Important information - the value of investments and the income from them can go down as well as up, so you may get back less than you invest.
The inauguration of President-elect Trump on Monday will be watched closely by the world. It comes at a critical time for US markets, during which investors will be on high alert for the emergence of non-conventional policies. Markets have had a good deal of time to come to terms with Donald Trump’s proposed directions of travel, but the differences between flagged versus actual policy actions may be key to what happens next.
The recent volatility across both stock and bond markets reflects, to some extent, a growing belief that it may have been better to travel hopefully than arrive. The “Trump bump”, that saw US shares extend their 2024 gains after November’s decisive election result, has quickly unwound. Investors expecting a smooth run into Inauguration Day will have already been disappointed.
In conjunction with the uncertainties posed by a new administration, markets are now in the middle of reappraising the outlook for inflation and interest rates. Last week’s blowout employment data – which showed the US economy added 256,000 jobs in December – cast fresh doubts on how much further US inflation can slow.
The data also all but erases any chance that the Federal Reserve will cut rates this month. Expectations for the year as a whole have become more mixed since the end of last year, with market rates implying either just one 0.25% cut for the whole of 2025 or none at all as the most likely outcomes1. That’s significantly down from the four cuts anticipated last autumn.
US bonds as well as shares have been starting to discount these less favourable possibilities. A further worry for bond markets is that the political aspirations of Donald Trump – principally less immigration, tax cuts and higher trade tariffs – could add to the inflationary pressures in the economy. Concerns that the new administration will prioritise growth over debt and inflation have been behind a sharp rise in the yields from 10-year US Treasuries to around 4.8% – a rate not seen since the autumn of 20232.
This more uncertain outlook will mean the upcoming corporate earnings season will have to do more of the heavy lifting if shares are to recover their joie de vivre. Thanks to developments in AI and a strong economy, estimates still look favourable. Analysts currently expect company earnings to grow by around 15% this year following growth of just under 10% in 20243. Earnings now have tailwinds in the form of the lagged effects of previous interest rate cuts and a domestic economy that was showing resilience even before the recent rate cutting cycle began.
Trade tariffs
Fears of trade wars – with China, Canada, Mexico and the EU – have taken much of the shine off Donald Trump’s victory of late. Increased trade frictions under the new administration could be a risk to both growth and inflation and might encourage countries to export cheaper goods to other markets. The Tax Foundation concluded last year that tariffs implemented under both Trump and Biden have had a net negative effect on economic output and employment in the US4.
Future tariffs will likely impact US consumer companies through higher input costs and households through raised prices for goods. Viewed optimistically, markets can hope that the threat of punitive tariffs is merely a starting point for negotiations, which the US, in any case, can approach from a position of strength. Even so, concerns about how big the tariffs will be, where they’re directed and how soon could well result in bouts of market volatility as the year progresses.
What next for US shares?
After two highly rewarding years in US shares, investors may be undecided about throwing caution to the wind for a third. The US market has undoubtedly come a long way. Last year, the S&P 500 Index had exceeded many end-of-year forecasts by the end of the first quarter. It then continued to rise to end 2024 about 25% ahead5. It was a year in which both company earnings and the multiple of those earnings investors were prepared to pay increased.
This is shaping up to be a critical year, dependant on the effectiveness of a new government’s policies and whether the US economy can stay strong with higher-for-longer interest rates. That makes it a little less likely that Inauguration Day will mark a turning point in markets for the better. More likely, they will be seeking assurances that the strong drivers of the past year – rising corporate earnings, moderating inflation and downwardly pointing interest rates – can all be held in place.
Valuations
Valuations were a bugbear throughout last year and it may continue to be that way a while longer. Overseas stock markets – particularly in Europe – are trading on considerably lower ratings. The US stock market currently trades on an estimated 21 times the amount companies are expected to earn this year – a little above the market’s five-year average of 20 times6.
Against that, there has been little sign of irrational exuberance pervading the market. On the journey travelled so far, many questions have been raised about valuations along the way. The quarterly results of America’s leading companies have been closely scrutinised, often resulting in short term bouts of market volatility.
That said, the increasing dominance by technology companies of the world’s largest market has created some extraordinary market effects. Companies such as Nvidia and Meta were richly rewarded by the market for their profits growth last year, leading to a further increase in market concentration. Today, the market’s ten largest stocks make up around 37% of the S&P 500 Index7.
