In our first macro update for 2025, Kevin Boscher considers the outlook for this year and what investors can expect.
At a glance:
- There is broad consensus that the Trump administration will be positive for markets and the US economy.
- Three key themes will dominate the investment outlook: the return of supply side policies in the US, an increased acceptance of fiscal loosening and the escalating battle between globalisation and protectionism.
- Central banks will cut rates but perhaps not as much as expected in the US and UK.
- The macro backdrop remains supportive for equities, although caution is required short-term.
- US equities should continue to perform strongly but the rally could broaden out both within the US and externally to include select small/mid-cap, cyclical and value stocks.
- Fixed-income investors should focus on quality income and avoid taking excessive risks with duration or credit quality.
- Key risks are that US growth disappoints, US inflation forces a change of Fed policy, a new Euro crisis, a deflationary slump in China, or an escalation of geopolitical concerns.
- Positive surprises could be that ‘Trump 2’ results in an easing of trade and geopolitical concerns.
As we start the new year, there is a broad consensus that the second Trump presidency will be positive for the US economy and financial markets thanks to his strong reflationary agenda, which includes tax cuts, deregulation, lower energy costs, a weaker dollar and a re-industrialisation of the US. The impact of these policies on the rest of the world are less clear as an escalation of a global trade war and increased geopolitical uncertainty would likely negatively impact both China and Europe at a time when they are already facing a cyclical and structural slowdown. There are also big question marks around the outlook for US inflation given the Trump agenda and whether the Federal Reserve (“Fed”) will be able to cut rates as much as markets currently expect. All of this means that growth, inflation and interest rates across the world’s biggest economies are liable to move in different directions over the next year or so and there remains considerable doubt about where the macro backdrop is headed and what this might mean for markets.
Despite this, I remain positive on the outlook for markets, especially equities, but the early part of the year could be volatile, and therefore more challenging, as we await clarity on some of the big issues at play and as markets go through a reset of expectations.
There are three key themes that are likely to dominate the investment outlook for 2025 and beyond. This includes the return of supply-side economic policies in the US; an increased acceptance of fiscal loosening in Europe, China and the UK; and the escalating battle between globalisation and protectionism. In addition, a number of critical questions remain unanswered, all of which will likely have a material impact on both the global economy and markets. These include what will ‘Trump 2’ actually look like? Where is US inflation headed and how will this influence the Fed? Will China finally go for growth and embark on meaningful monetary and fiscal stimulus? Are we in the early stages of another Euro crisis, but this time with Germany and France at the epicentre? Is Japan finally out of deflation and what does this mean for the yen? Can the extraordinary period of US exceptionalism and stock market out-performance, which began around the time of the great financial crisis in 2008, continue? Given these questions, it is not surprising that markets ended 2024 in a reflective mood after a good run with bond yields drifting higher and equities giving back some of their gains.
The US will benefit from supply side reforms and productivity growth
Trump’s economic policies and “America first” principle are similar to the supply-side policies adopted by Thatcher and Reagan in the early 1980s, which, together with tight monetary policy, led to a surge in US labour productivity, falling inflation, strong nominal and real growth and the booming 1990s. Financial markets worry less about how unconventional Trump might be and focus more on the positive impact his reflationary policies might have on US growth, productivity, income and wealth inequality, corporate profitability, and asset markets. The US will likely be the only major economy embracing such policies at a time when the economy has already proven relatively strong and innovations across multiple sectors (AI, Cloud computing, biosciences, quantum computing etc.) have boosted productivity growth since the pandemic. It’s true that there are several inconsistencies in Trump’s policies, most notably tax cuts and deregulation versus tariff hikes and restricted immigration. Also, it will take some time to work out exactly how those policies will be executed, what the reaction of other countries will be, and what the impact will be on US inflation and Fed policy. However, markets are anticipating a net positive impact, and I tend to agree. I think it is likely that US growth will continue to be well supported for the next year or so and could be in the early stages of a productivity-led boom, although the rising government debt burden is the underlying longer-term trend and threat. All of this makes it unlikely that the period of US exceptionalism will end any time soon.
