The valuation and investor sentiment gaps between U.S. stocks and the rest of the world appear extreme.
The year was dominated by three major investment themes: inflation, central bank rate policy and the US elections. The US election result has brought both clarity and uncertainty for 2025. The good news is that the election result is clear and undisputed, the bad news is that President-elect Donald Trump is rather unpredictable. His electoral program is quite clear, but the way in which he will implement it, or will be able to do so, and the speed with which he will do so, will be sources of uncertainty in the months to come. At this stage, investors have enthusiastically integrated the positive aspects of his program, mainly deregulation, tax cuts and the relative growth advantage of the American economy compared to its main trading partners. The US dollar and US stock markets have significantly outperformed most other markets since the election. This outperformance is justified in the short term, because the United States already benefits from a relative advantage in terms of growth and will probably still benefit in the short term from tax cuts and economic protectionism.
THE OUTLOOK FOR THE AMERICAN ECONOMY IS RATHER POSITIVE
The medium term is slightly more uncertain, because two parts of Trump’s program, namely the tariffs on imports and especially the plan to “deport” millions of immigrants, are likely to fuel inflation and possibly be to reduce economic growth. Tariffs can be implemented within a very short time frame; however, it will take much longer to adjust domestic supply to compensate for the decline in imports. If authorities simultaneously seek to deport 8 to 10 million undocumented aliens, most of whom contribute heavily to economic activity in sectors such as agriculture, recreation and construction, there is a great risk that labor costs will are increasing much faster than expected and relaunching an inflationary trend. At this stage, we believe this is the most significant risk for investors. The Federal Reserve (Fed) will have no choice but to stop lowering rates, or even increase them again. During the election campaign, Trump threatened the independence of the Fed, but he has recently toned down his rhetoric on the subject.
Given these risks, investors will need to find the right time to begin assessing the realities of the future president’s agenda. The medium- and long-term outlook for the U.S. economy is quite positive, as lower taxes, deregulation, reindustrialization, and innovation increase the potential long-term growth rate of the U.S. economy in both absolute and relative terms. compared to the other main economic blocs which are Europe and China. There is growing evidence that the US equity market deserves a structural valuation premium. The big question for investors is how high that premium should be. Equity markets have given some guidance, with the U.S. equity market now accounting for 70% of the widely followed MSCI World Index, up from 30% in the 1980s.
WAITING FOR A POSITIVE TRIGGER IN EUROPE
With capital flowing quite freely across the world, it is appropriate to consider alternatives to the US equity market today. Europe currently seems in a weak position, its growth has been hovering around 1% for several years and its two main economies, Germany and France, are facing political uncertainty which will last at least until spring 2025. The war in Ukraine has driven up energy prices in Europe and damaged consumer and business confidence. On the positive side, there is low unemployment and high savings rates. Politicians in Brussels are finally realizing that something needs to change. Former ECB President Mario Draghi and former Italian Prime Minister Enrico Letta presented studies and recommendations on how to revive European growth. At this stage, European equity markets are attractively valued, but investors need a trigger to redeploy their capital. One of them could be some form of resolution to the war in Ukraine. Trump is clearly putting pressure on all parties involved to move forward. It is too early to know if and how the situation will evolve, but it is most likely to act as a positive trigger for consumer, business and investor sentiment in Europe.
CHINA IN AMBUSH
On the other side of the world, Chinese authorities are working to stimulate the economy again. Faced with a probable trade war between the United States and China, they must urgently stimulate the domestic market to compensate for the potential loss of certain exports. The authorities have taken a significant number of measures. In other times, investors would have reacted positively, but at this stage they are only focused on US markets. We believe that the Chinese authorities have taken stock of the situation and that with a little patience, Chinese stock markets should regain investor interest in 2025. Europe will closely monitor trade tensions between states -United States and China, because Chinese exports could well end up on European markets. On the other hand, if the Chinese domestic market restarts, European exports could benefit.
A MORE BALANCED PERFORMANCE IN 2025?
Overall, 2024 was a pretty good year for investors, despite a tense geopolitical environment and below-trend growth in Europe and China. Clearly, this performance was mainly driven by US stocks and the strengthening US dollar. We think 2025 will likely see a more balanced performance, as valuation and investor sentiment gaps between U.S. stocks and the rest of the world appear extreme. We look forward to the first months of 2025.
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