What is in store for investors in 2025? A group of Newton’s research analysts and portfolio managers met to debate and discuss their top ten predictions for 2025 on key positions that oppose prevailing market trends. Could the ‘magnificent seven’ lose their lustre and become the ‘meagre seven’, ushering in a period where small caps rally and outpace large caps? Could the new US administration break inflation, prompting a Federal Reserve (Fed) rate-cutting cycle that moves interest rates to levels last seen during President-elect Trump’s first term?

These ten debates illustrate Newton’s core ability to unlock opportunity by leveraging our multidimensional research capabilities, where all investors and analysts have a seat at the table to engage in spirited debate on their most out-of-consensus viewpoints.

1. The Trump trade head fake: Will interest rates, inflation and the US dollar all lower in 2025?

Point: Growth and inflation are expected to rise in 2025, which should lead to higher rates, a stronger dollar and an increase in equities. The Fed is more cautious regarding inflation risks and global growth is weaker. While these conditions may persist through the first quarter of 2025, it could be a potential contrarian opportunity to buy bonds, sell dollars and favour global ex-US equities. The fiscal impulse may remain flat next year, and tariffs could eventually lower both growth and inflation, thereby posing downside risks to both. Moreover, the US appears very attractive—whether in bonds, equities or currencies—relative to the rest of the world. Additionally, there is an expressed interest among some incoming administration members for a weaker dollar in the future. Efficiencies in reducing the budget deficit through the proposed US Department of Government Efficiency (DOGE) could lower the term premium in bonds. Naturally, there are risks, primarily from the fiscal side, which could impose constraints via bond-market discipline.

Counterpoint: US economic activity remains strong. Consumer spending has recently risen, and corporate activity could also increase as we head into 2025. The recent election of a new pro-business, lighter regulation administration could further heighten inflation. Higher and more enduring inflation may result in structurally higher interest rates relative to recent history but not as restrictive as today.

2. AI winter is coming: Could overcapacity cause an unwind of the consensus AI trade?

Point: Investment in artificial intelligence (AI) is expected to continue growing, and concerns about oversupply may be overstated. The AI theme is still developing and early in its application. Companies are learning about this technology and experimenting with how it can optimise business functions, which could lead to higher future demand as enterprises further leverage AI. Additionally, agents (software applications capable of running tasks independently) and on-device AI might expand the investment opportunities in this space. AI has the potential to affect personal devices, work devices, cars, and homes, leading to a significant hardware upgrade cycle as AI chips are installed on devices for data analysis and decision-making. It is also important to note that AI influences investment beyond the technology sector, affecting areas such as infrastructure, utilities, industrials and nuclear power.

Counterpoint: Generative AI emerged in the technology industry two years ago, leading to a considerable rise in capital expenditure to construct data centres. Given that building data centres takes approximately three to four years, it is anticipated that significant capacity will become available in 2026-2027. However, there is a question as to whether there will be sufficient demand to utilise this capacity. While consumers are currently adopting AI technology, enterprises remain in the testing phase. An excess supply could affect tier 2 and tier 3 cloud companies and GPU-as-a-service (high-performance computing) providers that have smaller customer bases and/or are more exposed to AI training relative to inferencing. Companies with robust customer bases, complete AI computing stacks and greater capacity to generate inference revenue may be better positioned for success. 

3. America second: Will Europe outperform the US in the coming year?

Point: The United States appears to have surpassed its peak. US equity valuations are exceptionally high, with the disparity between US and UK/Europe valuations reaching unprecedented levels. This gap is primarily driven by a select group of high-performing and influential companies in the US stock market, commonly referred to as the ‘magnificent seven’. It is crucial to consider that any decline in AI demand would adversely affect these companies and consequently affect US valuations overall. In our assessment, European political conditions are anticipated to improve by 2025, which should positively influence European valuations. Furthermore, there is an acceleration in mergers and acquisitions in the UK, contributing to a more optimistic economic outlook. Finally, the US economy may be more vulnerable than generally perceived, with potential inflation on the horizon, thus positioning Europe to potentially outperform the US in the forthcoming years.

Counterpoint: Europe has underperformed for over a decade. While some anticipate a cyclical rebound, this slower growth could be secular. In the US, GDP grew by 2.5% in 2023 and is expected to grow by 2.6% in 2024.^1,2 The US also benefits from significant innovation, potentially boosting further GDP growth. Conversely, Europe saw 0.5% GDP growth in 2023 with an expected 1% growth in 2024.^3,4 It is also important to recognise that Europe consists of diverse countries, each facing unique challenges. Input costs across Europe are higher than in the US with more expensive electricity costs and a more fixed labour market. Additionally, valuation should be considered, and on a price-to-earnings/return-on-equity basis, the US is far cheaper than Europe.

4. US housing bulls become homeless: Could US housing sink further still?

Point: Existing home sales are at nearly 30-year lows, and there is a strong possibility that they could fall further in 2025.⁵ Housing affordability remains a real issue and mortgage rates are not declining, which presents a huge roadblock for improving existing home sales in the US.

Counterpoint: While interest rates remain a headwind, the economy and job outlook could become a more important driver for home sales. There is a lot of pent-up demand for housing, and with current rates being similar to rates in the mid-1990s, pent-up demand may be ready to be released. Existing home sales are unsustainably low, and companies participating in fragmented markets exposed to housing may be market winners.

5. The revenge of environmental, social and governance (ESG): Will companies pick up the banner as regulations come under pressure?

Point: Companies should be motivated to enhance value. At the same time, many consumers are concerned with addressing the needs of future generations, necessitating that companies and politicians consider these interests. With this in mind, ESG will remain relevant, but we may observe a balance in language emphasising value creation through ESG practices. For instance, many initiatives aimed at reducing emissions and environmental footprints are financially driven; the expansion of renewable energy has bolstered job creation and decreased foreign dependencies. Furthermore, the rise of AI and proliferation of data centres will require both supplemental power sources such as renewables, and more efficient power sources.On the social front, multiple studies indicate that diversity correlates with higher corporate returns, fosters innovation, enhances employee satisfaction and can reduce corporate costs. ESG is not merely a box-checking exercise; it is fundamentally about generating monetary value.

Counterpoint: ESG, as an acronym, has been politically charged for some time. The US has retreated from the concept while it has remained relevant in many parts of the world. This divergence highlights the varied standards for ESG across the globe. Additionally, regulators may heavily scrutinise any labelled claims of ESG and diversity, equity, and inclusion, which could lead to potential issues such as ‘greenhushing’ (when a company intentionally downplays information about its environmental efforts). The appointment of the next US Securities and Exchange Commission (SEC) chair will be critical, but it is anticipated that the new administration will be less supportive of shareholder proposals and resolutions compared to the current administration. There is also the possibility that the US may withdraw from United Nations climate initiatives, raising questions about whether China might take its place, and what that could mean geopolitically. Lastly, there is a belief that ESG could become a lesser priority as countries turn their focus to other pressing priorities such as security, reliability and affordability.

6. Executive in peace: Could the Trump administration usher in a period of global peace not seen since the Clinton era?

Point: Global peace is a very low probability outcome. Maybe somewhat counterintuitively, countries pursuing more isolationist policies should be a boon for defence spending globally. European countries in NATO have recognised the need to invest in their own defence owing to heightened aggression from Russia. As Trump has made clear, these countries cannot solely depend on the US for blanket defence against Russia, prompting many nations to begin the multi-year process of significantly increasing defence budgets. Additionally, China’s rise has led to heightened defence spending in Asia, which is expected to continue. The Ukraine/Russia conflict has also increased the use of battlefield drones, and there may be significant growth in this market.

Counterpoint: The past sets a precedent, and global peace might prevail once more. We saw how Trump governed from 2017-2020, and he ran his campaign on a very similar strategy this election season. During his first presidential term, the US refrained from entering any new or expanded conflicts. President Trump maintained diplomatic relationships with both North Korean President Kim Jong Un and Russian President Vladimir Putin, and he was committed to the US withdrawal from Afghanistan. Market trends suggest confidence in Trump’s potential to bring about a period of peace, as evidenced by the underperformance of defence stocks following the election. Additionally, Trump has expressed his dedication to mediating an end to the ongoing conflicts in Ukraine and Gaza.

7. David versus Goliath: Will small caps finally find their footing and start a long-term run of beating the ‘magnificent seven’?

