We believe a well-diversified portfolio can help navigate policy uncertainties. In our 2025 Market Outlook, we discuss potential asset allocation strategies to address challenges from higher inflation, rising fiscal deficits and protectionist trade policies.

November 2024 marked a pivotal moment, not just for the year, but for potentially reshaping the investment landscape for the foreseeable future. This shift was largely influenced by the U.S. presidential and congressional election outcomes. Former President, now President-elect Trump, secured victories in all seven swing states and won the popular vote. The Republican Party also gained control of both the Senate and the House of Representatives. President-elect Trump swiftly assembled his cabinet, and the market quickly responded to his campaign promises.

The risk of rekindling inflation

During the presidential campaign, Trump made several policy pledges, with taxes, immigration and trade policy being the three key areas of interest for investors. His stance on these policies suggests increased price pressures. Tax cuts are expected to stimulate the economy and extend the current growth phase, which is positive for risk assets. However, this may reduce the Federal Reserve’s (Fed’s) need to aggressively cut rates. More restrictive immigration policies, or even the deportation of undocumented immigrants, could tighten the labor market, given their roles in agriculture, manufacturing and service sectors. While many argued that tariffs during Trump's first administration did not cause a spike in inflation, the proposed scale of new tariffs (60% on all imports from China, 10-20% on all other imports) could be significant. The supply chain might not fully absorb this impact, potentially passing some costs onto consumers.

The ultimate outcome will depend on the actual implementation and timing of these policies. For instance, the inflationary impact of tariffs could be mitigated if implemented in phases. The practicality of some pledges, like deporting undocumented immigrants, could also temper the eventual effects.

Currently, the risk to our core scenario of a soft landing for the U.S. economy and gradual Fed rate cuts in 2025 is slightly tilted toward stickier inflation. The overnight index swap (OIS) and futures markets are pricing in only about 50 basis points (bps) of rate cuts for 2025. The December Federal Open Market Committee (FOMC) meeting, with its updated Summary of Economic Projections, may provide more insight into FOMC members' views on future policy paths. Fed Chair Jerome Powell refrained from speculating during the November FOMC meeting press conference on how the new administration might impact monetary policy. However, the committee will soon need to consider these factors in its policy deliberations.

The overall impact of these new policy expectations is an increase in U.S. Treasury yields, which has also strengthened the U.S. dollar (USD). Higher yields result from a combination of elevated inflation expectations, reduced recession risks and potentially a risk premium associated with rising federal government debt. High U.S. Treasury yields, coupled with a weak European economic outlook, have pushed the USD index higher. Prospects of higher U.S. import tariffs could also lead to currency depreciation in exporting countries, as seen with the Chinese yuan (CNY) in 2017-2019. The Mexican peso also depreciated at the end of November when Trump proposed a 25% tariff on Mexican exports to the U.S.

China: Patience is a virtue

Since the coordinated effort by the People’s Bank of China in late September, the pace of policy rollout in China has slowed. In early November, authorities announced a local government debt swap program worth CNY 6trillion. However, this announcement fell short of expectations as it lacked details on boosting consumption or addressing the sluggish real estate sector. The next focal point will be the Central Economic Work Committee meeting, scheduled for mid-December.

The local government debt swap program can be seen as risk mitigation rather than fiscal stimulus. Nonetheless, it helps alleviate some financial stress on local governments and their financing vehicles. This untangling of local government finances could enable more effective implementation of future stimulus programs when they eventually materialize.

In the Chinese market, there has been another round of rotation in outperforming stocks. Since late September, semiconductors and information technology have outperformed the CSI300 benchmark. Meanwhile, previous leaders, such as state-owned companies and high-dividend stocks, have experienced more subdued performance. E-commerce and internet stocks have shown mixed performance over the past two months. A rebound in the economic cycle and consumer sentiment would be needed to boost this sector.

A diversified portfolio as we approach inauguration day

Investors will closely scrutinize every word and action by President-elect Trump and his cabinet between now and January 20. He has already mentioned a "Day One" 25% tariff on imports from Mexico and Canada, and a 10% tariff on Chinese exports to the U.S. Tax cuts, immigration and other trade policies are likely to be key focuses in the near term.

We believe a well-diversified portfolio can help navigate these policy uncertainties. In our 2025 Market Outlook, we discuss potential asset allocation strategies to address challenges from higher inflation, rising fiscal deficits and protectionist trade policies. These strategies include short-duration government bonds, alternative assets such as infrastructure and transportation, as well as equity sectors and markets less exposed to tariffs on goods and potentially benefiting from the ongoing shift in the global supply chain.

