Trump 2.0: Time to curb your enthusiasm? 

Risk markets have been ecstatic over the US election results, with US equities climbing to record levels and credit spreads tightening. US exceptionalism is the running theme based on expectations of deregulation and lower taxes, and that has meant US outperformance over pretty much everything else. The big question is how long it can last.

The crystal ball is pretty cloudy right now. How does an allocator navigate markets when so much about the policy landscape is unknown and the details, once they emerge, could have major implications for sectors, companies, and regions? 

First, focus on what we do know (at least as of this writing in early December). We expect the new US administration to act on the four pillars of its campaign — lower taxes, more restrictive trade, deregulation, and less immigration. But changes in trade and regulation are likely to be implemented sooner than tax or immigration policies, which could require congressional approval. We also have deeper knowledge of fundamentals than politics, and we know current valuations. 

Second, take a scenario-based approach to what we don’t know. For instance, what is the likely impact of different growth/inflation mixes on interest rates? Third, use policy uncertainty and concomitant volatility to increase or decrease exposure when markets’ knee-jerk reactions put valuations out of sync with fundamentals. 

With that in mind, we are leaning into the good fundamental picture in the US — a better growth/inflation balance, stronger earnings than the rest of the world, and supportive Fed policy — with a moderately overweight view on US equities (Figure 1). What keeps us from having a larger overweight view? Valuations are at the rich end of the historical range, though we acknowledge that any reversion could take years not months. 

We expect the Trump administration to put tariffs on European goods, which, in combination with weaker growth, will hurt Europe relative to the US. We express that in our overweight view on US equities and on European duration relative to the US. Japanese equities have had a good run since we initiated our overweight view on the market in late 2022, but we have now moved to a neutral view given that the weak yen and uncertain political situation could offset the positives, including improving corporate governance and supportive valuations.

In fixed income, we have reduced our high-yield view to neutral. With spreads close to the zero percentile, the risk/reward has shifted negatively — though we recognize that attractive US yields, low default rates, and limited net supply could keep spreads tight for a while. We note that interest-rate volatility has been running higher than equity volatility, creating potential opportunities for allocators to take advantage of pricing anomalies in government bonds.

We remain positive on gold. De-dollarization continues to be a goal for many central banks concerned about US sanctions on US-dollar reserve assets. We see limits to the rise in yields, which hurt gold prices recently, and think the precious metal will again be valued for its hedging role amid geopolitical and inflation risks. 

While US political uncertainty will be a feature of the coming year, several guardrails could rein in the tail risks. First, the Senate confirmation process should mean that more extreme picks for key policymaker roles won’t be a shoo-in. Second, existing laws and regulations should limit the implementation of more radical policies. Third, the stock and bond markets will be “voting” on the economic implications of new policies. If either market tanks, the president is likely to respond.

Equities: Broadly bullish but weighing regional pros and cons

We maintain a modestly positive stance on global equities. Overall, economic growth remains on a steady positive trajectory and the disinflationary path is intact, although bumpier than before in some regions. Broadly speaking, market sentiment is bullish but not overextended, in our view. However, divergences remain. In the US, we think companies are well positioned to achieve robust earnings growth but valuations are a challenge. In other markets, such as Europe and Japan, earnings breadth is a concern but valuations are supportive. We think the biggest threat to global equities is the potential reemergence of inflationary pressures, which could lead to a disorderly move upwards in yields and create valuation headwinds. While these risks are not our base case, they give us reason to maintain some caution and keep us from moving to a full overweight view on global equities. 

Turning to our regional perspectives, we have moved from a neutral to a moderately overweight view on the US. The economy displays continued resilience, with a renewed pickup in macroeconomic leads, such as consumer confidence. Earnings surprised on the upside in the third quarter and we estimate they will grow by 14% over the next 12 months. The latest earnings show a picture of margin expansion, and a pickup in productivity has supported company bottom lines. Evidence of a more balanced advance in earnings thus far is mixed, as tech and related sectors still dominated cyclicals and energy in the third-quarter earnings season. However, the market advance turned more broad-based following the US election. And looking forward, expectations are for earnings growth in companies outside tech and mega-caps to close the gap with the leaders (Figure 2). When it comes to election impacts, markets face a balancing act between growth-boosting policies, including deregulation and the extension or addition of tax cuts, and the disruptive effects of tariffs and curbs on immigration. Still, we believe that the likely policy mix disproportionately favors the US over other regions. 

