Since the announcement of Donald Trump’s victory in the US presidential election last November, the last pessimists seem to have surrendered definitively and switched to the optimists’ camp. In fact, this capitulation process can be broken down into three successive phases:
In 2023, many investors were cautious. They missed the first upward leg of the cycle that began in October 2022.
By early 2024, they had normalised their equity risk budget, but remained wary of the narrative of US exceptionalism. With Donald Trump’s victory, they then surrendered their underweight position in the US market and the USD.
At the start of this year, we seem to be entering the third, and probably final, phase of this three-stage capitulation. After two years of record-breaking momentum outperformance, 2025 is beginning with a further surge in the leading stocks of 2023 and 2024, led by the Magnificent 7 Stocks (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, Tesla).
The impression is that having underperformed on their cash and bond allocations against equities, and then on their regional allocation by underweighting the US, professional managers are finally neutralising their specific risk relative to the benchmark equity indices. They are closing their value- or dividend-type positions. It should be noted in passing that while it was difficult for some to neutralise their allocation to the US market, which now accounts for 75% of the global developed equity market index, and then to neutralise the Magnificent 7, which represent 33% of the US index, it is unlikely that they will take the next step of significantly overweighting both. This would result in portfolios comprised almost entirely of US assets, which would likely mark the peak of US exceptionalism.
The US is priced for continued exceptionalism
At the start of this year, we are therefore facing a situation that is almost the opposite of what it was for most of the previous two years. The US macro- and microeconomic fundamentals, which surpass those of the rest of the world, are fully reflected in market valuations and positioning. This is somewhat paradoxical, given that while investors’ collective unconscious now seems entirely sold on the thesis of US exceptionalism, the continuation of the trends observed since October 2022 relies on a number of assumptions.
- First, the economic policy of the new US administration is still highly uncertain.
- Second, the world is eagerly awaiting the first measures of the Department of Government Efficiency under Elon Musk and Vivek Ramaswamy. Few observers really believe in their ability to save significant amounts of money in the US federal budget by 4 July 2026, which will mark the 250th anniversary of the signing of the Declaration of Independence.
- Tariffs and immigrant deportations are inflationary, reforms and the reduction of the size of the federal government are disinflationary, and the outcome of all this is highly uncertain.
No respite for Europe’s economy
Meanwhile, Europe’s industrial sector is sinking deeper into the doldrums of its structural loss of competitiveness vis-à-vis the rest of the world. All indicators are in the red. Unit labour costs are too high as they have risen disproportionately more, e.g. by 20.8% in Germany since the end of 2020, compared with just 6.8% in Switzerland, for example. High energy prices provide a drag on global competitiveness as well. Despite all these warning signs, Europe still does not seem ready to change course, i.e. to deregulate and liberalise in order to reinvigorate the spirit of the old continent – far from it.
Paris and Brussels continue to treat the symptoms rather than the causes of the continent’s malaise. Even the upcoming German elections seem unlikely to trigger a much-needed shift in macroeconomic policy. As we saw last November with the reactions to Donald Trump’s election on this side of the Atlantic, the median European voter still wants a larger welfare state. Here too, the markets expect a continuation of the long decline of the European economies without any sudden change of course.
China’s economic woes persist
In Beijing, there seems to be little concern about the balance sheet recession in the private sector and the resulting sluggish domestic demand. Indeed, Chinese policymakers are doing just enough to prevent deflationary pressures from intensifying and triggering a disorderly spiral of credit defaults, but not too much to prevent a new credit cycle as well as a bailout of Chinese households that have unwisely speculated on residential property. Interest rates on 10-year government bonds continue to plunge. In the 30-year maturity segment, the yield on Chinese government bonds has even fallen below that of Japanese government bonds with equivalent maturities. Indeed, over the next 30 years, the market expects China’s economy to be more deflationary and anaemic than that of Japan.
We expect 2025 to be a more turbulent year for equity markets than 2023 and 2024
As always, the performance of the major asset classes over the next few months will not be determined by the collective market expectations reflected in asset prices as summarised above, but by whether reality turns out better or worse than expected. Today, the relative calm on the equity markets, which reflects firm confidence in a benign macroeconomic scenario for 2025, contrasts with the nervousness on the US and UK government bond markets and the uncertainties surrounding the economic policies that Washington will implement.
Indeed, it is hard to reconcile the current lack of controversy in equity markets with the prevailing level of political uncertainty that extends to other major blocs beyond the US. No one seems to fear a US recession anymore, and complacency reigns supreme. All this in a context where most investors’ risk budgets have normalised, leaving the market vulnerable to any negative surprises. We remain invested with prudence, aware that we have entered the most uncomfortable phase of the cycle. All in all, we expect 2025 to be a more turbulent year for equity markets than 2023 and 2024.