Every which way, markets are ok

Go-go-go 

There has been enough in the first week of Trump’s new administration to suggest that, at some point, markets might react badly to something he says, or threatens to do. But so far, they have not. The President is predictably unpredictable, but we know that. Investors also recognise his agenda is wealth creation and to use as many means as possible to remove obstacles to wealth creation. It is not an agenda grounded in university-taught economic theory but one that relies on the use of conflict and dealmaking to the benefit of “those on his side.” It is clear who Trump does not want to benefit – immigrants in the US, foreign countries, those who voted against him or were close to the previous administration. It is not clear how the benefits of ‘Trumponomics’ will trickle down to low-income groups whose standard of living has been hit by three years of inflation. But ending “wokeism” and putting up straw men to draw the ire of the masses is enough to generate confidence and optimism in America, at least for now. The markets reflect that. Bond yields are down, equity prices are up and the cash registers in USA, Inc. are ringing.

Bull 

Between Joe Biden’s inauguration in 2021 and Trump’s this week, the S&P 500 index registered a total return of 63.3% (13% annualised). I am sure Trump will want to beat that. His support for artificial intelligence, technology more generally, for the oil and gas sector and for deregulation in finance are the nexus of hope for continued stock market performance. What Trump wants to prevent is inflation, or interest rates, or foreign competition messing up that wealth creation. Tariffs, in his mind, will hurt foreign exporters more than US consumers. Meanwhile, he has made a big show of securing promises of billions of dollars from foreign investors. There is a huge amount of goodwill towards the new administration which, for now, is positive for US markets.

Time for Europe? 

Yet it has been European equity markets setting the pace so far in 2025. As in most years, there is a lot of discussion about whether it is time for Europe to do better – which is a bit unfair because the Euro Stoxx index delivered a 10.3% total return last year. As always, there is a positive valuation argument. Some weeks ago, I used the cyclically and inflation adjusted approach to determining price-to-earnings (P/E) ratios. The US was close to 30 times earnings; Europe was nearer to 20 times and current unadjusted P/E ratios based on expectations for earnings over the next year are even lower. Regional European indices have dividend yields above 3.0% with this being higher in individual markets like Spain and Italy. The consensus growth expectation for earnings for the next year has ticked higher, standing at 8.4% in January. I would say that, for European equities, valuation is attractive, and the macroeconomic outlook has certainly not got any worse. Sentiment has been weak – because of political problems, fiscal concerns, and weakness in Germany – meaning there is scope for more optimism to emerge. An end to the Ukraine war, China’s economy bottoming and European Central Bank (ECB) rate cuts should be positive for European stocks. Furthermore, with Trump undermining support for green technologies in the US, Europe could benefit from ongoing government support for the carbon transition and the need to achieve more energy security. Another 10% this year does not look unattainable.

But USA eh? 

The case for investing in European equities is reasonable. However, it remains hard to bet against the US. The fourth quarter earnings season has got off to a strong start with results beating expectations overall and growth looking to be strong. Sector performance has been more balanced since the beginning of 2025 with industrials and energy the top performers. The slew of comments and executive orders from the White House and the fact that tariffs on imports have not been announced yet have all been positive for equities. The bond rally has also helped as it has not triggered any further relative valuation concerns which were emerging in week one. The US consumer continues to benefit from a healthy jobs market, growing real wages, and a substantial wealth effect. At least half the country’s voters will be feeling extremely optimistic about the direction of political travel. On the corporate side, the new administration is very pro-business. Animal spirits are at large. Business investment spending on technology will remain a key driver. Borrowing costs might be higher than they were a few years ago but earnings for listed companies are growing at an expected 14%. There is not much not to like about US companies.

Credit too 

If fundamentals are good for equities, then they are typically good for credit too. Listed credit sectors have outperformed interest rate benchmarks so far: excess returns from US high yield, for example, are already above 1.0%. There is more acceptance of the fact that tight credit spreads reflect the strong fundamental position of bond issuers. In the US high yield market, the general improvement in average quality in recent years (reduced percentage of CCC-rated bonds, increased percentage of BB-rated issues), and lower index duration are factors that might justify structurally lower spreads. Targeting US high yield returns around 7% and European high yield around 6% this year is a real possibility.

And I must come back to the income issue. Healthy earnings growth supports dividend yields in Europe and income returns from credit. As interest rates have fallen from their peak levels last year and as we expect further cuts in rates ahead, income from holding cash is rolling over. Looking back over the last 12 months cash income exceeded income returns from credit in US dollar, euro, and sterling markets. But that is changing as cash income returns move lower and bond income returns are higher, reflecting the higher level of coupons in the market.

At the end of 2020, the average coupons in investment grade markets were 3.8% in the US, 1.6% in Europe and 4.0% in the sterling market. Today, those average coupons stand at 4.3%, 2.5% and 4.3%. The average will increase further as low coupon bonds mature. Looking at the US dollar corporate bonds issued this week, coupons have been in the 4.5% - 6.0% range. Clearly there is a price risk in bonds and concerns about inflation and the fiscal outlook could impact on prices through underlying rates but the level of income is set to continue to gradually improve across credit markets. 

Sweet home USA 

So it seems like a sweet time to be invested. Trump’s wealth creation agenda is boosting equities; geopolitical risks are less intense with the ceasefire in Gaza and talk of a cessation of hostilities in Ukraine; and last week’s data suggests inflation is stable for now.

Markets will have to confront some negatives at some point. If trade tariffs are imposed on Canada, Mexico and China by the US, this would be a negative for US consumers and for the US inflation picture. Inflation rates could move higher as US growth remains strong and the labour market tight, incorporating the potential impact of the administration’s anti-immigration stance. And animal spirits might go too far – leveraged loan default rates have continued to rise, for example. Investors have long held a list of potential risks associated with the new administration. They could still manifest themselves in market volatility and periods of risk-off. The best way forward is to be diversified – European as well as US equities, being ready to play another China recovery, taking advantage of income from bonds, and having more duration at these elevated levels of yield. Technology, energy in the broadest sense (electricity and all things related), and finance (banks) are the key themes to be exposed to.

And do not forget the central banks 

Central banks will be back in focus next week with the US Federal Reserve (Fed) announcing its next policy decision on 29 January. The market has priced in no chance of a rate cut, and we do not expect one. Still, it will be interesting to hear from the Fed for the first time since the inauguration, as this could set the tone for the bond market for the rest of Q1. The ECB meets the day after - the market has a 25 basis points (bp) cut priced in, which we agree with. The same goes for the Bank of England on 6 February. On balance, the evolution of monetary policy globally remains a positive for markets. 

Remember the King 

I am totally lost with this Manchester United team. The coach, Ruben Amorim, might be right when he said it was “maybe, the worst ever” in the club’s history. It is up to him and the club to change things. It is another period of reset. The death of legend Denis Law last week reminded supporters not only of his huge impact as a United player on its history, but also his contribution to United being relegated to the old Division Two in 1974. It can happen. United are only five places and 10 points above the relegation zone. I am all for a reset but not for falling out of the Premier League altogether. We have an incredibly good record against Fulham, who is the opponent this weekend but on current form the risk is another demoralising result. Oh well, at least bonds and equities are up!          

(Performance data/data sources: LSEG Workspace DataStream, Bloomberg, AXA IM, as of 22 January 2025, unless otherwise stated). Past performance should not be seen as a guide to future returns.