We maintain a moderately underweight view on Europe, where earnings growth remains muted and earnings revisions are more negative. Germany’s sluggish economy and France’s political uncertainty have further clouded the economic outlook. European equities are clearly cheap relative to earnings in both absolute and sector-adjusted terms, but they lack a compelling catalyst for outperformance versus other regions, particularly in light of potential US tariffs. We will keep a watchful eye for a change in trend given low valuations.

We have moved from our long-term overweight view on Japan to a neutral view. We think the market faces a few potential stumbling blocks in the coming quarters. As with Europe, we think Japan faces uncertainty about whether potential trade frictions will stymie companies’ ability to capitalize on any improvement in the global demand picture. We have noted that earnings expectations are falling and revisions breadth is weak. Japan also faces some domestic policy uncertainty following its election this past fall, which has yielded an unstable coalition. Volatility in the exchange rate may also cause P/E compression and lead to margin uncertainty for exporters. We remain constructive on Japan structurally though, as improvements in corporate governance, buybacks, and domestic demand growth continue apace.

We have moved from a small underweight view on China to neutral. While recent fiscal stimulus has not sufficiently addressed weak private sector confidence, we believe it puts a floor under the equity downside. Policymakers have likely preserved dry powder for fiscal interventions in case tensions escalate. Looking at company fundamentals, we see room for modest optimism, as buybacks are increasing and short-term earnings expectations are moving slightly higher. We remain neutral, however, because we expect valuation expansion will continue to be limited by a weak and uncertain long-term earnings growth picture and a lack of visibility on the sequencing of a policy response to serious growth challenges. 

Within sectors, we are positive on financials and utilities, given favorable valuations and macro signals, and more negative on consumer staples and telecoms. Utilities appear to be in a good position to capitalize on strong projected electricity demand growth and the resulting pricing power. We think financials could benefit from the steeper yield curve, a recovery in private credit, and deregulation. Small caps in the US seem likely to benefit in relative terms from a deregulatory impulse and a pickup in mergers and acquisitions. They may also benefit from low starting-point valuations and are less exposed to an expansion in tariffs and supply-chain frictions than many large caps.

Government bonds: Expecting divergence ahead

Most central banks are easing monetary policy but Trump’s election victory inserts new risks into the outlook that are likely to induce greater divergence between countries’ bond markets. Our highest-conviction view is that the combination of fundamentals and politics will drive the gap between US and European yields wider. 

On the fundamental side, the difference between US and European growth is stark (Figure 3). The US has surprised on the upside, with 2.7% GDP growth expected for 2024, and should benefit from the Trump administration’s pro-growth agenda. Europe, on the other hand, is struggling with weakness in Germany, political uncertainty there and in France, and the threat of a negative growth shock from US-imposed tariffs. In fact, we think the market will price more rate cuts for the European Central Bank. In our probability-weighted excess return scenarios, we see the greatest upside for European bonds and the greatest downside for US bonds.

On the political side, we think inflation is the main risk in the US given Trump’s campaign promises to extend tax cuts, impose stiff tariffs, and deport immigrants. Interest-rate volatility, as proxied by the MOVE Index, has been running much higher than equity volatility, as proxied by the VIX. The market has cut easing expectations from 200 bps in September to around 90 bps today and 10-year yields are 60 bps higher, driven mostly by real yields. Of course, the bond market reaction to higher inflation would depend on whether it was driven by strong growth (deregulation), a supply shock (fewer workers or less trade), or fiscal profligacy (an end to Social Security taxes, for example). The risk is that the term premium spikes in response to “bad” inflation. That said, the policies that are actually implemented may be milder than the campaign rhetoric. We expect the feedback between higher US yields and the economy to cap the rise in yields and think allocators can potentially take advantage of high volatility and consider positioning tactically in a range of 3.75% to 5.25% on the US 10-year. 