Point: Over the last 100 years,US small-cap versus large-cap relative performance is consistently cyclical. We are now in the midst of cycle year 14 of large caps outperforming small caps. Earnings expectations for the Russell 2000 are poised to rise in 2025, and cash flows are improving. It should not take much capital to buoy the index given the low amount of market capitalisation in this arena. Additionally, private equity has been staying private for longer, creating a backlog of companies about to go public and join their small-cap brethren. Current large-cap dominators may be past their prime as these once traditionally capital-light businesses are now capital-intensive, translating to lower multiples.

Counterpoint: The bigger the better. Large-cap companies have outperformed because they have experienced better growth, and small-cap companies will need serious earnings improvement if they are to surpass these giant companies. When looking at the investable universe with an innovation lens, small-cap companies are cheap for a reason. Much of the true market innovation around AI and obesity drugs has been driven by large-cap companies despite the fact that small-cap companies are traditionally the most innovative. Historically, small caps have benefitted from the complacency of large caps, but this is no longer the case. Finally, companies are staying private for longer now, creating an IPO vacuum and minimising the universe of small-cap companies.

8. Make America healthy again: Will health care be the worst sector in 2025?

Point: Between Trump’s nominations for high-level positions, tariffs, further pricing pressure in the sector and subsidy cuts that many believe could come through, it appears every part of health care may be negatively affected. Overwhelming focus has been on the nominations for Trump’s administration, especially the choice of Robert F. Kennedy Jr (RFK) as US health secretary. Given RFK’s past statements, there is a worry that his personal agenda will override evidence-based policy, detracting from health-care and funding priorities. Beyond RFK, it does seem like the upcoming administration is comfortable ratcheting up pricing pressure on drugs, pressuring pharmaceutical companies and all the vendors that support them. Tariffs could also have an impact, to varying degrees, on the medical technology space. Some companies may shift manufacturing or pass this pressure on to consumers. Finally, Republican wins at the federal and state level could influence exchange subsidies and Medicaid rosters as well.

Counterpoint: While there is fear that RFK could upend the health-care system, the health-care sector is at its lowest percentage of the S&P 500® in 20 years while innovation is at an all-time high owing to obesity, immunology, genetic and oncology drug advancements. Kennedy’s rhetoric may be stronger than his eventual policies and, if confirmed, he may have a narrow focus on ingredients in the food supply chain, and the risk/rewards of vaccines. Other appointees for heads of the Food and Drug Administration (FDA), Centers for Disease Control and Prevention (CDC), and the National Institutes of Health (NIH), are all dedicated scientists with no polarising agendas. Overall, there could be some changes ahead surrounding food and some vaccines, but pricing worries and FDA/NIH disruption fears are likely overblown.

9. China in a bull shop: Could China come roaring back and benefit from the Trump administration?

Point: China has significantly reduced its dependency on exporting to the US with its Belt and Road initiative. Exports to the global south now represent roughly half of Chinese exports, while exports to the G7 have nearly halved. There is a misconception that China cannot catch up with Western peers; there are 3.6 million graduates in China each year in STEM subjects (science, technology, engineering and mathematics) versus less than one million in the US.⁶ These are the skills required for the industries of the future. Additionally, China is increasingly catching up in the semiconductor and AI space, opening many new technology companies. Innovation is especially important, with China filing a significant number of patents compared to the US.

Counterpoint: There are two gravitational forces that may pose concerns for China: a large growth problem and a lack of equity returns. China has trillions of dollars of unsold housing and sells only a fraction of that housing annually. Property still accounts for a high percentage of GDP and home ownership is nearly 100%. This indicates the need for a monumental rebalancing, and a transition from investment-driven growth without affecting other potential growth drivers presents difficulties. Remember, this occurs amid demographic headwinds and high total system leverage. The Chinese Communist Party faces both ideological and practical barriers to aggressive stimulus measures. It appears unlikely to replicate 2008 stimulus levels, and while pension or ‘hukou’ (household registration) reform is possible, it may only stabilise short-term growth. Chinese equities tend to be idiosyncratic and do not provide compound returns owing to significant equity dilution.

10. Tariffs, no biggie: Will a new wave of Trump tariffs be disastrous for the US consumer?

Point: In Trump’s previous presidency, tariffs had little impact on consumers. Tariffs may not always be passed on to the consumer. It is important to consider the competitive dynamics on the industry to which tariffs are being applied. While tariffs could fall heavily on consumers in instances where producers have pricing power, tariffs on undifferentiated products with competitive dynamics could fall heavily on the producer by way of lower margins. It is unlikely that the new administration will implement tariffs in industries where the producers hold pricing power. If aggregate nominal demand grows strongly, corporations could more easily pass on the cost of tariffs to consumers; however, this is not currently the case, and the current economic cycle is mature. Corporations may struggle to pass on tariffs to consumers, with profit pools through the value chain likely taking the bulk of the hit.

Counterpoint: The president-elect has said he believes the current trade system does not benefit American businesses and consumers, so tariffs are a credible threat to both US companies and consumers. Other countries could retaliate, potentially creating a full-blown trade war. Most importantly, tariffs are a headwind for the consumer, the global economy and equities, as they reduce real purchasing power and profit margins. A resulting stronger dollar is also an issue for US profits, and the inflationary effect of higher import prices could lead to a more hawkish Fed given rising inflation expectations. It is expected that these tariffs would be enacted at a time when equity valuations are rich, and do not offer much margin of safety. The transmission mechanism of these costs to the consumer could be through higher borrowing costs, lower asset prices, higher unemployment and higher inflation, lower real wages and a reduction in purchasing power.

Sources:

¹ Statista, Annual growth of the real gross domestic product of the United States from 1990 to 2023, January 2024, https://www.statista.com/statistics/188165/annual-gdp-growth-of-the-united-states-since-1990/#:~:text=In%202023%20the%20real%20gross,and%20high%20growth%20in%202021

² Federal Reserve Bank Philadelphia, Third Quarter 2024 Survey of Professional Forecasters, August 9, 2024, https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q3-2024#:~:text=Overall%2C%20the%20forecasters%20revised%20upward,compared%20with%20the%20previous%20survey

³ Statista, Gross domestic product (GDP) growth in Central and Eastern European countries compared to the European Union region from 1991 to 2023, November 2024, https://www.statista.com/statistics/1187041/cee-gdp-change/

⁴ European Commission, Autumn 2024 Economic Forecast: A gradual rebound in an adverse environment, November 2024, https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts/autumn-2024-economic-forecast-gradual-rebound-adverse-environment_en#:~:text=This%20Autumn%20Forecast%20projects%20real,unchanged%20for%20the%20euro%20area

⁵ Fannie Mae, Recent Rate Run-Up Expected to Keep Existing Home Sales Near Historic Lows Through 2025, November 2024, https://www.fanniemae.com/newsroom/fannie-mae-news/recent-rate-run-expected-keep-existing-home-sales-near-historic-lows-through-2025#:~:text=WASHINGTON%2C%20DC%20%E2%80%93%20Existing%20home%20sales,Strategic%20Research%20(ESR)%20Group

⁶ CSET, The Global Distribution of STEM Graduates: Which Countries Lead the Way?, November 2023, https://cset.georgetown.edu/article/the-global-distribution-of-stem-graduates-which-countries-lead-the-way/#:~:text=The%20WEF%20report%20identified%20China,of%20graduates%20in%20STEM%20fields

What is in store for investors in 2025? A group of Newton’s research analysts and portfolio managers met to debate and discuss their top ten predictions for 2025 on key positions that oppose prevailing market trends. Could the ‘magnificent seven’ lose their luster and become the ‘meager seven,’ ushering in a period where small caps rally and outpace large caps? Could the new US administration break inflation, prompting a Federal Reserve (Fed) rate-cutting cycle that moves interest rates to levels last seen during President-elect Trump’s first term?

These ten debates illustrate Newton’s core ability to unlock opportunity by leveraging our multidimensional research capabilities, where all investors and analysts have a seat at the table to engage in spirited debate on their most out-of-consensus viewpoints.