Global economy:

  • President-elect Donald Trump secured the electoral college victory. Both the House of Representatives and the Senate have a Republican majority, with markets expecting tax cuts, deregulation, harsher immigration policies and tariffs, among others, under the next administration. The Fed cut rates by 25 bps, as expected, in a unanimous decision, but markets have significantly pulled back on expectations of rate cuts in 2025 over worries of higher inflation risks. Markets are now expecting only around 50 bps of cuts, as opposed to 100 bps in the Fed’s most recent dot plot. The election results also caused yields to rise and the U.S. dollar to strengthen on prospects of stronger U.S. growth, higher deficits and tariffs. The October consumer price index (CPI) report came in line with expectations for both core and headline inflation.
    (GTMA P. 31, 32, 33)
  • The growth picture in Europe continues to look soft, with the looming tariff risks posing an additional headwind. Markets have shifted to expect a more aggressive rate cut cycle. The Bank of England cut the key bank rate by 25 bps, as expected. The UK is less exposed to tariff risks given a smaller manufacturing base compared to Europe.
    (GTMA P. 19, 24)
  • China’s National People's Congress Standing Committee (NPCSC) announced a CNY 10trillion plan for local government debt relief. Officials continued to focus on stabilization rather than growth stimulus, which was slightly disappointing for markets. October activity was mixed, but retail sales was a notable bright spot, up 4.8% year-over-year (y/y) versus a consensus of 3.6%.
    (GTMA P. 5, 9, 10)
  • In Japan, 3Q24 gross domestic product (GDP) expanded 0.9% quarter-on-quarter annualized, above consensus of 0.7%. November core CPI also beat consensus at 2.2% y/y, but markets see a December rate hike as unlikely. The new government stimulus package was approved, featuring cash handouts and electricity and gas subsidies.
    (GTMA P. 16)

Equities:

  • Equities were generally higher in October, with global markets down 1.2%. Developed markets outperformed, led by the U.S. The S&P 500 rose 2.8%, putting year-to-date returns at an impressive 25.8%. The November rally was driven by election uncertainties dissipating and prospects of market-friendly Republican policies. Top-performing sectors were Consumer Discretionary (10%), Financials (9.2%), Energy (6.7%) and Industrials (5.5%). The Russell 2000 also rose 8.4% in the month, fueled by deregulation expectations. Elsewhere, MSCI Europe was down 4.4% in USD terms while MSCI Japan was up slightly at 1.1%.
    (GTMA P. 36)
  • Emerging markets dropped 5% in November, dragged by weak performance in MSCI China (-7%), mainly due to tariff risks from a Trump administration as well as disappointing NPCSC results. Onshore markets were relatively resilient, with the CSI 300 down only 0.9% and Shanghai stock exchange ending the month positively at 0.5%. Elsewhere in Asia, markets were mainly down, with notable weakness in Philippines (-7.8%), Korea (-6.0%) and Indonesia (-5.8%)
    (GTMA P. 36)

Fixed income:

  • U.S. 10-year Treasury yields started the month at 4.16% end-October and rose to a peak of 4.34% mid-November, before falling back to 4.13% at the end of the month. 10-year Treasury yields in major markets also fell, with German bunds falling 23 bps and UK gilts falling 5 bps. Korea 10-year Treasury yields fell 36bps, driven by the Bank of Korea rate cut.
    (GTMA P. 63, 64)
  • The credit market benefited from the Republican party’s pro-market policy proposals, with spreads on both U.S. investment grades and high yields narrowing, and returning 1.3% and 1.2%, respectively.
    (GTMA P. 62)

Other financial assets:

  • The U.S. dollar extended further gains, as the proposed tariff plans will likely support the USD over the medium term by narrowing the U.S.’s trade deficit and potentially leading to a more hawkish Fed policy, before pulling back on the nomination of Scott Bessent as the U.S. Treasury Secretary. The DXY was 1.7% higher over the month, with most major currencies weaker against the strong USD (EUR +2.8%, GBP +1.1%, CHF +1.9%, AUD +0.5%). The Japanese yen was an exception, strengthening 1.4% as the likelihood for a December hike by the Bank of Japan increases.
    (GTMA P. 74, 75)
  • The Bloomberg Commodities Index fell 0.7% over the month. Brent crude ended the month 2.7% higher. Apart from geopolitical factors, OPEC+ was reportedly considering delaying a planned increase in oil output due to ongoing weak demand in Asia, putting upward pressure on oil prices. Gold fell by 4.6%, with less demand for safe haven assets after Bessent’s nomination and the de-escalation in geopolitical tensions in the Middle East.
    (GTMA P. 76, 78)
 
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