Goldman still expects the Fed to continue cutting interest rates, and small-cap stocks are worth more attention

Recent doubts on Wall Street about the pace and size of the Federal Reserve's rate cuts have been countered by Goldman, which tells investors that 2025 will still be a "bountiful year" for interest-rate sensitive assets, including small stocks and bonds.

The central bank began cutting short-term rates in September and most investors expect the easing policy to last until 2025. But there is a split over the size and pace of the cuts, with markets pricing in a 40% chance that the Fed will skip a rate cut at its December 17-18 meeting, up from 20% at the start of the week, after the consumer price index data in October and a cautious statement from Fed chairman Jerome Powell.

Any slowdown in the pace of rate cuts could put pressure on bonds, which move in the opposite direction to interest rates. But Goldman Asset Management does not agree.

"Despite the expanded range of economic outcomes from the US election, we still expect the Fed to continue to cut rates in December and early 2025," it said in its outlook for 2025, published on Tuesday.

The firm expects portfolio allocations to bonds to deliver attractive returns in 2025, especially in areas such as corporate bonds and securitised credit where opportunities have been found.

For equity investors, the rate cuts are also significant. In recent years, US stock markets have been driven by large-cap growth stocks, especially large technology companies in the artificial intelligence space. But Goldman warns that the dominance of these giants may not be sustainable, and reminds investors to be wary of passive index funds such as the S&P 500.

By contrast, small caps could be worth more attention in 2025. Goldman notes that small caps are more sensitive to changes in interest rates because these companies typically have weaker balance sheets and higher financing costs, so they benefit more from falling rates.

Despite lagging the S&P 500 by about 10 percentage points this year (about 15 per cent versus 25 per cent), small caps are more attractive on valuation grounds. Small caps currently trade at about 15 times earnings, compared with more than 21 times for large caps.

"We expect a reversal of fortune for small caps in 2025, driven by the valuation discount to large caps and a supportive rate-cutting environment," it said.

President Trump's victory in the election could also be a potential boon for small caps. Although rates have risen since his election, Goldman believes his tariff plans could be more detrimental to large multinational companies.

"Relative to large companies, small companies have more domestic revenue sources and shorter supply chains, making them more resilient to the negative effects of tariffs," it said.