1. The Trump Trade Head Fake: Will interest rates, inflation and the dollar all lower in 2025?

Point: Growth and inflation are expected to rise in 2025, which should lead to higher rates, a stronger dollar and an increase in equities. The Fed is more cautious regarding inflation risks and global growth is weaker. While these conditions may persist through the first quarter of 2025, it could be a potential contrarian opportunity to buy bonds, sell dollars and favor global ex-US equities. The fiscal impulse may remain flat next year, and tariffs could eventually lower both growth and inflation, thereby posing downside risks to both. Moreover, the US appears very attractive—whether in bonds, equities or currencies—relative to the rest of the world. Additionally, there is an expressed interest among some incoming administration members for a weaker dollar in the future. Efficiencies in reducing the budget deficit through the proposed Department of Government Efficiency (DOGE) could lower the term premium in bonds. Naturally, there are risks, primarily from the fiscal side, which could impose constraints via bond-market discipline.

Counterpoint: US economic activity remains strong. Consumer spending has recently risen, and corporate activity could also increase as we head into 2025. The recent election of a new pro-business, lighter regulation administration could further heighten inflation. Higher and more enduring inflation may result in structurally higher interest rates relative to recent history but not as restrictive as today.

2. AI Winter is Coming: Could overcapacity cause an unwind of the consensus AI trade?

Point: Investment in artificial intelligence (AI) is expected to continue growing, and concerns about oversupply may be overstated. The AI theme is still developing and early in its application. Companies are learning about this technology and experimenting with how it can optimize business functions, which could lead to higher future demand as enterprises further leverage AI. Additionally, agents (software applications capable of running tasks independently) and on-device AI might expand the investment opportunities in this space. AI has the potential to affect personal devices, work devices, cars, and homes, leading to a significant hardware upgrade cycle as AI chips are installed on devices for data analysis and decision-making. It is also important to note that AI influences investment beyond the technology sector, affecting areas such as infrastructure, utilities, industrials and nuclear power.

Counterpoint: Generative AI emerged in the technology industry two years ago, leading to a considerable rise in capital expenditure to construct data centers. Given that building data centers takes approximately three to four years, it is anticipated that significant capacity will become available in 2026-2027. However, there is a question as to whether there will be sufficient demand to utilize this capacity. While consumers are currently adopting AI technology, enterprises remain in the testing phase. An excess supply could affect tier 2 and tier 3 cloud companies and GPU-as-a-service (high-performance computing) providers that have smaller customer bases and/or are more exposed to AI training relative to inferencing. Companies with robust customer bases, complete AI computing stacks and greater capacity to generate inference revenue may be better positioned for success. 

Given that building data centers takes approximately three to four years, it is anticipated that significant capacity will become available in 2026-2027. However, there is a question as to whether there will be sufficient demand to utilize this capacity.

3. America Second: Will Europe outperform the US in the coming year?

Point: The United States appears to have surpassed its peak. US equity valuations are exceptionally high, with the disparity between US and UK/Europe valuations reaching unprecedented levels. This gap is primarily driven by a select group of high-performing and influential companies in the US stock market, commonly referred to as the ‘magnificent seven.’ It is crucial to consider that any decline in AI demand would adversely affect these companies and consequently affect US valuations overall. In our assessment, European political conditions are anticipated to improve by 2025, which should positively influence European valuations. Furthermore, there is an acceleration in mergers and acquisitions in the UK, contributing to a more optimistic economic outlook. Finally, the US economy may be more vulnerable than generally perceived, with potential inflation on the horizon, thus positioning Europe to potentially outperform the US in the forthcoming years.

Counterpoint: Europe has underperformed for over a decade. While some anticipate a cyclical rebound, this slower growth could be secular. In the US, GDP grew by 2.5% in 2023 and is expected to grow by 2.6% in 2024.^1,2 The US also benefits from significant innovation, potentially boosting further GDP growth. Conversely, Europe saw 0.5% GDP growth in 2023 with an expected 1% growth in 2024.^3,4 It is also important to recognize that Europe consists of diverse countries, each facing unique challenges. Input costs across Europe are higher than in the US with more expensive electricity costs and a more fixed labor market. Additionally, valuation should be considered, and on a price-to-earnings/return-on-equity basis, the US is far cheaper than Europe.

4. US Housing Bulls Become Homeless: Could US housing sink further still?

Point: Existing home sales are at nearly 30-year lows, and there is a strong possibility that they could fall further in 2025.⁵ Housing affordability remains a real issue and mortgage rates are not declining, which presents a huge roadblock for improving existing home sales in the US.

Counterpoint: While interest rates remain a headwind, the economy and job outlook could become a more important driver for home sales. There is a lot of pent-up demand for housing, and with current rates being similar to rates in the mid-1990s, pent-up demand may be ready to be released. Existing home sales are unsustainably low, and companies participating in fragmented markets exposed to housing may be market winners.

5. The Revenge of Environmental, Social and Governance (ESG): Will companies pick up the banner as regulations come under pressure?

Point: Companies should be motivated to enhance value. At the same time, many consumers are concerned with addressing the needs of future generations, necessitating that companies and politicians consider these interests. With this in mind, ESG will remain relevant, but we may observe a balance in language emphasizing value creation through ESG practices. For instance, many initiatives aimed at reducing emissions and environmental footprints are financially driven; the expansion of renewable energy has bolstered job creation and decreased foreign dependencies. Furthermore, the rise of AI and proliferation of data centers will require both supplemental power sources such as renewables, and more efficient power sources. On the social front, multiple studies indicate that diversity correlates with higher corporate returns, fosters innovation, enhances employee satisfaction and can reduce corporate costs. ESG is not merely a box-checking exercise; it is fundamentally about generating monetary value.

Counterpoint: ESG, as an acronym, has been politically charged for some time. The US has retreated from the concept while it has remained relevant in many parts of the world. This divergence highlights the varied standards for ESG across the globe. Additionally, regulators may heavily scrutinize any labelled claims of ESG and diversity, equity, and inclusion, which could lead to potential issues such as ‘greenhushing’ (when a company intentionally downplays information about its environmental efforts). The appointment of the next US Securities and Exchange Commission (SEC) chair will be critical, but it is anticipated that the new administration will be less supportive of shareholder proposals and resolutions compared to the current administration. There is also the possibility that the US may withdraw from United Nations climate initiatives, raising questions about whether China might take its place, and what that could mean geopolitically. Lastly, there is a belief that ESG could become a lesser priority as countries turn their focus to other pressing priorities such as security, reliability and affordability.

6. Executive in Peace: Could the Trump Administration usher in a period of global peace not seen since the Clinton era?

Point: Global peace is a very low probability outcome. Maybe somewhat counterintuitively, countries pursuing more isolationist policies should be a boon for defense spending globally. European countries in NATO have recognized the need to invest in their own defense owing to heightened aggression from Russia. As Trump has made clear, these countries cannot solely depend on the US for blanket defense against Russia, prompting many nations to begin the multi-year process of significantly increasing defense budgets. Additionally, China’s rise has led to heightened defense spending in Asia, which is expected to continue. The Ukraine/Russia conflict has also increased the use of battlefield drones, and there may be significant growth in this market.

Counterpoint: The past sets a precedent, and global peace might prevail once more. We saw how Trump governed from 2017-2020, and he ran his campaign on a very similar strategy this election season. During his first presidential term, the US refrained from entering any new or expanded conflicts. President Trump maintained diplomatic relationships with both North Korean President Kim Jong Un and Russian President Vladimir Putin, and he was committed to the US withdrawal from Afghanistan. Market trends suggest confidence in Trump’s potential to bring about a period of peace, as evidenced by the underperformance of defense stocks following the election. Additionally, Trump has expressed his dedication to mediating an end to the ongoing conflicts in Ukraine and Gaza.

The past sets a precedent, and global peace might prevail once more. We saw how Trump governed from 2017-2020, and he ran his campaign on a very similar strategy this election season.

7. David versus Goliath: Will small caps finally find their footing and start a long-term run of beating the ‘magnificent seven’?

Point: Over the last 100 years, US small-cap versus large-cap relative performance is consistently cyclical. We are now in the midst of cycle year 14 of large caps outperforming small caps. Earnings expectations for the Russell 2000 are poised to rise in 2025, and cash flows are improving. It should not take much capital to buoy the index given the low amount of market capitalization in this arena. Additionally, private equity has been staying private for longer, creating a backlog of companies about to go public and join their small-cap brethren. Current large-cap dominators may be past their prime as these once traditionally capital-light businesses are now capital-intensive, translating to lower multiples.