China and Europe need to loosen fiscal policy
One of the key reasons why the US economy has consistently outperformed its major peers over recent times is that it is the only country to have consistently loosened fiscal policy during crises or recessions. This has been especially evident since the pandemic. Most other governments fear that a sustained rise in indebtedness will eventually lead to fiscal ruin and have adopted a more conservative approach targeting balanced budgets and deficit and debt reduction. It is perhaps ironic that countries that have pursued such a strategy have experienced economic pain and political turmoil, such as France, Germany and the UK.
Whilst it's true that rising debt levels and fiscal deficits can lead to major economic and financial difficulties, it’s also true that fiscal conservatism presents significant risks in a world still burdened with excess private savings. For example, in Japan, Germany, China and the US, the combined private sector generates excess savings amounting to $1.4 trillion. In Japan this equates to 11% of GDP and 9% in Germany. Excess savings represent a demand deficit and put downward pressure on growth (consumption and investment), inflation, and bond yields. Either these savings are exported via current account surpluses, as in Japan and China, or the public sector needs to offset them through fiscal deficits. In the case of the US, it helps that the dollar is the world’s reserve currency and needs to run a big deficit (trade and budget) in order to soak up these excess reserves. I have previously argued that many governments will need to adopt easier fiscal policies to boost growth, help inflate away their growing indebtedness and as they face multiple spending challenges, including income and wealth inequality, a fragmenting global economy, climate change, and an ageing demographic. It’s clear that the incoming Trump administration will no longer tolerate large trade imbalances and this will put further pressure on countries with large surpluses to act.
China has been forced to run increasing fiscal deficits in recent years due to slowing growth, rising excess savings, increasing unemployment, and price deflation. China has also been hit by a collapsing property market, increasing trade tensions and falling consumer and business confidence at the same time as it attempts to re-balance its economy towards domestic consumption and higher-end manufacturing. With nominal growth having fallen below real growth as inflation has turned negative, this risks a real crisis and demands more robust government action. It is likely that the government will continue to focus on preventing an economic crisis rather than trying to engineer a sharp turnaround in economic growth given its long-term objectives. This challenge will be more difficult under a Trump administration. Hence Chinese growth will likely continue to disappoint in 2025 and beyond and the country may remain a source of global deflation. However we will see further monetary and fiscal stimulus as the year progresses and should China abandon its conservatism and act aggressively, this would be a major boost for the global economy but also a threat to inflation elsewhere.
The Eurozone economy will likely continue to struggle in 2025 as it faces a number of cyclical and structural issues, including a shrinking workforce and ageing demographic, poor productivity growth, an excess of private sector savings, a weak China, and rising US protectionism. The Maastricht Treaty has institutionalised fiscal conservatism, which has exacerbated the region’s weak growth and over-saving dynamics. For example, Germany has been in fiscal austerity since 2021, despite economic stagnation. This tough macro backdrop is resulting in major political change with a move to both the extreme left and right in many countries and the unseating of incumbent governments, most notably in Germany and France. Without a decisive shift in fiscal policy, it is likely that Europe will face more economic pain and political unrest. The European Central Bank is also expected to be the most aggressive central bank in terms of monetary easing with at least four rate cuts expected this year.
The UK economy also faces multiple challenges, as the new Labour government is quickly finding out. If the government is to turn around the long-term decline in growth and labour productivity, it really needs to copy some of the supply side reforms favoured by Trump, such as tax cuts and deregulation, in an effort to attract long-term investment and boost labour productivity. It also needs a cheaper energy policy. In Japan, the government has been focused on breaking out of its long-term deflationary trends through a combination of relatively easy monetary and fiscal policies. There are some encouraging signs that these policies are working with inflation back above 2% and wage growth also strong. The Bank of Japan will likely be the only major central bank raising rates this year, but at a gradual pace, whilst fiscal policy will stay accommodative.
