The combination of continued US economic growth and falling interest rates remains favourable for corporate earnings and valuation support, and the economic cycle appears to have further runway. Unlike previous cycles driven by excess borrowing, however, this expansion has been fuelled by income growth rather than private sector credit, leaving household and corporate balance sheets in good health. Additionally, the US benefits from its reserve currency status, allowing for extended fiscal support without immediate constraints.
However, market sentiment remains in flux. Concentrated investor positions, rising bond yields and escalating trade tensions could trigger short-term pullbacks. Yet such conditions often present tactical buying opportunities.
The struggle to calibrate interest rate expectations continues, with the market currently not expecting many cuts from the US Federal Reserve (the Fed) in 2025. Rising productivity and increasing capital demand by businesses have likely raised the level of interest rates required to balance the economy versus the last decade.
Despite its valuation premium, the US market remains an anchor for global capital. The forces required to alter this dynamic in any meaningful way appear absent for now, reinforcing the case for continued US ‘exceptionalism’. Some have argued that a speculative bubble akin to the late-1990s dot-com era could be necessary to initiate a new cycle. But while valuation matters over the long term, shorter-term returns are increasingly shaped by market flows, investor sentiment, liquidity and share buybacks – all of which remain supportive.
The wildcard remains inflation. Should persistent price pressures force the Fed into renewed tightening, equity markets could see downside risk. While this is not our base case – given the strength of the US dollar, global manufacturing capacity and abundant energy supplies – fiscal policy excesses could still act as an inflationary accelerant.
Emerging markets continue to grapple with headwinds from a robust US dollar and tariff uncertainty. However, current valuations offer compelling long-term upside, making strategic entry points crucial. Should China implement bold measures to stimulate domestic demand, they could serve as a game-changer for the broader emerging market complex. In this context, South Africa stands out as a model ‘self-help’ case – it has managed to virtually end loadshedding and the new government of national unity supports the necessary structural reforms to improve growth.
ENTER TRUMP 2.0
President Donald Trump’s return to office has introduced another layer of complexity. Trump has historically viewed the US stock market as a measure of his success, suggesting he will strive to maintain a supportive environment. While his stance on trade deficits frames them as unfair to the US, they stem from US reliance on foreign savings to fund the country’s fiscal shortfall. Consequently, tariffs alone are unlikely to resolve trade imbalances under the current fiscal regime.
Economic growth under Trump’s policies could present a mixed picture. Positive elements include deregulation, enhanced government efficiency and tax cuts. However, negative impacts may arise from stricter immigration policies and heightened tariff risks. The sequencing of these policies will be crucial – unlike during his previous term, when tax cuts preceded tariffs, Trump seems to be prioritising tariffs and immigration reform through quick executive orders while fiscal policy will take longer to materialise given the budgetary process.
Historical patterns suggest that initial trade escalations could prompt equity sell-offs, followed by de-escalations as growth takes precedence. Key sectors likely to benefit include financials and domestically focused industrials. On the downside, businesses reliant on imports and immigrant labour, as well as US trading partners, may face challenges.
Reflecting these dynamics, we have increased exposure to US mid-cap stocks and global large-cap quality names while holding off on emerging markets until trade-related noise peaks.
MARKET SCENARIOS
In our base case, we envision US gross domestic product (GDP) growth in the 2-2.5% range, with inflation slowly drifting towards the Fed’s 2% target. The Fed is expected to proceed cautiously, with limited rate cuts in 2025, pausing at most meetings. This environment should remain supportive for corporate earnings, with the S&P 500 expected to deliver approximately 10% earnings growth – consistent with historical averages outside recessions.
We expect the 10-year US Treasury yield to remain in the 4-5% range, providing a stable backdrop for equities. While high valuations persist, periodic market dips are likely to present as entry points, particularly for domestic cyclicals, should economic momentum remain firm and inflation contained. Trade tensions will generate noise, but tariffs are likely to be used as leverage in negotiations rather than outright disruptions.
There is, of course, always the risk of unexpected surprises – which we consider when we construct investment portfolios. Alternative scenarios include an inflationary shock, which could be triggered by supply chain disruptions, aggressive tariffs or fiscal policy missteps, forcing the Fed into renewed rate hikes. This scenario could lead to a 2022-style equity and bond market sell-off.
A recessionary or deflationary shock also remains a tail risk, particularly in the event of financial instability or a collapse in private sector confidence. While the market is not yet exhibiting classic bubble characteristics, a more pronounced ‘melt-up’ remains another material possibility. If AI-driven companies continue to report exceptional earnings, investor euphoria could drive valuations to extreme levels, setting the stage for a subsequent correction.
INVESTMENT IMPLICATIONS
In recent months we have tilted our clients’ portfolios towards companies that we expect to benefit from a broadening of the cycle, while maintaining balanced exposure to high-quality credit and real assets. Global economic expansion still seems to have some fuel left in the tank, but given the potential for market surprises, maintaining a resilient and diversified portfolio is critical.
