Markets are oscillating between a ‘soft landing’ and a ‘no landing’ outlook for the US economy, but recent equity returns point to something different.
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Prior to last month’s US election, consensus expectations were that US economic growth would slow back towards the US Federal Reserve’s long-run trend rate of 1.75%, and core inflation would revert towards its 2% medium-term target. The latest inflation data for November show that market expectations of a soft landing were exactly that – expectations rather than a reality.
Though November’s consumer price index (CPI) inflation matched analyst expectations, it was still somewhat high in absolute terms. Year-on-year core inflation remained at 3.3%, while the monthly annualised change rose from 3.4% in October to 3.8% in November, suggesting that near-term price pressures were increasing.
If one adds in the expected boost to the economy from the policy plans of the incoming Trump administration, one can wonder how quickly growth and inflation will actually decelerate.
The Fed, nonetheless, cut the fed funds rate by 25bp at its latest meeting. This reflects two factors:
- First, that monetary policy works with a lag and central banks are thinking about the impact on inflation in 12 to 18-months’ time of policy changes today
- Second, that even if many anticipate higher growth and inflation after the 20 January inauguration of Donald Trump, this is largely speculation. As Fed Chair Jerome Powell emphasised: “We don’t guess, we don’t speculate, and we don’t assume.”
We do not know what policies will actually be proposed or implemented. Some may well have a negative impact. We will be able to evaluate better what may happen with Fed policy in 2025 from 20 January on when we learn what Trump’s day-one plans will be.
Global economics
Other recent data releases have confirmed the existing impression that global growth outside of the US is weak. Eurozone industrial production was flat in October relative to the prior month. It declined sharply in the UK despite forecasts for a gain.
In China, both imports and exports disappointed. Imports are a particular concern as year-on-year growth was negative when expectations had been for a modest gain. The data highlights the challenges Beijing faces to revitalise growth even as the country’s deflated property bubble weighs on consumer and business sentiment.
Equity returns
Whatever the near-term outlook — soft or no landing — the environment should be supportive of US equities. More economic growth should benefit corporate profits, and steady inflation (at a moderate level) means higher revenues.
While there are investor concerns over higher tariffs, immigration restrictions and tax cuts in 2025, the market, at least initially, appeared to focus on the economic benefits of the new Trump administration including deregulation and mergers and acquisitions rather than the risks.
From the election through to the end of November, the Russell 2000 small cap index gained 10%, the Russell 1000 Value 7%, and the NASDAQ 100 5%. Non-US markets were either down (emerging markets -4%, Europe -0.1%), or up by rather less (Japan 1%).
One might have expected that pattern to continue, albeit at a slower pace, in December. Instead, we have seen a partial reversal. Though the NASDAQ 100 index has continued to climb, other US indices have fallen, while non-US markets have gained (see Exhibit 1).
Is this just a pause after initial (US) exuberance, or does it signal a more fundamental change in the market’s assessment of the outlook? Will the cost of tariffs, immigration restrictions, and higher bond yields outweigh the benefits of deregulation and the rest?
We believe it is a bit of both. After such sharp moves, it is not surprising for the market to take a break and reassess. We should note that 10-year US Treasury yields, after falling by 14bp after the election, have moved back up. At the time of writing (16 December), they are higher than they were on 4 November. If inflation and/or growth come in stronger than expected, the rise in Treasury yields could continue.
Rising (market) interest rates are generally negative for equities. Interest rate-sensitive sectors such as utilities and real estate have fallen by more in December than most other sectors (hence the underperformance of the value index). Small-cap companies are also vulnerable to higher rates as they tend to have higher debt levels. But once the adjustment in interest rates has taken place, equity prices should rebase and move back up as earnings grow.
Energy and materials stocks have reacted to recent more positive news in the Middle East. Healthcare stocks reflect uncertainty about the future US regulatory environment.
Tech stocks not immune to rate risks
Technology stocks, though, are also at risk when rates rise. A greater share of their earnings lies further out in the future and hence a rise in the discount rate disproportionately reduces the net present value of those earnings. The recently positive performance of the tech-heavy NASDAQ 100 index, then, must be explained by other factors.
Broadcom accounts for part of the performance, contributing about 44% to December’s return. The so-called Mag-7 stocks account for most of the remaining gain (with the exception of NVIDIA).
The divergence in returns across sectors suggests investors will need to be more nuanced in their assessment of the outlook for US equities. There will be winners and losers from the policies of the incoming administration and that will be reflected across different sectors, styles and market capitalisation categories.
We emphasise that earnings momentum has been positive. There has been a particularly sharp upturn for US small-cap stocks since the election, while the existing uptrend for the NASDAQ remains in place (see Exhibit 2).
Since we view valuations for growth stocks as relatively more attractive, US equities still look to be the best game in town.*
*Also read The case for US growth stocks and The outlook for US small caps
Disclaimer
Please note that articles may contain technical language. For this reason, they may not be suitable for readers without professional investment experience. Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients. This document does not constitute investment advice. The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns. Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions). Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation, and conservation on behalf of funds invested in emerging markets may carry greater risk.