On balance, the combination of winners and losers in an era of deglobalization makes us neutral on overall duration.

Credit: Upside is limited, but not enough for an underweight view

Having had an overweight view on high-yield credit spreads since the start of 2024, we have now moved to a neutral view. We think the macro and fundamental backdrop remains supportive for credit — central bank rate cuts are underway, economic growth is strong, earnings and balance sheets are healthy, and high-yield default rates globally continue to trend down. However, the upside for credit is now limited by the fact that spreads are at extreme tights relative to history. Last quarter, there was at least some value remaining in the riskiest parts of the credit markets, but that gap has closed and we see very tight spreads across the entire quality spectrum. This means the upside potential of the asset class, compared to equities, for example, is more limited. 

Having said that, we opted for a neutral rather than underweight view because we think spreads could remain at current levels for some time. We don’t see any immediate catalysts for widening (especially now that the US election is behind us). There also remains technical support for credit markets, with yield-sensitive buyers continuing to flow into the asset class in search of attractive yields and seemingly agnostic about slim spread levels. We expect this to continue into the new year. Regionally, we remain neutral, seeing limited forward return differentials between different credit markets.

Commodities: As good as gold

We maintain our moderately overweight stance on commodities, driven by positive views on gold. Gold has had an incredible run in 2024, and we see reasons for it to continue into 2025. Our base case is that central bank buying, ETF demand, and interest-rate cuts should be supportive for prices going forward. We have stuck with a moderate rather than full overweight view because there are risks — particularly the possibility that central bank buying fades or real yields increase with sticky or rising inflation. But for now, the status quo remains supportive for the asset class.

Within oil, we have moved to a neutral view after previously being positive. While we continue to think economic growth will be supportive for prices, there is a growing risk (particularly coming out of the US election) that supply will increase and hurt prices in the new year. A positive roll yield, which reflects the lower cost of longer-dated futures, continues to support the asset class, in our view.

Risks to our views

Downside risks to our views include:

• A scenario in which core inflation reaccelerates or spikes, leading central banks to push back against aggressive rate-cut expectations or even to resume hiking  
• A jump in fiscal risk that pushes long-term rates higher in a disorderly fashion
• A big reversal in one or more of the mega-cap stocks, which could threaten the market’s current sharp upward momentum 
• A spike in geopolitical risk that pushes up the oil price and increases macro uncertainty
• Punitive US tariffs on China and/or the rest of the world
• The risk that capital flows to China are constrained by political maneuvers

Upside risks include:

• A breakthrough in US/China relations that results in lower-than-expected tariffs or no tariffs 
• More widespread diffusion of growth globally and inflation moving closer to target, giving central banks room to cut more than is currently priced in
• Meaningful fiscal stimulus in China, targeted to the consumer and private sector companies
• A broad resolution to the Middle East conflict
• Lower oil prices, suppressing inflation fears

Investment implications 

Prepare for US exceptionalism to dominate in equities — We expect the optimistic mood in risk assets to continue as pro-growth policies will likely dominate the narrative over the coming months. Rich valuations make the decision to be long equities less straightforward, as does the risk of inflation down the road. To express this balance, we prefer a slight overweight view on global equities and a regional equity view favoring the US over Europe. 

Expect further broadening in the equity rally — With better growth prospects, we expect earnings improvement to expand beyond the mega-cap tech sector. We think this should benefit value, small cap, and some cyclicals. Among sectors, we favor financials and utilities and are more negative on consumer staples and telecoms. 

Seek relative value in fixed income — We think the positive backdrop for credit, including strong technicals and falling default rates, is fully priced and that a neutral view on credit is appropriate. We also have a neutral view on duration on the basis of central bank easing continuing, albeit at a slower pace. We have higher conviction in relative calls, favoring securitized credit over other credit sectors and favoring European duration over US duration. 

Consider a small allocation to gold — Central bank buying continues to be a positive demand technical for gold as countries look to diversify their currency reserves and avoid the risk of US sanctions. A more muscular approach to foreign policy from the new US administration could insert more geopolitical uncertainty into the landscape.

Capabilities