In Fidelity’s latest Investment Outlook, Investment Director Tom Stevenson strikes a cautiously optimistic tone:
“The expectation is that Trump 2.0 will mean tariffs, tax cuts, immigration curbs, and less regulation. That’s not all good for business – it is likely to be inflationary and threatens a more unstable environment for global trade – but it does argue for continuing economic growth, especially in the US” he says.
- Read, watch, or listen: Investment Outlook - Q1 2025
Where are the opportunities?
Despite current uncertainties about the precise outlook for inflation, the US continues to look forward to another year of decent earnings growth backed by a resilient economy. Deregulation and tax cuts may prove catalysts to further growth.
There have already been signs that “Trump 2.0” has prompted some investors to reappraise their strategies in the US. Smaller companies, in particular, have started to outperform big tech after a long hiatus. The concepts of deregulation and lower taxes are positive for the domestic US economy, which is where smaller US companies tend do more of their business.
The technology sector remains a difficult call. AI has undoubtedly generated an enthusiastic response from investors to the point that the biggest enablers and users have come to dominate the US market. America’s “Magnificent Seven” now trade on ratings that suggest they will all remain highly successful companies over the years ahead, which may not be the case. The early drivers and adopters of the dotcom boom around the turn of the millennium certainly didn’t all turn out to be winners. In fact, only a small handful did.
Notwithstanding the success of passive funds tracking US market indices in 2024, active investment strategies have a chance at least to sift the ultimate winners from the losers and may be a better option from here. Given the dominance of the US among world markets, the same might apply to active global strategies as well.
Tom Stevenson also warns against backing last year’s winners for too long. “Now feels like the moment to look beyond the recent market leaders”, he says. “In part this is an AI story. The initial winners – Nvidia and the other ‘enablers’ – have had their moment in the sun. Now investors must look to the companies that will enhance their productivity and profitability through the use of AI.”
Investment ideas
Tom Stevenson’s four fund picks for 2025 includes the Brown Advisory US Smaller Companies Fund. This is a Select 50 fund which targets a concentrated portfolio of smaller companies with above-average growth, sound management and competitive advantages. Brown Advisory is based in the US and is backed by an extensive team researching and investing in smaller companies, important factors when it comes to this asset class.
Another Select 50 choice, the Dodge & Cox Worldwide US Stock Fund, takes a contrarian investment approach focused on medium-sized and large companies with strong value credentials. The manager often invests in companies with depressed share prices. This might appeal to investors still wishing to participate in the progress of the US stock market but who are cautious about the valuation of the market as a whole.
A more racy selection would be the Brown Advisory US Sustainable Growth Fund. Fidelity’s experts favour this fund for its experienced management and the strong pool of company analysts its draws on. The fund is mostly invested in larger companies with a durable competitive advantage and steady rather than necessarily rapid growth. It also has a focus on quality.
This is a reasonably concentrated growth portfolio of between 30 and 40 holdings in companies worth $2 billion or more. As such it deviates significantly from the market as a whole with, for example, just four of America’s “Magnificent Seven” tech companies currently among its top-10 holdings.
For more fund ideas from Tom Stevenson, check out his fund picks for 2025 in this video.
1 CME FedWatch, 14.01.25
2 Federal Reserve Bank of St Louis, 14.01.25
3 FactSet, 03.01.25
4 Tax Foundation, 26.06.24
5 Bloomberg, 31.12.24
6 FactSet, 03.01.25
7 S&P Global, 31.12.24
Important information - The value of investments and the income from them can go down as well as up so you may get back less than you invest. Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. Past performance is not a reliable indicator of future returns. The funds featured invest in overseas markets so the value of investments could be affected by changes in currency exchange rates. The Brown Advisory US Smaller Companies Fund invests more heavily than others in smaller companies, which can carry a higher risk because their share prices may be more volatile than those of larger companies and the securities are often less liquid. The Brown Advisory US Smaller Companies Fund has or is likely to have, high volatility owing to its portfolio composition or the portfolio management techniques. The Key Investor Information Document (KIID) / Key Information Document (KID) for Fidelity and non-Fidelity funds is available in English and can be obtained from our website at www.fidelity.co.uk. Please note that Tom’s picks and Select 50 are not a personal recommendation for you. If you are unsure about the suitability of an investment you should speak to one of Fidelity’s advisers or an authorised financial adviser of your choice.
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