Post-election realities

The US election results were a significant market driver, with Donald Trump’s victory and the Republican majority in Congress boosting expectations of tax cuts, deregulation, expansionary fiscal policy and a stricter trade policy. In November, this optimism led to a strong performance by US equities, particularly small caps. In the aftermath of the election, Donald Trump’s announcement of new tariffs led to negative reactions elsewhere, including in emerging markets, which underperformed their developed peers. In Europe, political developments in France and Germany, particularly concerning the government’s budgets, weighed on Euro area equities. We acknowledge that regional performance differences have stabilised recently, as markets await the inauguration and first decisions of the new President. Our strategy at the turn of the year is straightforward: we have an overweight Equity portfolio positioning, expressed via a preference for US equities. European assets could shine in the fixed-income segment where we are positive on core European bonds and negative on US duration as a monetary policy divergence could drive yields in 2025.

American equities come first

In November, we adjusted our equity positioning based on the potential upcoming policy shifts of the new Trump administration. In December, we have confirmed the regional choices and slightly adjusted the sector exposures:

• We hold an overweight position on US equities, the broad market, including small-cap stocks and sectors that would benefit from stronger GDP growth and stimulus policies. Financial stocks are expected to gain from deregulation, with banks comprising 20% of the small-cap index, while we expect Software and services to outperform.
• We hold an underweight position on EMU equities which face stagnating growth, domestic political challenges and appear vulnerable to the trade policies of the future US administration. Regarding pan-European equities, we have a neutral view on UK equities.
• Finally, in emerging markets, although the US election result poses a challenge through currency impacts and trade tensions, we keep our position where we see an asymmetric upside risk on Chinese equities. We are awaiting greater clarity from the local authorities and potential new support measures on housing completions and consumer confidence as we expect the country to fight back internal deflationary forces and respond to external trade tariffs.

In summary, our current moves reflect a preference for US equities, while retaining some flexibility in emerging markets. Interestingly, big-cap stocks in the S&P500 generate 60% of their revenues in the US, while the small-caps in the S&P600 Small index are even more domestically-oriented, generating 80% of their revenues in the region.

The US economy is expected to outperform globally in the coming year, driven by the tax cuts, deregulation and fiscal policies proposed by the Trump administration. Based on our recent forecasts, US GDP growth is projected at 2.6% in 2025, with inflation moderating to around 3.3%. However, the impact of tariffs, particularly on China, could increase consumer prices and reduce GDP growth by 0.7% in the US if implemented too aggressively.

According to consensus forecasts, this will trickle down and support profit growth for corporate America. Contrary to the past two years, the vast majority of stocks in the US will again enjoy profit growth on aggregate – a privilege which was previously limited to the most dynamic, technology-driven “Magnificent Seven” stocks. As a result, the expected narrowing of the profit growth differential should support the entire US stock market.

Trade uncertainty has already risen sharply

China’s economy is expected to grow at a slower rate in the coming years, with GDP growth forecast to moderate to 4.3% in 2025. While the Chinese government has announced stimulus measures, including infrastructure investments and monetary easing, these have so far been insufficient to counteract the persistent deflationary pressures in the economy. The country’s manufacturing PMI has shown improvement, but the services sector remains weak, indicating a broader challenge in transitioning toward a more consumption-driven economy.

Real-estate investment, a major driver of China’s growth in previous years, remains under pressure, as home sales show signs of recovery but broader real-estate investments continue to drag on economic performance. As inflation remains low and weak domestic demand persists, China may be forced to announce further stimulus measures to prevent a more significant slowdown. The Chinese authorities will likely continue to focus on supporting industrial sectors, while consumption growth remains limited due to low consumer confidence and high levels of household debt.