Counterpoint: The bigger the better. Large-cap companies have outperformed because they have experienced better growth, and small-cap companies will need serious earnings improvement if they are to surpass these giant companies. When looking at the investable universe with an innovation lens, small-cap companies are cheap for a reason. Much of the true market innovation around AI and obesity drugs has been driven by large-cap companies despite the fact that small-cap companies are traditionally the most innovative. Historically, small caps have benefitted from the complacency of large caps, but this is no longer the case. Finally, companies are staying private for longer now, creating an IPO vacuum and minimizing the universe of small-cap companies.

8. Make America Healthy Again: Will health care be the worst sector in 2025?

Point: Between Trump’s nominations for high-level positions, tariffs, further pricing pressure in the sector and subsidy cuts that many believe could come through, it appears every part of health care may be negatively affected. Overwhelming focus has been on the nominations for Trump’s administration, especially the choice of Robert F. Kennedy Jr (RFK) as health secretary. Given RFK’s past statements, there is a worry that his personal agenda will override evidence-based policy, detracting from health-care and funding priorities. Beyond RFK, it does seem like the upcoming administration is comfortable ratcheting up pricing pressure on drugs, pressuring pharmaceutical companies and all the vendors that support them. Tariffs could also have an impact, to varying degrees, on the medical technology space. Some companies may shift manufacturing or pass this pressure on to consumers. Finally, Republican wins at the federal and state level could influence exchange subsidies and Medicaid rosters as well.

Counterpoint: While there is fear that RFK could upend the health-care system, the health-care sector is at its lowest percentage of the S&P 500® in 20 years while innovation is at an all-time high owing to obesity, immunology, genetic and oncology drug advancements. Kennedy’s rhetoric may be stronger than his eventual policies and, if confirmed, he may have a narrow focus on ingredients in the food supply chain, and the risk/rewards of vaccines. Other appointees for heads of the Food and Drug Administration (FDA), Centers for Disease Control and Prevention (CDC), and the National Institutes of Health (NIH), are all dedicated scientists with no polarizing agendas. Overall, there could be some changes ahead surrounding food and some vaccines, but pricing worries and FDA/NIH disruption fears are likely overblown.

9. China in a Bull Shop: Could China come roaring back and benefit from the Trump administration?

Point: China has significantly reduced its dependency on exporting to the US with the Belt and Road initiative. Exports to the global south now represent roughly half of Chinese exports, while exports to the G7 have nearly halved. There is a misconception that China cannot catch up with Western peers; there are 3.6 million graduates in China each year in STEM subjects (Science, Technology, Engineering and Mathematics) versus less than one million in the US.⁶ These are the skills required for the industries of the future. Additionally, China is increasingly catching up in the semiconductor and AI space, opening many new technology companies. Innovation is especially important, with China filing a significant number of patents compared to the US.

Counterpoint: There are two gravitational forces that may pose concerns for China: a large growth problem and a lack of equity returns. China has trillions of dollars of unsold housing and sells only a fraction of that housing annually. Property still accounts for a high percentage of GDP and home ownership is nearly 100%. This indicates the need for a monumental rebalancing, and a transition from investment-driven growth without affecting other potential growth drivers presents difficulties. Remember, this occurs amid demographic headwinds and high total system leverage. The Chinese Communist Party faces both ideological and practical barriers to aggressive stimulus measures. It appears unlikely to replicate 2008 stimulus levels, and while pension or ‘hukou’ (household registration) reform is possible, it may only stabilize short-term growth. Chinese equities tend to be idiosyncratic and do not provide compound returns owing to significant equity dilution.

There are two gravitational forces that may pose concerns for China: a large growth problem and a lack of equity returns.

10. Tariffs, No Biggie: Will a new wave of Trump tariffs be disastrous for the US consumer?

Point: In Trump’s previous presidency, tariffs had little impact on consumers. Tariffs may not always be passed on to the consumer. It is important to consider the competitive dynamics on the industry to which tariffs are being applied. While tariffs could fall heavily on consumers in instances where producers have pricing power, tariffs on undifferentiated products with competitive dynamics could fall heavily on the producer by way of lower margins. It is unlikely that the new administration will implement tariffs in industries where the producers hold pricing power. If aggregate nominal demand grows strongly, corporations could more easily pass on the cost of tariffs to consumers; however, this is not currently the case, and the current economic cycle is mature. Corporations may struggle to pass on tariffs to consumers, with profit pools through the value chain likely taking the bulk of the hit.

Counterpoint: The president elect has said he believes the current trade system does not benefit American businesses and consumers, so tariffs are a credible threat to both US companies and consumers. Other countries could retaliate, potentially creating a full-blown trade war. Most importantly, tariffs are a headwind for the consumer, the global economy and equities, as they reduce real purchasing power and profit margins. A resulting stronger dollar is also an issue for US profits, and the inflationary effect of higher import prices could lead to a more hawkish Fed given rising inflation expectations. It is expected that these tariffs would be enacted at a time when equity valuations are rich, and do not offer much margin of safety. The transmission mechanism of these costs to the consumer could be through higher borrowing costs, lower asset prices, higher unemployment and higher inflation, lower real wages and a reduction in purchasing power.

Sources:

¹ Statista, Annual growth of the real gross domestic product of the United States from 1990 to 2023, January 2024, https://www.statista.com/statistics/188165/annual-gdp-growth-of-the-united-states-since-1990/#:~:text=In%202023%20the%20real%20gross,and%20high%20growth%20in%202021

² Federal Reserve Bank Philadelphia, Third Quarter 2024 Survey of Professional Forecasters, August 9, 2024, https://www.philadelphiafed.org/surveys-and-data/real-time-data-research/spf-q3-2024#:~:text=Overall%2C%20the%20forecasters%20revised%20upward,compared%20with%20the%20previous%20survey

³ Statista, Gross domestic product (GDP) growth in Central and Eastern European countries compared to the European Union region from 1991 to 2023, November 2024, https://www.statista.com/statistics/1187041/cee-gdp-change/

⁴ European Commission, Autumn 2024 Economic Forecast: A gradual rebound in an adverse environment, November 2024, https://economy-finance.ec.europa.eu/economic-forecast-and-surveys/economic-forecasts/autumn-2024-economic-forecast-gradual-rebound-adverse-environment_en#:~:text=This%20Autumn%20Forecast%20projects%20real,unchanged%20for%20the%20euro%20area

⁵ Fannie Mae, Recent Rate Run-Up Expected to Keep Existing Home Sales Near Historic Lows Through 2025, November 2024, https://www.fanniemae.com/newsroom/fannie-mae-news/recent-rate-run-expected-keep-existing-home-sales-near-historic-lows-through-2025#:~:text=WASHINGTON%2C%20DC%20%E2%80%93%20Existing%20home%20sales,Strategic%20Research%20(ESR)%20Group

⁶ CSET, The Global Distribution of STEM Graduates: Which Countries Lead the Way?, November 2023, https://cset.georgetown.edu/article/the-global-distribution-of-stem-graduates-which-countries-lead-the-way/#:~:text=The%20WEF%20report%20identified%20China,of%20graduates%20in%20STEM%20fields

The global outlook

From a global perspective, there are mixed signals for the economic outlook. Recent activity data such as purchasing managers’ indexes (PMIs) indicate contraction in Europe, Asia and some emerging-market countries. The US, however, has been an exception to this, with a more positive outlook, at least for the time being. The key question is whether this growth momentum will extend beyond the US.

Given its more promising short-term outlook, there is a divergence between the US and the rest of the world in terms of interest rates, currency performance and equity markets. This divergence may persist into the first quarter of 2025, but beyond that, uncertainty prevails, and some recoupling may be possible in the second half of the year.

The policy agenda of President-elect Donald Trump’s new US administration could have major implications. Policies focused on curbing immigration and imposing tariffs could hinder growth and increase inflation. Conversely, deregulation and potential tax cuts could boost growth. There is also discussion about improving government efficiency, reducing red tape, and cutting some expenditure programmes to control the budget deficit. The incoming administration will not be in place until 20 January 2025, and some policies may be implemented while others may be scaled back.

Interest-rate expectations in the US have been revised in line with growth and the election outcome. In other regions, interest-rate expectations are declining given weaker growth. The US Federal Reserve (Fed) is expected to be cautious in 2025, balancing inflationary pressures and growth uncertainties.

