world dodged a potentially severe disruption of the global supply chain for semiconductors.
• Geopolitical risks - While the conflicts surrounding Ukraine and Israel continue to exact an immeasurable human toll, the market and economic impacts have been limited, with oil prices wrapping up the year close to their lows. While ceasefire agreements may take place in 2025, the conflicts could linger on or even expand. Should oil facilities in Russia or Iran be targeted, oil prices may surge on supply shocks and act as a drag on growth and a boost to inflation.
• Technology-related outages - The cyberattack on the Colonial Pipeline in the U.S. in 2021, and IT outages such as the CrowdStrike faulty system update in July 2024, could derail the flow of energy or information.

With global trade volumes having recently climbed to new all-time highs after two years of stagnation, supply chains may be more vulnerable to any disruption. Where and when these disruptions could occur are naturally unpredictable and could come out of seemingly nowhere to surprise markets, reduce growth and boost inflation.

Strong performance by China's stock market in 2025 might surprise many investors given the weakening outlook for GDP growth and Trump's "America First" policies. Since election day, markets have seen leadership led by U.S. small caps while international stocks and especially emerging market stocks lagged badly. That is exactly what happened after Trump won in 2016. But, surprising to many, market behavior completely reversed in 2017, the first year of Trump's term. Despite risk of tariffs and the uncertainty of a Trump administration, emerging market stocks rose nearly 40% in 2017, led by 56% gains in China. This was followed by outperformance of international stocks with U.S. small caps being the worst performers in that year.

In 2017, China implemented a fiscal stimulus package that amounted to roughly 10 trillion yuan (approximately $1.4 trillion), primarily focused on addressing local government debt issues and boosting a slowing domestic economy through infrastructure spending and other measures. This package was considered a significant effort to counter potential economic volatility and was equivalent to a whopping 12% of China's economy at the time.

Despite China's government announcing a flurry of measures in September to reinvigorate economic growth, the missing piece has been fiscal stimulus. Policy meetings in the months following produced only vague references to new measures yet to come, resulting in the stimulus-driven stock market rally to fade. It is possible China's government may be waiting to have better visibility on the extent and timing of U.S. tariff increases and could provide fiscal stimulus details at the March National People's Congress. Policy meetings in October, November, and December have suggested additional fiscal measures in 2025, including increasing the fiscal deficit and boosting consumption.

Chinese stocks have surprised to the upside–and downside–in the past. While a fiscal stimulus equal in size to the 2017 package is unlikely, stocks may rise on a much smaller package if it includes concrete measures to boost consumption and halt the property market downturn. However, stocks could slip again if hopes fade and China under-delivers on its promises.

While we highlighted our top five, there are many other potential surprises for 2025 including those that are an ever-present part of investing and not unique to the outlook for any particular year. These include rising fiscal sustainability concerns as debt and deficits continue to spiral ever higher, another pandemic could emerge that evades existing vaccines, the outbreak of wars, among many others.

Whether or not these particular surprises for 2025 come to pass, a new year almost always brings surprises of one form or another. Having a well-balanced, diversified portfolio with a risk profile consistent with your goals and being prepared with a plan in the event of an unexpected outcome are keys to achieving goals.

Michelle Gibley, CFA^®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.