First off, we wish you and your loved ones a joyful and prosperous New Year.
Time for Trumponomics
With President Trump’s return to the White House on January 20th, expectations for change are high. How much he will be able to implement and what his policy effects will be, will have a major impact on global markets in the near-term.
Domestic deregulation, corporate tax cuts, and tariff hikes will be key features of the Trump administration’s economic policies. These initiatives are a natural extension of Trump’s “America First” doctrine.
Trump’s economic policies are rooted in supply-side economics, similar to those applied by former U.S. President Ronald Reagan in the early 1980s. These supply-side reforms implemented in the 1980s played a pivotal role in bolstering U.S. labor productivity, reducing inflation, and laying the groundwork for the booming 1990s.
A Positive View but with Many Pitfalls
Equity and bond markets could face turbulence and heightened volatility on the back of policy changes in 2025, but opportunities are likely to outweigh risks. The benefit of deregulation and a more business-friendly environment could unlock productivity gains and capital deployment.
In the coming quarters, the U.S. will remain the global growth engine with the business cycle in expansion, a healthy labor market, broadening of AI-related capital spending, and prospect of stronger capital market and deal activity. Europe continues to face structural challenges while Emerging Markets struggle with a strong USD, and incremental trade policy headwinds.
Several key developments may dominate 2025 and beyond. First, Trump has proposed a broad range of tax cuts, including exemptions for Social Security, tips, auto loans, and overtime pay. He also aims to lower the corporate tax rate to 15% from 21% for domestic manufacturers and potentially for the entire corporate sector. The U.S. corporate tax rate is already lower than all G7 nations. If the rate drops to 15%, the U.S. will have one of the lowest corporate tax rates in the developed world.
This change would make the U.S. a highly attractive and competitive destination for business, potentially triggering a global “race to the bottom” in corporate tax rates, which could be a clear positive for global growth beyond 2025.
Second, the U.S. is already one of the least regulated economies among G7 nations, and most American businesses do not view overregulation as a significant hurdle. Thus, Trump’s deregulation efforts will likely be targeted, focusing on financial services, fossil fuels, AI applications and rolling back climate restrictions.
Innovations across multiple sectors have the potential to spur productivity growth, and there is some evidence that suggests that U.S. labor productivity is picking up. Increased productivity is a key element to support an extended economic cycle.
With steady labor force growth at 0.5-0.6%, labor productivity growth would need to rise to 2.5% annually from the current 2.0%. This is achievable, as seen in the late 1990s and early 2000s when the Internet revolution drove productivity growth above 3% annually.
Today, we are on the cusp of an AI-driven technological wave. With Trump’s deregulation, fewer restrictions could hasten AI adoption. Combined with cheap energy and lower corporate taxes stimulating business investment, productivity growth could accelerate to 2.5%. This would support continued economic growth, and therefore the U.S. would avoid a slowdown or a recession in 2025.
Currently, the U.S. is the only major economy embracing supply-side economic policies, which is a significant positive for growth. While inconsistencies in Trump’s policies remain such as tax cuts versus tariff hikes or GDP growth versus restricted immigration, the overall direction is aimed at boosting productivity, economic growth, and asset prices.
A lot will depend which policy plans actually get implemented and in which order. Trump has floated many ideas over the past few months, and everyone seems to have embraced the positive sides of these potential policy ideas, from equity markets to crypto.
There are, however, several pitfalls. While markets are embracing the potential for profits from the oncoming wave of Trump policies, the deficit hawks already fired the first shot, with 38 Republicans voting against the proposed suspension of the debt ceiling due to lack of spending restraint.
Trump will have at most three votes to lose if the House votes along party lines. If Republican deficit hawks hold their line, Speaker Johnson may have to rely on Democrats to pass any legislation, and particularly the debt ceiling. Any sign that President Trump cannot rapidly move his agenda forward may undermine the current positive sentiment.
There is a risk that Trump’s focus on extending tax cuts without cutting spending could push U.S Treasury yields to 5% or above, which would be negative for equity markets.
- Tariffs
- A Replay of 1990s?
- U.S. Equities in 2025
- The Fed Signals Less Urgency to Cut
- Key Risks to the Positive View
- Will Trump Facilitate a Truce in Ukraine and the Middle East?
- Could the Rest of the World Outperform in 2025?
- China’s Reluctance to Stimulate Aggressively
- Japan Remains Attractive
- Gold Prices Can Rise Further
- Negative on Oil
- Our Portfolio Positioning
Tariffs
The hope is that Trump will use the threat of implementing tariffs to renegotiate certain trade terms or incentivize trading partners to invest more in the U.S., which would obviously be a positive for the U.S. economy.
The risk is that President Trump will start his term with announcing a slew of new tariffs on different trading partners without a clear objective other than reducing imports to reduce the trade deficit. That would be negative for economic growth in the U.S. and abroad, which would be negative for equity markets.
A Replay of 1990s?