The US dollar’s strength, driven by recent appreciation, may face challenges as the new administration aims to boost US manufacturing competitiveness, which would require a shift in policy on the dollar. If the US dollar is part of the policy toolkit for the incoming administration, we should pay attention to how it approaches policies to weaken the dollar, as they could create volatility in markets. If successful, we could see a reversal in dollar strength in the second quarter and later into the year.

One aspect that we think is worth monitoring is the term premium (the excess return that investors demand to hold a longer-term bond instead of investing in shorter-term securities), which reflects investors’ fiscal concerns. There has been some build-up in 2024, but it has come with a re-steepening of the US yield curve. At this juncture, we are not unduly concerned, but we remain vigilant.

Inflation and interest rates

We believe the neutral interest rate (the level at which economic activity is neither stimulated nor restrained) in the US is currently somewhere between 3.5% and 4%, which seems to be already priced in by the market. The surprise element is what will matter – whether the economy stays strong beyond the first quarter of 2025. For rates to fall significantly below 4%, we believe growth would need to surprise to the downside.

In terms of inflation, the core components remain sticky, which is why we think the Fed is likely to adopt a cautious policy. If the growth elements of the new administration’s policy agenda do not turn out to be as supportive as expected, the Fed could engage in further rate cuts. We need to be wary in understanding which factors will have more weight – whether it is the tax and deregulation agenda, or immigration and tariffs. Tariffs could come sooner and hit sentiment, being more painful for countries in Asia and Europe. Deregulation and migration would take some time to be reflected in company earnings and inflation. The net risks to inflation are higher, but the macro backdrop remains unclear, so we caution against drawing major conclusions.

For these reasons, we need to monitor the term premium in the bond markets. A lot of what could occur is fiscally expansive and puts upward risks on inflation in the US. Could such developments rile bond markets so that this fiscal term premium emerges? The US is a prime candidate for bond vigilantes.

The US is a prime candidate for bond vigilantes.

Weakening of the US dollar?

As dynamic investors with a long-term view of markets, we think the most interesting aspect is the policy which aims to reindustrialise the US. The ‘America First’ policy has major implications for the currency setup. While some incoming administration officials have suggested efforts to weaken the US dollar – and whether the administration actively pursues such measures remains to be seen – this does not guarantee that the currency will weaken significantly. The market’s response so far has suggested stickier rates, more persistent inflation and higher growth in the US, which is likely to lead to a rising dollar. This theme could continue, but we must be cautious as a stronger US dollar could undercut Trump’s stated policies to boost US manufacturing competitiveness.

The dollar’s trajectory is likely to be influenced by negotiations between the US and China, Europe, and other emerging-market economies which are trading partners. We believe there is a multi-year risk of the dollar’s strength reversing, leading to a weaker dollar over the long term.

Geopolitics at play

China is seen not only as a trading partner for the US, but also as a rival in the technology sector, as well as economically. This divergence in relationships may persist. Since 2018, when the last set of tariffs was imposed, China has been increasing its efforts to move away from its current account surplus with the US. We have seen this in the country’s transition from low-cost manufacturing to higher-end manufacturing of goods such as electric vehicles. We expect this trend to continue.

Europe, traditionally seen as a partner to the US, is in a tough spot owing to its economic exposure to China. The euro has weakened, and Europe faces a choice between US tariffs and its own tariffs on Chinese electric vehicles. Europe might need to offer something in return for defence protection, possibly increasing investment in the US or accepting appreciation of the euro. There might be scope for the US to negotiate with Europe, but China is a different story.

Opportunities for 2025

From a contrarian perspective, we think the US dollar’s future could be interesting. We believe an intriguing possibility is that foreign assets could outperform US assets in 2025. The euro and European assets look particularly interesting to us, as do emerging-market currencies and local rates.

In the short term, there is likely to be more pressure on the currencies, bond markets and equity markets of emerging-market economies. However, we believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term. If dollar strength does materialise, we think the most appealing assets could be in emerging markets as well as in Europe, where the market is currently pricing in a lot of pessimism. In this scenario, there could be capital outflows from the US. 

We believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term.

There is also the possibility that Europe could react under pressure. There has been more discussion around the Draghi report, which is a very detailed plan on how to deal with competitiveness and most of the major stumbling blocks that Europe faces. Should the Draghi plan receive more attention, we could see a multi-year period of investment in which Europe invests as much as 5% of GDP to repair its framework, which is still incomplete. This would be very bullish for European assets, but it is not a given.

The Global Outlook

From a global perspective, there are mixed signals for the economic outlook. Recent activity data such as purchasing managers’ indexes (PMIs) indicate contraction in Europe, Asia and some emerging-market countries. The US, however, has been an exception to this, with a more positive outlook, at least for the time being. The key question is whether this growth momentum will extend beyond the US.

Given its more promising short-term outlook, there is a divergence between the US and the rest of the world in terms of interest rates, currency performance and equity markets. This divergence may persist into the first quarter of 2025, but beyond that, uncertainty prevails, and some recoupling may be possible in the second half of the year.

The policy agenda of President-elect Donald Trump’s new US administration could have major implications. Policies focused on curbing immigration and imposing tariffs could hinder growth and increase inflation. Conversely, deregulation and potential tax cuts could boost growth. There is also discussion about improving government efficiency, reducing red tape, and cutting some expenditure programs to control the budget deficit. The incoming administration will not be in place until January 20, 2025, and some policies may be implemented while others may be scaled back.

Interest-rate expectations in the US have been revised in line with growth and the election outcome. In other regions, interest-rate expectations are declining given weaker growth. The US Federal Reserve (Fed) is expected to be cautious in 2025, balancing inflationary pressures and growth uncertainties.

The US dollar’s strength, driven by recent appreciation, may face challenges as the new administration aims to boost US manufacturing competitiveness, which would require a shift in policy on the dollar. If the US dollar is part of the policy toolkit for the incoming administration, we should pay attention to how it approaches policies to weaken the dollar, as they could create volatility in markets. If successful, we could see a reversal in dollar strength in the second quarter and later into the year.

One aspect that we think is worth monitoring is the term premium (the excess return that investors demand to hold a longer-term bond instead of investing in shorter-term securities), which reflects investors’ fiscal concerns. There has been some build-up in 2024, but it has come with a re-steepening of the US yield curve. At this juncture, we are not unduly concerned, but we remain vigilant.

Inflation and Interest Rates

We believe the neutral interest rate (the level at which economic activity is neither stimulated nor restrained) in the US is currently somewhere between 3.5% and 4%, which seems to be already priced in by the market. The surprise element is what will matter – whether the economy stays strong beyond the first quarter of 2025. For rates to fall significantly below 4%, we believe growth would need to surprise to the downside.

In terms of inflation, the core components remain sticky, which is why we think the Fed is likely to adopt a cautious policy. If the growth elements of the new administration’s policy agenda do not turn out to be as supportive as expected, the Fed could engage in further rate cuts. We need to be wary in understanding which factors will have more weight – whether it is the tax and deregulation agenda, or immigration and tariffs. Tariffs could come sooner and hit sentiment, being more painful for countries in Asia and Europe. Deregulation and migration would take some time to be reflected in company earnings and inflation. The net risks to inflation are higher, but the macro backdrop remains unclear, so we caution against drawing major conclusions.

For these reasons, we need to monitor the term premium in the bond markets. A lot of what could occur is fiscally expansive and puts upward risks on inflation in the US. Could such developments rile bond markets so that this fiscal term premium emerges? The US is a prime candidate for bond vigilantes.

The US is a prime candidate for bond vigilantes.

Weakening of the US Dollar?

As dynamic investors with a long-term view of markets, we think the most interesting aspect is the policy which aims to reindustrialize the US. The ‘America First’ policy has major implications for the currency setup. While some incoming administration officials have suggested efforts to weaken the US dollar – and whether the administration actively pursues such measures remains to be seen – this does not guarantee that the currency will weaken significantly. The market’s response so far has suggested stickier rates, more persistent inflation and higher growth in the US, which is likely to lead to a rising dollar. This theme could continue, but we must be cautious as a stronger US dollar could undercut Trump’s stated policies to boost US manufacturing competitiveness.

The dollar’s trajectory is likely to be influenced by negotiations between the US and China, Europe, and other emerging-market economies which are trading partners. We believe there is a multi-year risk of the dollar’s strength reversing, leading to a weaker dollar over the long term.

