The inauguration of President-elect Trump on Monday will be watched closely by the world. It comes at a critical time for investors, who will be on high alert for the emergence of non-conventional policies. Markets have had ample time to digest Donald Trump’s proposed policy directions, but the gap between anticipated and actual policy actions may be key to what happens next.
The “Trump bump,” which saw U.S. shares extend their 2024 gains after November’s decisive election result, has quickly unwound. Investors expecting a smooth run into Inauguration Day may already be disappointed. Alongside the uncertainties posed by a new administration, markets are reappraising the outlook for inflation and interest rates.
Last week’s employment data revealed that the U.S. economy added 256,000 jobs in December, casting fresh doubts on how much further U.S. inflation can slow. The data also almost eliminates any chance that the Federal Reserve will cut rates this month. Expectations for 2025 have become more mixed, with market rates suggesting just one 0.25% cut for the whole year or none at all, significantly down from the four cuts anticipated last autumn.
Further inflationary worries stem from Trump’s policy priorities of reduced immigration, tax cuts, and higher trade tariffs. Concerns that the new administration will prioritize growth over managing debt and inflation have driven yields on 10-year U.S. Treasuries to around 4.8%—a rate not seen since the autumn of 2023. This uncertain outlook implies that the upcoming corporate earnings season will need to carry more weight for shares to recover.
Thanks to developments in AI and a robust economy, corporate earnings estimates still appear favorable. Analysts expect company earnings to grow by around 15% this year after just under 10% growth in 2024. Earnings now benefit from the lagged effects of previous interest rate cuts and a resilient domestic economy.
However, fears of trade wars, particularly with China, Canada, Mexico, and the EU, have dimmed Trump’s victory glow. Increased trade frictions could risk both growth and inflation, which might encourage countries to export cheaper goods to other markets. The Tax Foundation concluded last year that tariffs imposed by both Trump and Biden had a net negative effect on U.S. economic output and employment.
Investors’ cautious approach to Trump
Future tariffs might impact U.S. consumer companies through higher input costs and households through raised prices for goods. Viewed optimistically, punitive tariffs could serve as a starting point for negotiations, with the U.S. approaching these from a position of strength.
Still, concerns about the timing and size of these tariffs could contribute to market volatility as the year progresses. After two highly rewarding years in U.S. stocks, investors may hesitate to throw caution to the wind for a third year. Last year, the market exceeded many end-of-year forecasts by the end of the first quarter and continued to rise, ending 2024 about 25% ahead.
This year will be critical, depending on the new government’s policies and whether the U.S. economy can remain strong amid higher-for-longer interest rates. This year, the U.S. stock market trades at an estimated 21 times projected earnings, slightly above the five-year average of 20 times. Against this backdrop, there has been little sign of irrational exuberance.
Quarterly results of America’s leading companies have been closely scrutinized, often resulting in short-term market volatility. The increasing dominance of technology companies has led to some extraordinary market effects. Companies rewarded for their profits growth last year have increased market concentration, with the top ten stocks now comprising around 37% of the S&P 500 Index.
Despite uncertainties about inflation, the U.S. anticipates another year of solid earnings growth backed by a resilient economy. Deregulation and tax cuts may further drive growth, although “Trump 2.0” has already prompted some investors to reappraise their strategies. Smaller companies, which tend to do more business domestically, have started to outperform big tech after a long hiatus.
The technology sector remains a complex call. AI has generated enthusiastic investor responses, dominating the U.S. market, with America’s “Magnificent Seven” now trading on ratings that suggest sustained success. However, not all early drivers and adopters of AI will be winners, akin to the dot-com boom in the early 2000s.
Despite the success of passive funds tracking U.S. market indices in 2024, active investment strategies may better sift ultimate winners from losers, potentially proving a better option. Given the U.S.’s dominance in world markets, active global strategies may also benefit.
