Summary

US corporate earnings growth seems poised to accelerate in 2025 as the US economy remains strong, international economic growth is increasing from low base levels, and monetary policy is becoming more accommodative with lower interest rates anticipated. While the S&P 500 valuation is high at 22x forward earnings, this valuation is still much lower than the 27x forward earnings reached at the peak of the dot-com bubble in the late 1990s. With a strong economy and accommodative monetary policy, the outlook for US equities is still reasonably favorable. Historically, equities have performed well when the Fed has cut rates while the economy is growing as opposed to in recession. Valuation is a potential constraint on outsized gains, and there may be volatility as the market absorbs Trump policies and their impacts. On balance, Trump’s pro-growth policies of lower taxes and reduced regulation should be beneficial for US equities. During his first term, the S&P 500 appreciated by 57.8% cumulatively (15.6% annualized) from November 8, 2016, through December 31, 2019 (pre-COVID). However, the potential application of tariffs presents a large wildcard for equity markets as the magnitude of tariff enactment and likely retaliatory actions are difficult to predict. The resultant impact on corporate earnings is also difficult to forecast as companies may shift or delay investment and inventory plans. Trump’s tariff plans, as they are announced, could significantly increase equity market volatility over the balance of 2024 and 2025. We believe the bond market will serve as a natural check on certain policies, as equity markets have shown sensitivity to rising bond yields, often stumbling when the 10-year U.S. Treasury yield approaches 5.0%. Trump, more than other presidents, has consistently referred to the stock market as a key measure of economic success. For instance, in 2018, he retreated from increasing tariffs when equity markets declined. Recently, stronger-than-expected U.S. economic performance and a plateau in inflation declines have driven interest rates higher across the yield curve. This has led bond markets to adjust their outlook, now predicting a slower pace of Federal Reserve rate cuts in 2025 compared to expectations from just a few months ago. Since mid-September, the 10-year Treasury yield has risen from lows of 3.7% to around 4.4%. This increase reflects a combination of robust economic growth and market perceptions that Trump’s policies could contribute to higher inflation over time. While it is extremely early post the election and specific Trump policies will take time to materialize, we have the following views: 

• Maintain overall public equities exposure, but shift towards US overweight especially during S&P 500 pullbacks (tax considerations regarding capital gains need to be considered).  US exceptionalism should continue given a) higher exposure to sectors with better structural growth, b) US companies better positioned to withstand effects from tariffs, c) US companies benefiting if the corporate tax rate is reduced further.
• Add duration to fixed income when the 10-year yield nears 4.5% as the risk / reward becomes favorable, with a sufficiently high current income if securities are held to maturity.
• We recommend that investors stay the course and continue to allocate to private investment strategies where appropriate.  It is important to build vintage year diversification, and several private investment strategies such as secondaries are highly compelling given the current environment.

Appendix – Equity Performance During Trump’s First Term

In the table below, we detail equity performance during Trump’s first term from post-election date (Nov 8, 2016) through the end of 2019 (prior to COVID). At a geographical level, equities performed largely as expected with the US outperforming international markets. However, within the US, winners and losers were markedly different from expectations in terms of sectoral, market-cap and style-factor performance. Additionally, the sequencing of policy action in the next Trump Administration may differ from that in 2017-2019. During his first term, Trump passed his signature Tax and Jobs Act first and then focused on tariffs. Given the high US federal deficit and high starting interest rate levels, Trump may focus on tariffs first and then turn attention to tax cuts (or focus on them simultaneously). As such, we caution investors from becoming too focused on predicting “Trump beneficiaries” at a very granular level.

• The US handily outperformed international markets during this period.  Even so, there was considerable variation in performance by year.  In 2017 for instance, international stocks significantly outperformed as global growth resumed following a lull in 2015 and 2016.   US stocks then performed much better in 2018 and 2019 as international stocks were hurt more by tariffs and international sectors did not have as much exposure to the technology sector (best performing sector) as the US.
• While value stocks were widely expected to benefit from Trump’s policies, US growth stocks handily outperformed value stocks over this time period.
• Similarly, small-cap stocks were expected to benefit more than large cap stocks as small caps would benefit more from the corporate tax rate reduction that passed in 2018. However, large caps outperformed small caps by 290bps annually over the period.
• Sectorally, the energy, industrial and financial sectors were expected to outperform given Trump’s policies.  In actuality, the technology sector was the dominant outperformer, and healthcare performed much better than expected.