Geopolitics at Play

China is seen not only as a trading partner for the US, but also as a rival in the technology sector, as well as economically. This divergence in relationships may persist. Since 2018, when the last set of tariffs was imposed, China has been increasing its efforts to move away from its current account surplus with the US. We have seen this in the country’s transition from low-cost manufacturing to higher-end manufacturing of goods such as electric vehicles. We expect this trend to continue.

Europe, traditionally seen as a partner to the US, is in a tough spot owing to its economic exposure to China. The euro has weakened, and Europe faces a choice between US tariffs and its own tariffs on Chinese electric vehicles. Europe might need to offer something in return for defense protection, possibly increasing investment in the US or accepting appreciation of the euro. There might be scope for the US to negotiate with Europe, but China is a different story.

Opportunities for 2025

From a contrarian perspective, we think the US dollar’s future could be interesting. We believe an intriguing possibility is that foreign assets could outperform US assets in 2025. The euro and European assets look particularly interesting to us, as do emerging-market currencies and local rates.

In the short term, there is likely to be more pressure on the currencies, bond markets and equity markets of emerging-market economies. However, we believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term. If dollar strength does materialize, we think the most appealing assets could be in emerging markets as well as in Europe, where the market is currently pricing in a lot of pessimism. In this scenario, there could be capital outflows from the US. 

We believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term.

There is also the possibility that Europe could react under pressure. There has been more discussion around the Draghi report, which is a very detailed plan on how to deal with competitiveness and most of the major stumbling blocks that Europe faces. Should the Draghi plan receive more attention, we could see a multi-year period of investment in which Europe invests as much as 5% of GDP to repair its framework, which is still incomplete. This would be very bullish for European assets, but it is not a given.

The global outlook

From a global perspective, there are mixed signals for the economic outlook. Recent activity data such as purchasing managers’ indexes (PMIs) indicate contraction in Europe, Asia and some emerging-market countries. The US, however, has been an exception to this, with a more positive outlook, at least for the time being. The key question is whether this growth momentum will extend beyond the US.

Given its more promising short-term outlook, there is a divergence between the US and the rest of the world in terms of interest rates, currency performance and equity markets. This divergence may persist into the first quarter of 2025, but beyond that, uncertainty prevails, and some recoupling may be possible in the second half of the year.

The policy agenda of President-elect Donald Trump’s new US administration could have major implications. Policies focused on curbing immigration and imposing tariffs could hinder growth and increase inflation. Conversely, deregulation and potential tax cuts could boost growth. There is also discussion about improving government efficiency, reducing red tape, and cutting some expenditure programmes to control the budget deficit. The incoming administration will not be in place until 20 January 2025, and some policies may be implemented while others may be scaled back.

Interest-rate expectations in the US have been revised in line with growth and the election outcome. In other regions, interest-rate expectations are declining given weaker growth. The US Federal Reserve (Fed) is expected to be cautious in 2025, balancing inflationary pressures and growth uncertainties.

The US dollar’s strength, driven by recent appreciation, may face challenges as the new administration aims to boost US manufacturing competitiveness, which would require a shift in policy on the dollar. If the US dollar is part of the policy toolkit for the incoming administration, we should pay attention to how it approaches policies to weaken the dollar, as they could create volatility in markets. If successful, we could see a reversal in dollar strength in the second quarter and later into the year.

One aspect that we think is worth monitoring is the term premium (the excess return that investors demand to hold a longer-term bond instead of investing in shorter-term securities), which reflects investors’ fiscal concerns. There has been some build-up in 2024, but it has come with a re-steepening of the US yield curve. At this juncture, we are not unduly concerned, but we remain vigilant.

Inflation and interest rates

We believe the neutral interest rate (the level at which economic activity is neither stimulated nor restrained) in the US is currently somewhere between 3.5% and 4%, which seems to be already priced in by the market. The surprise element is what will matter – whether the economy stays strong beyond the first quarter of 2025. For rates to fall significantly below 4%, we believe growth would need to surprise to the downside.

In terms of inflation, the core components remain sticky, which is why we think the Fed is likely to adopt a cautious policy. If the growth elements of the new administration’s policy agenda do not turn out to be as supportive as expected, the Fed could engage in further rate cuts. We need to be wary in understanding which factors will have more weight – whether it is the tax and deregulation agenda, or immigration and tariffs. Tariffs could come sooner and hit sentiment, being more painful for countries in Asia and Europe. Deregulation and migration would take some time to be reflected in company earnings and inflation. The net risks to inflation are higher, but the macro backdrop remains unclear, so we caution against drawing major conclusions.

For these reasons, we need to monitor the term premium in the bond markets. A lot of what could occur is fiscally expansive and puts upward risks on inflation in the US. Could such developments rile bond markets so that this fiscal term premium emerges? The US is a prime candidate for bond vigilantes.

The US is a prime candidate for bond vigilantes.

Weakening of the US dollar?

As dynamic investors with a long-term view of markets, we think the most interesting aspect is the policy which aims to reindustrialise the US. The ‘America First’ policy has major implications for the currency setup. While some incoming administration officials have suggested efforts to weaken the US dollar – and whether the administration actively pursues such measures remains to be seen – this does not guarantee that the currency will weaken significantly. The market’s response so far has suggested stickier rates, more persistent inflation and higher growth in the US, which is likely to lead to a rising dollar. This theme could continue, but we must be cautious as a stronger US dollar could undercut Trump’s stated policies to boost US manufacturing competitiveness.

The dollar’s trajectory is likely to be influenced by negotiations between the US and China, Europe, and other emerging-market economies which are trading partners. We believe there is a multi-year risk of the dollar’s strength reversing, leading to a weaker dollar over the long term.

Geopolitics at play

China is seen not only as a trading partner for the US, but also as a rival in the technology sector, as well as economically. This divergence in relationships may persist. Since 2018, when the last set of tariffs was imposed, China has been increasing its efforts to move away from its current account surplus with the US. We have seen this in the country’s transition from low-cost manufacturing to higher-end manufacturing of goods such as electric vehicles. We expect this trend to continue.

Europe, traditionally seen as a partner to the US, is in a tough spot owing to its economic exposure to China. The euro has weakened, and Europe faces a choice between US tariffs and its own tariffs on Chinese electric vehicles. Europe might need to offer something in return for defence protection, possibly increasing investment in the US or accepting appreciation of the euro. There might be scope for the US to negotiate with Europe, but China is a different story.

Opportunities for 2025

From a contrarian perspective, we think the US dollar’s future could be interesting. We believe an intriguing possibility is that foreign assets could outperform US assets in 2025. The euro and European assets look particularly interesting to us, as do emerging-market currencies and local rates.

In the short term, there is likely to be more pressure on the currencies, bond markets and equity markets of emerging-market economies. However, we believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term. If dollar strength does materialise, we think the most appealing assets could be in emerging markets as well as in Europe, where the market is currently pricing in a lot of pessimism. In this scenario, there could be capital outflows from the US. 

We believe there is a once-in-a-decade opportunity to buy attractively priced assets in many emerging economies, although this is predicated on the strength of the US dollar over the short term.

There is also the possibility that Europe could react under pressure. There has been more discussion around the Draghi report, which is a very detailed plan on how to deal with competitiveness and most of the major stumbling blocks that Europe faces. Should the Draghi plan receive more attention, we could see a multi-year period of investment in which Europe invests as much as 5% of GDP to repair its framework, which is still incomplete. This would be very bullish for European assets, but it is not a given.

Donald Trump has secured victory in his third US presidential bid, and with it the popular vote. This outcome reinforces the anti-incumbent trend seen across the world, with voters expressing their discontent on issues such as inflation, immigration, and lack of trust with public institutions. Trump will re-enter the White House in an evolving geopolitical landscape, as countries grapple with continuing conflicts in Eastern Europe and the Middle East, as well as tensions in Asia.

In the early days of Trump’s second term, his administration is likely to begin taking steps to extend tax cuts, deliver business-friendly, pro-growth policies and deregulation, and take a tougher stance on China. He is also likely to pursue executive orders on tighter immigration policy, energy policy, and higher trade tariffs.

As the election outcome became increasingly apparent, risk assets rallied while the US dollar strengthened. There has been a wide consensus view that a Trump victory will be positive for financial markets. However, there are several other key factors to consider when assessing the longer-term outlook, which we consider here.

A boost for US equities?

