2025 Thematic Outlook: AI and geopolitics forge new paths

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Key takeaways:

1. Modest rate cuts could support sensitive assets: Recent fed rate cuts could start to take pressure off interest rate sensitive companies and non-cash-flowing  assets. This presents potential tailwinds for biotech stocks, bitcoin, and gold.
2. Rebuilding the U.S. physical economy: Themes centered around rebuilding the physical economy, like infrastructure, manufacturing, and homebuilding may be better poised to benefit in the post-election environment, as they sit at the intersection of policy tailwinds and structural changes.
3. AI’s build phase accelerates: Massive investment in AI infrastructure as well as ever more powerful chips and models, are laying the groundwork for increased adoption.

MODEST RATE CUTS COULD SUPPORT RATE-SENSITIVE COMPANIES AND ASSETS

From March 2022 to September 2024, the markets entered a period of quickly rising and elevated interest rates, bringing the federal funds rate to its highest levels since 2001 . This environment punishes rate-sensitive investments on two fronts:

1. companies with long paths to profitability saw valuations contract given higher discount rates, and;
2. firms dependent on floating rate debt or that had to roll over maturing debt were hurt by higher financing costs

Additionally, non-cash-flowing assets like bitcoin and gold faced pressure from rising opportunity costs compared to holding interest-paying assets like bonds. The Federal Reserve's recent rate cuts and potential further reductions in 2025 could help alleviate these pressures, while regulatory clarity may accelerate bitcoin’s adoption in the coming years.

In the biotech sector, rate cuts could lower financing costs and encourage firms to expand their R&D budgets, especially with AI innovations in drug discovery and trials.

REBUILDING THE U.S. PHYSICAL ECONOMY: INFRASTRUCTURE, MANUFACTUING AND HOUSING

Rebuilding the physical economy in the U.S. –including, improving and repairing infrastructure, expanding manufacturing capacity, and accelerating homebuilding– has gained consensus priority across public and private sectors. The 2021 Infrastructure Investment and Jobs Act (IIJA) allocated $1.2 trillion for infrastructure, with significant spending increases expected in 2025 .

1. Non-cash-flowing assets refer to assets that have no expectation of ever paying a dividend or coupon 
2. St. Louis Federal Reserve Bank. “FRED Economic Data-Federal Funds Effective Rate” As of 10/1/2024.
3. U.S. Department of Transportation. Bipartisan Infrastructure (BILS) / Infrastructure Investment and       Jobs Act (IIJA), November 15, 2021. Source for spending increases expected in 2025: BlackRock, using data from the Congressional Budget Office. As of 10/15/24
4. The White House. “Investing In America.” Accessed on 10/30/2024

Supported by other major legislation like the IIJA, CHIPS+ Science Act, and Inflation Reduction Act, the theme of reshoring manufacturing has led to substantial private investment . Finally, homebuilding is crucial due to a significant housing supply gap, with policies and potentially lower interest rates anticipated to support construction in the years ahead.

Forecast of IIJA implementation supports an acceleration of infrastructure 

Source: BlackRock using data from Congressional Budget Office. As of October 15, 2024. For illustrative purposes only. Future estimates may not come to pass.

AI’S BUILD PHASE ACCELERATES INFRASTRUCTURE AND MODELS

The release of ChatGPT in November 2022 ignited the generative AI revolution. Surging optimism in AI since then has led to an estimation of up to $15.4 Trillion5 for the total annual value of AI and analytics across industries. It is our belief that AI’s continued infrastructure buildout, along with hardware and model upgrades, will drive ever more powerful AI tools in the years ahead. Secondary impacts of AI's rise include politics and cybersecurity becoming increasingly relevant.

CONCLUSION

Thematic narratives drove markets in 2024 and could continue to do so in 2025 — though the landscape has shifted meaningfully. With falling rates, public policy tailwinds, and AI’s infrastructure buildout, there are select thematic opportunities for investors to potentially capture as they look to position their portfolios.

For more insights, check out the iShares 2025 Thematic Outlook.

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