The battle between globalisation and protectionism will continue to escalate
History can teach us a lot when it comes to the battle between globalisation and protectionism. Economic prosperity usually coincides with rising globalisation, as was evident from the experience since the fall of the Berlin Wall in the early 1990s and China’s entry into the World Trade Organisation in the early 2000s. The last major protectionist era emerged in the 1920s and 30s, when rising tariffs contributed to a global economic collapse, a salutary lesson which is very relevant today. It is ironic that the US is leading the anti-globalisation charge despite having the strongest economy and lowest unemployment rate in years. US companies have also been significant beneficiaries through increased sales and lower costs as have US assets generally as surplus global savings have been re-invested in the US. Rising discontent over income inequality and declining middle-class living standards have fuelled the anti-globalisation sentiment and been a major factor in the rise of Trump. These trends are likely to continue over the next few years with tensions between protectionism and globalisation expected to escalate.
Whilst Trump’s domestic policies are targeting higher growth, his trade policies may backfire as tariffs are unlikely to create US jobs and could hinder growth. His policy on sending back illegal immigrants could also weaken the workforce and dampen growth. With high US labour costs and a strong dollar, re-building US manufacturing will be tough. So far, the protectionist policies in place since Trump‘s first presidency have failed to lift manufacturing as a share of US GDP. There’s little doubt that a second Trump administration will result in global trade relations becoming more volatile and unpredictable. However, the world now has some experience in navigating these challenges and there are many mechanisms to help offset the negative impacts from tariff hikes, such as currency depreciation, tax rebates and export incentives. Central banks can also ease monetary policy if required. In addition, China and other emerging countries, which are significant beneficiaries of globalisation, can continue to promote it, as we are now seeing with China increasing trade with Asia, the Middle East, Latin America and Africa.
If the world can avoid a 1930s-style trade war, then the impact of trade tensions should not derail the global economy in the near-term, although they will continue to have a major bearing on the changing world order as I have discussed previously. I am also of the view that a potential positive surprise for this year could be that trade tensions actually ease a little as Trump finds a way to agree deals with China, Europe and Japan. Given that his major objective with trade is to reduce America’s deficit and thereby boost growth, his transactional style might result in a significantly different result than expected. For example, a deal with China could involve China assisting in establishing peace in Ukraine and the Middle East while simultaneously revaluing the yuan in return for lower tariffs and more two-way trade. With Europe, any deal could see Europe importing more energy from the US whilst Japan might be encouraged to let the yen revalue versus the dollar, especially if the Chinese currency also strengthens.
Central banks will continue to cut rates but the Fed and Bank of England may disappoint markets
We will see further monetary easing from the major central banks this year, but perhaps not as much as currently expected in markets, especially in the US. Market expectations have already shifted in this direction following data implying that the disinflation trends in the US and UK are coming to an end and after a surprisingly hawkish Fed December meeting. In the US, there are strong reasons to take encouragement that longer-term growth potential is increasing thanks to rising productivity, a deleveraged and more confident consumer, and accelerating money supply and credit creation. This implies a higher neutral interest rate going forward and although the Fed will have little conviction or evidence to back this up at this point, it is also acutely aware of the potential impact of Trump’s policies on both growth and inflation.
It is also worth noting that an escalation of the trade wars will not automatically drive inflation higher in the US. Long-term inflation normally stems from sustained excess demand, but increased tariffs represent a once off, transitory event and a price shock, similar to a tax hike. Also, some of the inflationary impact can be offset by a rise in the dollar, for example, or a fall in demand or import substitution. Given this backdrop, I think that markets are broadly right to assume that the Fed is unlikely to ease much this year, especially if Trump’s policies result in an economic boom and inflation starts to rise again. Having said that, and as I have previously argued, I also think that 2% is now the floor for US inflation rather than a target and the Fed will be happy to tolerate inflation in a 2-3% range, even if it can’t explicitly confirm this. The real risk is if inflation starts to move back above this level forcing the Fed to resume rate hikes. This would certainly be a market-changing event. Elsewhere, the Bank of England may also struggle to cut rates as much as expected, despite weaker growth, as inflationary pressures appear to have troughed and are rising again. The European Central Bank will cut rates aggressively, as already mentioned whilst the Bank of Japan will buck the trend and raise rates, albeit gradually.