Trump’s Republican Party has won the Senate and looks very likely to take control of the House of Representatives, though several House races are yet to be called. A Republican sweep would allow Trump’s administration to get to work implementing its full policy platform. Front and centre are tax cuts and deregulation, both of which should benefit the profitability and competitiveness of US producers. This should be positive for US equities, both in absolute and in relative terms, as it should be supportive for the US dollar. Additionally, Trump has promised to use tariffs to support US producers.

While Trump has proposed to extend his 2017 tax cuts on individual incomes, to repeal the deduction cap on state and local taxes, and to cut corporate taxes, the ultimate make-up of the House will play a role in the size and scope of any tax bill. That said, all roads point to a bigger budget deficit, and the private sector will therefore need to absorb ever more US government debt. As has become increasingly clear, financial-market participants’ willingness to absorb that debt is considerably less when nominal GDP growth is high. Therein lies the irony: economic populism, whether implemented by Trump or Joe Biden, involves pro-cyclical fiscal policy. This approach increases nominal growth but, in turn, results in investors requiring a higher interest rate to lend money to the US government.

Inflation and interest-rate risks

In combination with higher tariffs and restrictions on immigration, higher deficits have the potential to generate a cyclical inflationary impulse. To be clear, the conditions necessary for a repeat of the inflation rates seen in 2021 and 2022 are not likely to stem from Trump’s policy agenda. However, a reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s (Fed) target and thus allow for an extended easing cycle. We are not yet at the point at which investors are countenancing interest-rate hikes from the Fed, but it appears very much on the central bank’s agenda to price out the rate cuts that it had previously pencilled in for 2025 at its September summary of economic projections.

A reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s target and thus allow for an extended easing cycle.

Additionally, investors would be likely to demand more of a yield pickup over short rates to take on interest-rate risk. As such, the new administration’s policy agenda, while likely to be positive for nominal growth over the short term, could increase the risk of further increases in interest rates and interest-rate volatility, both of which could have consequences for financial-market and economic volatility. In this context, it appears that the bond market is already beginning to reflect the Fed’s inability to ease policy as much as it has indicated it would like to, with government bond yields moving higher.

This time it’s different

It has been widely opined that a new Trump administration will benefit financial markets, based on historical performance following Trump’s first victory in 2016. However, while this may appear logical, the backdrop looks very different today.

Prior to Trump’s 2016 victory, global growth was slowing, evident in the commodity and emerging-market bust of 2014-15. Eighteen months of cross-market volatility had ensured that many market participants had deleveraged, leaving aggregate exposure to risk assets at historically depressed levels. Additionally, the then Fed Chair Janet Yellen had performed a dovish policy pivot in early 2016 which created the space for a broad, simultaneous easing of policy in the US, Europe and China. In turn, 2017 was the first period of synchronised global growth since the 2008 global financial crisis, and stocks soared.

We are currently several years into an economic cycle and market participants are heavily exposed to risk assets. Additionally, the growth outlook is not what it was in late 2016 following globally coordinated easing of monetary and fiscal policy.

Today, the regional outlook is increasingly divergent, and the imposition of higher tariffs by the US could mean lower growth elsewhere, particularly in China and Europe. China will probably respond with further policy announcements, and Europe is likely to ease monetary policy given fiscal constraints. We expect interest-rate differentials to diverge further as growth outside the US comes under further pressure.

Maintaining a long-term perspective

Overall, while the immediate investment implications of the US election result appear benign, it will be important to consider broader economic factors. The Trump administration’s pro-growth policies, including tax cuts and deregulation, could provide additional support for US equities. However, the potential for higher tariffs, immigration restrictions and increased deficits may lead to cyclical inflationary pressures. This could challenge the current consensus on disinflation and force a re-evaluation of the Fed’s easing cycle, potentially affecting economic stability over the longer term.

Against a complex backdrop, as investors also seek to navigate other challenges including heightened geopolitical tensions, it will be critical to remain vigilant and adaptable in seeking to identify the opportunities and avoid the risks.

Donald Trump has secured victory in his third US presidential bid, and with it the popular vote. This outcome reinforces the anti-incumbent trend seen across the world, with voters expressing their discontent on issues such as inflation, immigration, and lack of trust with public institutions. Trump will re-enter the White House in an evolving geopolitical landscape, as countries grapple with continuing conflicts in Eastern Europe and the Middle East, as well as tensions in Asia.

In the early days of Trump’s second term, his administration is likely to begin taking steps to extend tax cuts, deliver business-friendly, pro-growth policies and deregulation, and take a tougher stance on China. He is also likely to pursue executive orders on tighter immigration policy, energy policy, and higher trade tariffs.

As the election outcome became increasingly apparent, risk assets rallied while the US dollar strengthened. There has been a wide consensus view that a Trump victory will be positive for financial markets. However, there are several other key factors to consider when assessing the longer-term outlook, which we consider here.

A Boost for US Equities?

Trump’s Republican Party has won the Senate and looks very likely to take control of the House of Representatives, though several House races are yet to be called. A Republican sweep would allow Trump’s administration to get to work implementing its full policy platform. Front and center are tax cuts and deregulation, both of which should benefit the profitability and competitiveness of US producers. This should be positive for US equities, both in absolute and in relative terms, as it should be supportive for the US dollar. Additionally, Trump has promised to use tariffs to support US producers.

While Trump has proposed to extend his 2017 tax cuts on individual incomes, to repeal the deduction cap on state and local taxes, and to cut corporate taxes, the ultimate make-up of the House will play a role in the size and scope of any tax bill. That said, all roads point to a bigger budget deficit, and the private sector will therefore need to absorb ever more US government debt. As has become increasingly clear, financial-market participants’ willingness to absorb that debt is considerably less when nominal GDP growth is high. Therein lies the irony: economic populism, whether implemented by Trump or Joe Biden, involves pro-cyclical fiscal policy. This approach increases nominal growth but, in turn, results in investors requiring a higher interest rate to lend money to the US government.

Inflation and Interest-Rate Risks

In combination with higher tariffs and restrictions on immigration, higher deficits have the potential to generate a cyclical inflationary impulse. To be clear, the conditions necessary for a repeat of the inflation rates seen in 2021 and 2022 are not likely to stem from Trump’s policy agenda. However, a reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s (Fed) target and thus allow for an extended easing cycle. We are not yet at the point at which investors are countenancing interest-rate hikes from the Fed, but it appears very much on the central bank’s agenda to price out the rate cuts that it had previously penciled in for 2025 at its September summary of economic projections.

A reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s target and thus allow for an extended easing cycle.

Additionally, investors would be likely to demand more of a yield pickup over short rates to take on interest-rate risk. As such, the new administration’s policy agenda, while likely to be positive for nominal growth over the short term, could increase the risk of further increases in interest rates and interest-rate volatility, both of which could have consequences for financial-market and economic volatility. In this context, it appears that the bond market is already beginning to reflect the Fed’s inability to ease policy as much as it has indicated it would like to, with government bond yields moving higher.

This Time It’s Different

It has been widely opined that a new Trump administration will benefit financial markets, based on historical performance following Trump’s first victory in 2016. However, while this may appear logical, the backdrop looks very different today.

Prior to Trump’s 2016 victory, global growth was slowing, evident in the commodity and emerging-market bust of 2014-15. Eighteen months of cross-market volatility had ensured that many market participants had deleveraged, leaving aggregate exposure to risk assets at historically depressed levels. Additionally, the then Fed Chair Janet Yellen had performed a dovish policy pivot in early 2016 which created the space for a broad, simultaneous easing of policy in the US, Europe and China. In turn, 2017 was the first period of synchronized global growth since the 2008 global financial crisis, and stocks soared.

We are currently several years into an economic cycle and market participants are heavily exposed to risk assets. Additionally, the growth outlook is not what it was in late 2016 following globally coordinated easing of monetary and fiscal policy.

Today, the regional outlook is increasingly divergent, and the imposition of higher tariffs by the US could mean lower growth elsewhere, particularly in China and Europe. China will probably respond with further policy announcements, and Europe is likely to ease monetary policy given fiscal constraints. We expect interest-rate differentials to diverge further as growth outside the US comes under further pressure.

Maintaining a Long-Term Perspective

Overall, while the immediate investment implications of the US election result appear benign, it will be important to consider broader economic factors. The Trump administration’s pro-growth policies, including tax cuts and deregulation, could provide additional support for US equities. However, the potential for higher tariffs, immigration restrictions and increased deficits may lead to cyclical inflationary pressures. This could challenge the current consensus on disinflation and force a re-evaluation of the Fed’s easing cycle, potentially affecting economic stability over the longer term.