We see a volatile environment for equities in 2025, driven by remarkable macro similarities to the second half of the 1990s when the bull market became parabolic, culminating in the dot-com bubble. These parallels include the Fed easing into a growing economy in 1995, sparking an equity rally that propelled technology stocks to new highs. We face a similar policy backdrop today, with the Fed having also eased into a strong economy.
The internet boom of the 1990s and the artificial intelligence boom today both represent transformative technologies that directly impact labor productivity. The recent rise in U.S. labor productivity growth may be linked to the broader adoption of AI.
A globally divergent economy: In the 1990s, the U.S. was strong while Japan, Germany, and emerging markets struggled. Today, Europe and China are weak spots, while the U.S. economy is robust. This divergence drove up the dollar in the 1990s and is doing so again today.
U.S. Equities In 2025: Correction First, New Highs Later?
In 2024 the S&P 500 index has risen 25% while per-share earnings have risen 13%. In other words, there has been a sizable P/E expansion in 2024. Therefore, the U.S. equity market has been front-running policy shifts that have not yet occurred, in addition to many potential positive developments in the economy.
Going forward, economic fundamentals and the policy environment remain bullish for U.S. equities, making it more likely that the bull market in stocks will persist rather than end in 2025.
Equity sentiment is very positive at the moment, contrasting with the 2022 sentiment low that helped the current bull market begin ascending the wall of worry. In addition, corporate bond spreads are extremely tight.
Financial markets are clearly discounting a rather positive scenario with only a negligible probability of recession. Relatively high valuations make risk assets vulnerable to disappointments. Therefore, risk assets could disappoint even in the absence of a recession, as current valuations will limit material future returns.
In a nutshell, expect to see turbulence in the first half of 2025, followed by potential new highs.
It is difficult to pinpoint what might trigger a correction. Perhaps, while markets anticipate a tax cut, Trump might impose tariff hikes on U.S. trading partners first, unsettling investors. The resilient inflation outlook might dissuade the Fed from cutting rates as much as the market expects. Or a further selloff in bonds could upset the stock market.
The Fed Signals Less Urgency to Cut
In December, the Federal Reserve cut the fed funds rate by 25 bps to a 4.25%-4.5% range, as expected. However, it was a “hawkish cut” as Powell indicated to expect a slower pace of easing ahead. The FOMC statement signalled less urgency, saying the “extent and timing” for further cuts will depend on incoming data. The dot plot was also revised higher, with only two cuts in 2025, or half what was expected in September.
The negative reaction from both the bond and equity market to this news shows that the market is counting on further easing of monetary conditions to support valuations and boost the economy.
We do think the Fed has room to cut rates further in 2025 as inflation pressures will likely continue to soften, especially in the coming months.
Also, underneath the surface, cracks are emerging for consumer spending, adding to the odds that the Fed will eventually ease more.
Key Risks to the Positive View
A key risk to continued economic growth would be a higher unemployment rate. Recently, job openings trended down, and the hiring rate hit an 11-year low, which means it becomes more difficult for unemployed workers to find jobs.
As not only people who lose their job will spend less, also people who still have a job will become more cautious and then economic growth can slow down quickly, potentially leading to a recession, which is not our base case scenario for 2025 but something we will closely watch.
Other than a recession, a major spike in bond yields could also sink the stock market. Taken together, Trump’s proposed tax measures are set to add more than $7.75 trillion to the federal debt over the subsequent ten years. We think the 10-year Treasury yield should be in the 4-4.5% range, but if the bond market fears that U.S. fiscal deficits will keep rising, bond yields could spike. Even though we think that would be just a temporary spike, it would definitely spook the equity market.
Will Trump Facilitate a Truce in Ukraine and the Middle East?
The Trump administration will try to broker a truce between Russia and Ukraine. Ukraine will remain an independent, NATO-armed state (though not in NATO) but will not reclaim its lost territories. Russia will stay sanctioned and hostile to Europe. But some sanctions might be lifted, allowing Russia to export natural gas to Europe.
Ukraine will accept the deal as it cannot win the war without Western support and faces severe manpower shortages. Russia will agree due to the war’s economic and political toll and limited offensive capacity.
The main risk lies in pre-negotiation escalations. Ukraine may try to drag NATO states in the war, while Russia will try to gain further territory.
The situation in the Middle East is more complex. It is clear that Iran’s position has weakened, and Trump will add additional pressure and sanctions on Iran. As internal domestic dynamics also put a lot of pressure on Iran’s regime, the risk is that it will be pushed to escalate the conflict in the Middle East. This would have a major impact on the oil price.
Could the Rest of the World Outperform in 2025?
For investors it is important to remember that the economy is not the stock market. In other words, a strong economy does not necessarily mean high equity market returns. This is because equity markets already discount future growth. So, it is actually more important if an economy performs better or worse than the market expects.
