First and foremost, we would like to wish you a happy, healthy and prosperous 2025. We’re using the first weekly market update of 2025 to answer some questions we’ve received following the release of our 2025 Market Outlook.
Overall, we think markets may have overreacted to the potential impact of tariffs on inflation and, more generally, the consequences of Trump’s impact on the economic outlook. Many feel that Trump’s arrival will mean more growth and inflation. To be fair, this could be true, but only to a certain extent. Trump will have to manage two central conundrums: growth and inflation.
He’ll have to reconcile his potentially inflationary agenda due to the tariffs and tax cuts with his campaign promises to fight inflation. It’s unclear whether the current 21% corporate tax rate will be rolled over in 2025. While this rate is currently fixed, other provisions of the Tax Cut and Jobs Act signed during Tump’s first mandate are set to expire at the end of the 2025 fiscal year (30 September 2025). Any change to the corporate tax rate would require legislative approval by Congress. For now, no new legislation has been enacted to modify the existing rate.
In addition, it’s also worth noting that higher tariffs, which have been in place since Trump 1.0, have not narrowed the trade deficit (exports net of imports). It’s widened even more. After all, a stronger US dollar allows US importers to import more, but it hurts US exporters. We think tariffs are a means to an end, not an end in itself. With Trump’s entourage seemingly more pro-business vs Trump 1.0, the new Trump administration policy tone could be more balanced, albeit still influenced by “America First”.
Trump faces similar challenges with growth. Fiscal stimulus, if not so big to trigger inflation and rate hikes, is positive for the economy. What about anti-immigration laws? Tightening immigration policies for skilled foreign workers, whom tech companies hire a lot, may lead to increased business offshoring, contradicting Trump’s goal of reshoring jobs to the US.
From an investment perspective, we maintain an equity overweight, with a preference for US equities. Still-strong US growth (see below) supported by an AI investment cycle and the US Federal Reserve’s (Fed’s) rate cuts are positive catalysts. Meanwhile, risks of higher inflation made us swap shorter-dated inflation-protected bonds with longer-dated ones. Moreover, tariffs are likely to be negative for the rest of the world. We recently lowered our European equity exposure, and we don’t have tactical emerging market positions across equities and fixed income.
Market expectations of interest rates are notoriously volatile. The recent rise in US yields has had ripple effects on European markets, particularly in the UK, compounded by domestic factors. The recent sell-off in the gilt market underscores the fragile balance central banks face between combating inflation and maintaining financial stability, along with the need for the government to maintain fiscal discipline.
Nevertheless, we think most central banks across the globe will continue cutting interest rates in 2025 as inflation gets close to target. This means that rate cuts are likely to remain a tailwind for bonds. That said, central banks will only reduce rates to more ‘normal’ levels of around 4% for the US and the UK and 2% for the eurozone, rather than the lows we saw following the global financial crisis.
A more sluggish growth outlook and lower inflation in the eurozone and the UK make it easier for the European Central Bank and Bank of England to cut rates. That’s why we are overweight in short-dated government bonds, which are less sensitive to the fiscal outlook and more dependent on the near-term central bank path.
Conversely, the outlook is less clear for the US, given that Fed Chair Powell dampened expectations of interest rate cuts due to solid US economic data. That said, we think the Fed, after pausing for a few months, will continue cutting rates in 2025 for the following reasons:
We’ve so often heard that the US market is overvalued. Now we hear it’s concentrated. On the former, while currency values tend to mean revert over (a long) time, there’s less evidence for equities. Valuation is not a timing tool, and elevated valuation is not necessarily a bad thing. The rise in valuations significantly contributed to the good performance of the equity market in 2024, accounting for more than half the return of the S&P 500 equity index and nearly half the return of the MSCI All-Country Index. Market concentration risk refers to the danger of relying too much on a few companies, industries and/or sectors when investing. While we run a diversified approach, concentration risk could be present in some of the assets we own.
For instance, we still like large caps and tech companies due to the ongoing AI investment cycle. However, they dominate the US equity market. Looking at the numbers, the combined market capitalization of the biggest seven US public companies (the Magnificent 7) accounts for more than a third of the total S&P 500 market capitalisation. Relative to peers, the Magnificent 7 added USD 10.5 trillion in market value in 2024; that’s the size of the French, German and UK stock markets combined.
But concentration is not just a US risk. The largest 10% of companies in the S&P 500 or the Nasdaq 100 index account for around 60% of both indices. However, the largest 10% of companies in the pan-European STOXX 600 index account for 58% of the index and 45% for the UK FTSE 100 index and the Japanese Nikkei index. In addition, in 2024 these top US companies delivered strong earnings of around 15% on average, which mitigates this concentration risk.
So, how do we tackle this risk? We’ve diversified our exposure away from tech and large caps by adding the S&P equal weight index to our portfolios. Trump’s policies point to a broadening of growth across other sectors. Less regulation would benefit financials. Tax incentives, tariffs on offshoring, and the special economic zone would each support industrials. There’s a valuation argument, too, as this part of the market has more average valuations.
The focus is on US and UK inflation data (Wednesday). US consumer prices are expected to have moved up in December, just below 3%. It’s mainly due to a rise in energy and possibly also services prices. Core inflation (without energy and food prices) is expected to remain a bit higher at 3.3%.
In the eurozone, apart from hard industrial and retail figures in November, Germany’s first GDP estimate for 2024 (Wednesday) will likely show a marginal shrinking of the region’s biggest economy for a second consecutive year (the consensus is -0.1%). This would support the case for further ECB cuts. Moving East, China’s GDP for the last quarter of 2024 (Friday) should have risen closer to Beijing’s 5% target, supported by the late-2024 stimulus measures.
Lastly, the US Q4 earnings season will start, with JP Morgan and UnitedHealth among the first to report in the second half of the week.