Against a complex backdrop, as investors also seek to navigate other challenges including heightened geopolitical tensions, it will be critical to remain vigilant and adaptable in seeking to identify the opportunities and avoid the risks.

Donald Trump has secured victory in his third US presidential bid, and with it the popular vote. This outcome reinforces the anti-incumbent trend seen across the world, with voters expressing their discontent on issues such as inflation, immigration, and lack of trust with public institutions. Trump will re-enter the White House in an evolving geopolitical landscape, as countries grapple with continuing conflicts in Eastern Europe and the Middle East, as well as tensions in Asia.

In the early days of Trump’s second term, his administration is likely to begin taking steps to extend tax cuts, deliver business-friendly, pro-growth policies and deregulation, and take a tougher stance on China. He is also likely to pursue executive orders on tighter immigration policy, energy policy, and higher trade tariffs.

As the election outcome became increasingly apparent, risk assets rallied while the US dollar strengthened. There has been a wide consensus view that a Trump victory will be positive for financial markets. However, there are several other key factors to consider when assessing the longer-term outlook, which we consider here.

A boost for US equities?

Trump’s Republican Party has won the Senate and looks very likely to take control of the House of Representatives, though several House races are yet to be called. A Republican sweep would allow Trump’s administration to get to work implementing its full policy platform. Front and centre are tax cuts and deregulation, both of which should benefit the profitability and competitiveness of US producers. This should be positive for US equities, both in absolute and in relative terms, as it should be supportive for the US dollar. Additionally, Trump has promised to use tariffs to support US producers.

While Trump has proposed to extend his 2017 tax cuts on individual incomes, to repeal the deduction cap on state and local taxes, and to cut corporate taxes, the ultimate make-up of the House will play a role in the size and scope of any tax bill. That said, all roads point to a bigger budget deficit, and the private sector will therefore need to absorb ever more US government debt. As has become increasingly clear, financial-market participants’ willingness to absorb that debt is considerably less when nominal GDP growth is high. Therein lies the irony: economic populism, whether implemented by Trump or Joe Biden, involves pro-cyclical fiscal policy. This approach increases nominal growth but, in turn, results in investors requiring a higher interest rate to lend money to the US government.

Inflation and interest-rate risks

In combination with higher tariffs and restrictions on immigration, higher deficits have the potential to generate a cyclical inflationary impulse. To be clear, the conditions necessary for a repeat of the inflation rates seen in 2021 and 2022 are not likely to stem from Trump’s policy agenda. However, a reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s (Fed) target and thus allow for an extended easing cycle. We are not yet at the point at which investors are countenancing interest-rate hikes from the Fed, but it appears very much on the central bank’s agenda to price out the rate cuts that it had previously pencilled in for 2025 at its September summary of economic projections.

A reacceleration of inflation would force a serious rethink of the now-consensus view that continued disinflation will track inflation back to the US Federal Reserve’s target and thus allow for an extended easing cycle.

Additionally, investors would be likely to demand more of a yield pickup over short rates to take on interest-rate risk. As such, the new administration’s policy agenda, while likely to be positive for nominal growth over the short term, could increase the risk of further increases in interest rates and interest-rate volatility, both of which could have consequences for financial-market and economic volatility. In this context, it appears that the bond market is already beginning to reflect the Fed’s inability to ease policy as much as it has indicated it would like to, with government bond yields moving higher.

This time it’s different

It has been widely opined that a new Trump administration will benefit financial markets, based on historical performance following Trump’s first victory in 2016. However, while this may appear logical, the backdrop looks very different today.

Prior to Trump’s 2016 victory, global growth was slowing, evident in the commodity and emerging-market bust of 2014-15. Eighteen months of cross-market volatility had ensured that many market participants had deleveraged, leaving aggregate exposure to risk assets at historically depressed levels. Additionally, the then Fed Chair Janet Yellen had performed a dovish policy pivot in early 2016 which created the space for a broad, simultaneous easing of policy in the US, Europe and China. In turn, 2017 was the first period of synchronised global growth since the 2008 global financial crisis, and stocks soared.

We are currently several years into an economic cycle and market participants are heavily exposed to risk assets. Additionally, the growth outlook is not what it was in late 2016 following globally coordinated easing of monetary and fiscal policy.

Today, the regional outlook is increasingly divergent, and the imposition of higher tariffs by the US could mean lower growth elsewhere, particularly in China and Europe. China will probably respond with further policy announcements, and Europe is likely to ease monetary policy given fiscal constraints. We expect interest-rate differentials to diverge further as growth outside the US comes under further pressure.

Maintaining a long-term perspective

Overall, while the immediate investment implications of the US election result appear benign, it will be important to consider broader economic factors. The Trump administration’s pro-growth policies, including tax cuts and deregulation, could provide additional support for US equities. However, the potential for higher tariffs, immigration restrictions and increased deficits may lead to cyclical inflationary pressures. This could challenge the current consensus on disinflation and force a re-evaluation of the Fed’s easing cycle, potentially affecting economic stability over the longer term.

Against a complex backdrop, as investors also seek to navigate other challenges including heightened geopolitical tensions, it will be critical to remain vigilant and adaptable in seeking to identify the opportunities and avoid the risks.

The long-awaited Budget, the first for the Labour government in over 14 years, was unveiled on Wednesday. The focus of the bond market has been on the widely telegraphed re-writing of the fiscal rules, the impact of investment and spending plans on near-term gilt issuance, and the short and medium-term impact on inflation and economic growth of the various measures announced. The outturn was directionally similar to market expectations; however, the Office for Budget Responsibility (OBR) forecasts point to moderately higher borrowing needs than expected each year, and inflation a little above target until 2028, potentially curtailing the ability of the Bank of England to cut rates. These two factors pushed yields up during the course of the afternoon.

The previous Conservative government had progressively eroded fiscal headroom and public investment had been falling in real terms, indicating a need for change. At the same time, the new Labour government has made clear political choices to focus on lower-income and unionised wage-earners and public-sector workers, possibly at the cost of older and, in some cases, asset-rich citizens.

The fiscal rules and many of the measures announced had been shared in advance, and the bond and currency markets had anticipated much of this, but the gilt market has reacted mildly negatively to the fact that gilt issuance will be at the upper end of what was feared.

Long-dated gilt yields had risen more than short-dated gilt yields since the UK election, partly in anticipation of higher spending and greater gilt issuance in future years. More recently, yields had risen a little faster for medium-dated maturities as some investors thought that the extra gilt supply may be concentrated in that area, to take advantage of lower yields in those maturities.

Sterling had strengthened modestly since the election, but this was more likely owing to expectations of a closer relationship with the European Union, and a period of relative stability after the election, rather than a clear verdict on growth or the interest-rate trajectory.

Immediate market reaction

While Chancellor Rachel Reeves spoke, there was little reaction, but the OBR forecast and the UK Debt Management Office (DMO) revised supply guidance has caused a small sell-off in gilts. Changes to the fiscal rules to the public sector net financial liabilities definition of borrowings created additional headroom, and the Chancellor has used most of this immediately. Expectations had been for tens of billions of pounds in extra borrowing each year compared to prior OBR forecasts. However, the reality is more in the range of £20-30bn per annum, which is larger than the supposed ‘black hole’, despite billions of pounds of tax increases.

Bank of England reaction function

On balance, the Bank of England has maintained a dovish stance. This week’s Budget may temper that, but the Bank of England governor Andrew Bailey has previously expressed less concern about higher public sector pay compared to private sector pay as an inflationary catalyst. In addition, tax increases are more front-loaded, while much of the investment spending will take longer to deploy, potentially keeping a lid on short-term growth.

Inflationary pressures

The OBR has confirmed our expectation that the measures announced would tend to be inflationary. Avoiding the main direct personal taxes, but imposing higher costs on businesses (through higher employer national insurance contributions and an above-inflation increase in the living wage), as well as raising indirect taxes, is likely to result in higher prices.

Consumer Prices Index (CPI) inflation

Source: OBR

Productive investment or spending?

Key for the long term will be whether this budget and this administration delivers productive investment, or simply spending. Infrastructure upgrades would be welcome, as would measures to reduce the swollen ranks of those not in work owing to health issues. Increasing the pool of those able to work would reduce some of the upward pressures on employment costs linked to other measures.

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