Even though the U.S. economy is clearly the best positioned for continued growth, its equity market is also the most expensive. Actually, the valuation difference between the U.S. and the rest of the world is at a historically large gap. On top of that, the U.S. dollar is very strong versus almost every other currency.
We can see a number of different scenarios where Europe and China’s economies could surprise to the upside. Whether through additional stimulus, a peace dividend if global conflicts get resolved, or less uncertainty through trade deals with the U.S.
Given that most of the negative news is already priced in, equity markets and currencies could outperform the U.S. market, especially in dollar terms. We think this is more likely in the second half of the year. Therefore, we would focus on global diversification in portfolios.
China’s Reluctance to Stimulate Aggressively
Traditionally conservative, China has been forced to run increasing fiscal deficits in recent years due to price deflation, slowing growth, and rising unemployment. However, with nominal GDP growth having fallen below real growth, the economy demands more robust government action.
Financial markets are calling for increased stimulus, as bonds outperform stocks and China’s 30-year bond yields have fallen below Japanese government bond yields of the same maturity. Will Beijing take bold actions to get ahead of the curve? Possible but not very likely.
The Chinese government has a deep-rooted fear of debt and will likely move cautiously. President Xi does not aim at a sharp turnaround in economic growth but rather to prevent a crisis or sharp fall in economic activity. Thus, growth in China will continue to disappoint financial markets in 2025. Given the low equity market valuation, there is still potential upside, especially if there would be fiscal policy surprises.
Japan Remains Attractive
In 2025, as the economy enters its third year of normalization, we expect Japanese stocks to enter a sustained growth phase, driven by corporate governance reforms that lead to a different pace of corporate behavior. We set year-end targets of 3,000 points for the TOPIX and 43,000 for the Nikkei 225. In the first half of the year, uncertainty surrounding Trump 2.0 policies may weigh heavily, particularly on overseas demand sectors, but as uncertainty declines, we expect this pressure to ease. Meanwhile, as the domestic economic recovery progresses, we expect a rise in the BOJ’s base interest rate to 1% to have a positive impact on the economy and the stock market. Although the benefits of a weaker yen on corporate earnings will dissipate, assuming corporate profit growth of around 8%, we expect the combined effects of corporate growth investments, efficiency improvements, balance sheet enhancements, and share buybacks to drive improvements in Japanese companies’ ROE, serving as a catalyst for sustained growth in Japanese stocks.
We do not expect the rate hike to 1% to trigger a repeat of the stock price decline shock seen in August, but rather to have a positive impact on the Japanese economy and stock market.
Gold Prices Can Rise Further
Gold prices could continue to advance. Gold demand remains high due to central bank purchases, ongoing wars, and geopolitical tensions. Most gold purchases since 2008 have come from central banks in developing countries.
Since the Russia-Ukraine war, there has been heightened apprehension among the Global South that the West can easily weaponize the dollar and the financial system for geopolitical purposes. This fear has fueled central bank demand for gold. Gold continues to be viewed as a safe-haven asset.
Negative on Oil
The Trump administration is expected to deregulate the fossil fuel industry and encourage increased oil production. The Treasury Secretary nominee, Scott Bessent, has a well-known “3-3-3” plan, one component of which is to increase crude production by 3 million barrels per day.
The U.S. remains the largest oil producer and the most important swing supplier in the crude market. With the Trump administration focused on cheap energy to fuel economic growth, the odds are high that crude oil prices will trend downward.
Additional negatives for the crude oil market include a strong dollar, a soft Chinese economy, and a continued slump in global manufacturing.
Our Portfolio Positioning
We have not changed our portfolio positioning. Going into 2025, we think there could be more upside in equity markets, but we will see volatility, especially in the first half of the year when Trump’s policy choices become more clear, while at the same time Fed policy will play an important role for the market outlook.
We continue to favor global diversification to deal with unexpected surprises next year, even though some of them could very well be positive surprises, especially for international equity markets.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all
times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor’s 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
Diversification does not guarantee a profit or protect against a loss in a declining market. It is a method used to help manage investment risk.
Tokyo Stock Price Index, commonly known as TOPIX, along with the Nikkei 225, is an important stock market index for the Tokyo Stock Exchange (TSE) in Japan, tracking all domestic companies of the exchange’s Prime market division. It is calculated and published by the TSE.
The Nikkei225, commonly called the Nikkei, is a price-weighted stock market index for the Tokyo Stock Exchange (TSE). It has been calculated daily by the Nihon Keizai Shimbun (Nikkei) newspaper since 1950 and the components are reviewed once a year.
Investments in commodities may have greater volatility than investments in traditional securities, particularly if the instruments involve leverage. The value of commodity-linked derivative instruments may be affected by changes in overall market movements, commodity index volatility, changes in interest rates or factors affecting a particular industry or commodity, such as drought, floods, weather, livestock disease, embargoes, tariffs and international economic, political and regulatory developments. Use of leveraged commodity-linked derivatives creates an opportunity for increased return but, at the same time, creates the possibility for greater loss.