Supporting domestic sectors in China will be key as external trade will likely be shocked by the new US administration. The Politburo announced a set of counter-cyclical measures but so far little is known about the size and composition of fiscal support. Meanwhile, China unveiled a 10 trillion-yuan debt swap programme to ease local government financing strains. Overall, the programme is expected to reduce the interest burden by about 500 billion yuan in the next five years, which should help mitigate fiscal stresses on local governments and free up resources to support growth, although we do not expect the debt swap programme to be a game changer for activity in the country.

In addition to domestic challenges, global trade uncertainty has sharply increased following the election of Donald Trump, with the largest recorded jump in the monthly data since 1960!

Yuan weakening comes second

Higher trade tariffs imposed by the US are likely to lead to retaliation from trading partners, particularly China. One potential retaliatory measure is the devaluation of the Chinese yuan (CNY). By lowering the value of its currency, China can offset the impact of tariffs on its exports, making its goods more competitive in international markets.

The ongoing devaluation of the CNY during Q4 has broader implications for the global economy: it has led to increased volatility in currency markets, may impact trade balances if weakness persists, and could impact affect the profitability of multinational companies with exposure to China. Additionally, a weaker CNY could contribute to global disinflationary pressures, as cheaper Chinese goods reduce overall price levels. During Donald Trump’s first term as US President, this was the response by Chinese authorities and the authorities have recently confirmed that they would use this tool if new tariffs were to be imposed on Chinese goods.

Of course, both investors and Donald Trump’s team remember his first administration and China’s response at that time to counter US tariff hikes. Nominations for the upcoming administration and the fact that President-elect Donald Trump has invited Chinese President Xi Jinping to attend his inauguration on 20 January could indicate that China could avoid new tariffs on day one. Longer-term, the US agenda for China economic relations appears to be one of decoupling – or even cancellation – in sensitive sectors that will likely not be open to negotiation.

Monitoring supply chain pressures remains key for upcoming monetary policies

From a fixed-income investor perspective, the fact that China is a global source of disinflation represents good news. Clearly, global supply chain pressures are currently under control, with China playing a key role. It is worth noting that China’s role in the global supply chain is significant, as it is a major producer of intermediate goods and components used in manufacturing processes worldwide. Investors are sensitive to that measure, as it was at the origin of the inflationary boost at the start of this decade.

As was the case five years ago, at the onset of the pandemic, a rise in trade tariffs would represent a grain of sand in the mechanism of global trade. Investors and central bank policymakers will estimate the impact of this issue on the smooth functioning of global trade according to the timing, size and potential retaliations in a trade war scenario.

Again, while trade uncertainty has already risen and tariff hikes are likely to come, the good news is that there is currently no significant tension in the global supply chain. We will continue to closely monitor this indicator in the coming months in order to gain insights for estimating the central bank’s reaction function.

By lowering rates, the ECB could represent a support for Europe

Market-implied central bank interest rates expected for July 2025 show that the spread between the Federal Reserve (Fed) and the European Central Bank (ECB) is widening beyond 200 bps (from 140 bps). This widening spread already reflects the divergent monetary policy paths of the two central banks. On the one hand, the Fed is expected to pause its easing cycle, maintaining interest rates at a level to combat inflation. On the other hand, the ECB is likely to maintain a more accommodative stance, to support economic growth in the Euro area.

The widening spread has implications for currency markets, with the US dollar expected to strengthen against the euro. But US president-elect Donald Trump wants to avoid a strengthening of his currency. Transatlantic monetary policy divergence may impact trade balances and capital flows between the US and Europe, and could represent a subject of tension between the two regions.

While policy uncertainty has already sharply risen, a weaker currency and a more accommodative policy mix could represent a pleasant surprise for European investors. At the current juncture, we expect the US economy to outperform, fuelled by reflationary policies, while Europe faces challenges, particularly from weak growth, trade uncertainties and political instability. These elements underpin our preference for a long duration via core European sovereign bonds.

At the end of 2024, we expect global equity markets to register further progress, led by the broader US equity market. Emerging markets and the Eurozone may continue to struggle under the weight of rising trade tensions and economic uncertainties