Equities remain in a bull market but caution is required near-term
The macro environment continues to favour equities and the US, in particular. Hence, we likely remain in a bull market, although there are plenty of reasons for caution in the near-term. Markets have already discounted many positives, which may not occur as quickly as anticipated or with the expected outcomes. Also, most measures of equity sentiment and positioning suggest that momentum and bullishness may be over-extended. Valuations also look stretched in some areas, most notably large-cap US, and especially after the recent rise in bond yields. In addition, and as already explained, Trump’s actual policies and their impact could differ materially from expectations, whilst interest rates may not fall as much as expected.
Beyond the next few months, however, there are several reasons to stay positive about equities. Both monetary and fiscal policy should be supportive for global reflation, especially if Europe eases its fiscal restraint and China becomes more aggressive in targeting higher growth. This will be positive for company earnings and help alleviate some of the valuation concerns. Lower rates will also add to the reflationary impulse and enable some expansion at the same time as valuations in many markets and sectors (outside of the US mega-cap) look reasonable. In the US, equities should benefit from two rare bullish combinations. The Fed will cut interest rates, even if not as much as expected, into an expanding economy and with inflation above 2%. The last time this happened was in the mid-90s, a period with many similarities to the present. Secondly, rising productivity, lower energy and input prices and steady pricing power point to rising margin growth for many companies. All of this is happening at a time, of course, when Trump’s deregulation and tax cuts could significantly boost the economy and stock prices. Generally, improving global liquidity as monetary and fiscal policies are eased and business and consumer confidence improves will add to the positive case for equities.
There are sound reasons why the extraordinary decade-plus of US exceptionalism should continue for some time, despite the fact that this is the overwhelming consensus view (which can be right for long periods of time in markets)s. The US economy has proven more resilient than other major economies and pro-business policies under the incoming Trump administration should further strengthen growth in absolute and relative terms. No other economy is expected to pursue a similar policy. Whilst US equities look expensive, this largely reflects superior earnings growth and other financial dynamics. For example, US equities may trade at a 40% premium to other developed markets, but US companies have delivered superior relative earnings in the region of over 100% during the same period. There are good reasons to believe that this earnings superiority and market outperformance can continue for a while longer.
The equity recovery should broaden out
I am hopeful that the next stage of the bull market could see a broadening out of the rally, not only domestically within the US but also globally. Small and mid-cap stocks and select cyclical and value stocks should also benefit from stronger growth and improving earnings. However, those companies most exposed to global trades frictions may still struggle depending on how events unfold. It’s true that the mega-cap growth stocks in the US look expensive and reflect a very bullish sentiment and positioning, but the key question for these companies is whether they can continue their trend of delivering relatively strong earnings growth, cash flows, and superior returns on capital. They are certainly well positioned to benefit from the AI boom but one of the features this year may be that markets look more positively on other beneficiaries of this exciting technology. Emerging markets should be boosted by a stronger global economy and lower rates, especially if China acts more aggressively and Trump is successful in weakening the dollar. Asia generally stands out as it looks set to benefit from the secular trend of supply chain diversification and an increasing share of foreign direct investment from across the world.
Fixed income investors should focus on quality and avoid unnecessary risks
The outlook for global bond markets is mixed and a key objective for fixed income investors in 2025 should be to focus on quality income and avoid taking excessive risks with either duration or credit quality. Another key theme for bond investors will be to see where US interest rates find themselves at the end of this cycle. Sovereign bond yields have drifted higher over recent months as investors have become concerned about the long-term implications of growing fiscal deficits and the impact of ‘Trump 2’ on US inflation and Fed policy. The yield curve has also moved to a more normal positive shape as longer-dated securities now offer a higher yield than shorter maturity issues, albeit by a relatively modest amount. This is understandable given the macro backdrop and it is sensible for investors to desire a higher risk premium for longer-dated sovereign bonds.
There are certainly plenty of reasons for caution around US Treasuries given the reflationary policies, growing deficit and debt dynamics, plentiful supply and falling appetite for ownership from foreigners and central banks. Having said that, assuming that inflation stays below 3% and the Fed cut rates once or twice more this year, US sovereigns look reasonable value at current levels and the upside for yields is likely modest. As I have previously pointed out, financial repression is here to stay given global debt levels and central bank policies. UK Gilts and European sovereign bonds also look reasonable value, but care is required given sticky UK inflation and the increasing problems in the Eurozone. Credit markets should benefit from lower rates and a strengthening global economy but again caution is warranted as spreads are at or near record lows for investment and high yield issues, implying that a lot of good news is priced in. The global macro backdrop continues to favour a preference for shorter dated and higher quality fixed income securities, where attractive yields can still be obtained relative to cash, inflation and most equity markets.
