Philipp Bärtschi, chief investment officer at J. Safra Sarasin Sustainable Asset Management, shares his latest thinking on the current state of play for global markets and asset classes following the US election result. In the following analysis, he reflects on recent market moves and what we might expect in the weeks and months ahead.
Since the summer, increased uncertainty in the financial markets has been noticeable. Concerns about the US economy alternated alongside hopes of additional stimulus programs from the Chinese government. The start of a new cycle of interest rate cuts by the US Federal Reserve (Fed) in September was for some investors too early and too severe and for others, too late. The US presidential election also led investors to reduce the risks in their portfolios and increasingly look for hedging. Consequently, implied volatility, measured by option prices, rose again at the end of October.
The clear and swift outcome of the US election reduced uncertainty and investors’ appetite for risk improved significantly. This trend is likely to continue and ensure a positive year-end on the financial markets.
Robust US economy, weak eurozone
The latest US macroeconomic data was better than expected. Both retail sales and the ISM Purchasing Managers’ Index for services came as a positive surprise. With the Republican victory, the volatility in macro forecasts is likely to increase due to Donald Trump’s plans. Deregulation and tax cuts would accelerate nominal growth, while a trade war should slow growth. Wall Street’s mind seems to be made up. Although many of Trump’s proposals will only have an impact after a delay – if at all – consumer sentiment and the business climate are likely to improve in the short term. The potential for US recession has receded. On the other hand, growth in the eurozone remains weak. There is little improvement in the manufacturing sector with impending higher US tariffs and no positive impetus from China likely to make the situation tougher. The weaker euro and further interest rate cuts could boost growth again towards the end of next year. Until then, economic performance is expected to remain weak.
Until recently, there were hopes of a major stimulus program in China. However, it appears that the government is only doing what is necessary to avoid recession. With Trump’s victory, the Chinese government likely will wait to see if trade tariffs are implemented before launching additional fiscal programs. Therefore, growth will remain weak in the short term and hardly play a role for the global economy.
Inflation could become an issue for bonds again in 2025
In November, the Fed stuck to its strategy of lowering interest rates further. According to Chairman Powell, the economic plans proposed by Trump will only be considered once implemented. In the short term, the Fed is likely to lower interest rates to a neutral level as inflation risks fall. The aim is to counteract a further weakening of the labour market. With stable long-term interest rates expected, the USD yield curve is likely to steepen in the coming months. The biggest risk for bonds is a return of inflation in the US. Inflation expectations in the markets have already risen as many investors bet on a Republican victory. If growth remains above trend due to the planned stimulus, inflationary pressure will likely increase. This would initially lead to higher long-term interest rates but could also pose a problem for risk assets.
In Europe, inflation risks are lower, therefore, the European Central Bank (ECB) is likely to make several rate cuts. European bonds appear more attractive than US bonds and the interest rate differential is likely to widen further. Risk premiums on the credit markets are historically low, which is hardly surprising given the stable growth. Against a favourable economic backdrop, we expect high-yield bonds to yield higher returns than the investment grade segment in the coming months. The financial bond segment also remains interesting.
USA remains in pole position for equities
The clear Republican victory in the presidential election has triggered short-term euphoria in US equity markets. Many indices rose to new record highs, driven by bank shares, which could benefit from the deregulation plans. However, the expected tax cuts are also an important component in analysts’ assessments, as the opposite would have occurred if the Democrats had won. After a brief spike following results, markets have tended to fall. This could be particularly true, the expected increase in trade tariffs is likely to have a negative impact on exports from European companies. The trends that have been evident since the beginning of the year have continued. This will likely remain the case in a possible year-end rally. It seems uncertain how much upside potential is available on the equities market this year, as valuations have already risen sharply. However, with the positive economic outlook and rising corporate profits, the positive trend is likely to continue at the beginning of next year.
Slight overweight in equities
The probability of a US recession has decreased, and the US Federal Reserve has cut interest rates by 0.75%, with further rate cuts expected. Lower interest rates and reduced uncertainty should encourage investment into riskier assets such as equities. As such, we expect equities to outperform bonds in the coming months. With a slight overweighting of equities, portfolios can benefit even more from the current positive trend – we are favouring developed countries over emerging markets. In the bond sector, we favour high-yield bonds over government and investment-grade bonds. Commodity investments remain a good addition to the portfolio as a hedge against inflation risks.