Trump would like a weaker dollar but may not get it
The Trump administration would like a weaker dollar to reduce the trade deficit, boost growth, and improve the competitiveness of US industry. However, the policies being outlined are more likely to support the dollar in the near-term given the focus on higher tariffs, easier fiscal policy and stronger growth. The Fed is likely to keep monetary policy tighter than it would otherwise have done over the next year or so and US bond yields remain higher than other major sovereigns. The combination of a loose fiscal policy and strong monetary policy is usually supportive for a currency. The continued relative strength of the US economy and corporate profitability is also likely to attract further inward investment. At the same time, it is difficult to see how the dollar could weaken against other major currencies, especially the euro, given the relative economic backgrounds. The one caveat here is that Trump might try to force Japan and China to revalue their currencies upwards, as previously mentioned, and as part of his tariff negotiations. Longer-term, it is perhaps easier to see a path to a weaker dollar as investors shy away from the growing fiscal deficit and as the China-led economic alliance seek to diversify away from dollar assets.
The outlook for commodities is complex and driven by political as well as economic factors. A key part of Trump’s strategy will be to drive down energy prices within the US to help keep inflation in check and also to help the US manufacturing revival. His administration is expected to deregulate the fossil fuel industry and encourage increased oil production. As the US is the largest oil producer, if this strategy is successful this will tend to put downward pressure on oil and energy prices. A soft Chinese economy, a relatively weak European economy, an escalation of trade tensions and a stronger dollar could also be negative for energy prices. Gold should also continue to do well thanks to global central bank purchases, growing debt and deficits and geopolitical tensions. Central banks in China and other emerging countries have been the biggest buyers of gold since 2008 and this has been fuelled by heightened apprehension that the US can easily weaponise the dollar and the financial system for geopolitical reasons. There is increasing evidence, including a recent issue of a $2bn bond in Saudi by China, that China and its allies are planning moves to fund global trade in currencies other than the dollar. There has also been talk of a digital yuan backed by gold. For other industrial commodities, developments in China and trends in the dollar will be key factors but geopolitics will also play a part, for example if China restricts exports of rare earths as a retaliation for increased tariffs.
Despite threats to the macro and market outlook, I expect a positive outcome
As always, there are plenty of potential threats that could derail the positive consensus and throw both economic projections and markets off course. The macro backdrop continues to evolve in an unpredictable manner with cyclical, secular and political forces all pulling in multiple directions. The biggest risk is probably that the US economy struggles and growth slows sharply on the back of a major global trade war or a spike in US bond yields, either because of rising US inflation or bond vigilantes rebelling against the growing fiscal deficit. This would certainly be a negative shock for the consensus and markets, equities especially. Another key risk is a new Euro crisis as Germany ushers in a new right-wing government and the German-French axis falls apart. Other risks include a renewed deflationary slump in China or an escalation of geopolitical risks in the Middle East, Ukraine or even the South China Seas.
Despite this, I remain optimistic that the global economy will strengthen over the course of 2025 and beyond thanks to a pro-growth US administration, a more aggressive Chinese stimulus and a relaxation of the Eurozone fiscal jacket. I also think that one of the positive surprises could be that ‘Trump 2’ is actually positive for the geopolitical environment as he seeks to work with China to bring an end to the Ukraine war and avoid an all-out trade war. Assuming the macro-outlook turns out as expected, the next stage of the bull market could see a change of leadership and a broadening out of the rally. For many markets and sectors, we are still in the early stages of a recovery from the pandemic and war-related shock and valuations look attractive. Inflation remains the key for the longer-term outlook and the pendulum continues to move slowly towards the higher for longer (Fire) camp, but with the caveat that nobody knows and things can change very quickly. In the shorter-term, the general macro, fundamental and technical environment remains supportive for markets but investors should remain flexible and adopt a diversified and balanced approach.
