Global equity markets have made a choppy start to 2025, as concerns around Chinese competition in AI (DeepSeek) and President Trump’s (volatile) tariff announcements have buffeted markets.
However, in both cases the impact has been relatively transitory, with equities able to regain composure relatively quickly.
US Economy Still Providing Support
The new year has brought more evidence that the US economy is continuing to expand at a robust pace. The US economy expanded an annualized 2.3% in Q4 2024. This is the slowest growth in three quarters, down from 3.1% in Q3 and forecasts of 2.6%. However, the miss was due to a technical drag from net exports, as US imports surged to get ahead of expected tariff hikes. The engine of the US economy - personal consumption, actually accelerated to a very strong 4.2%, the most since Q1 2023 (vs 3.7% in Q3 2024).
At the same time, the US corporate earnings season has so far been better than expected, with both the percentage of companies reporting positive surprises and the magnitude of those surprises coming in above 10-year averages. For Q4 2024, the blended (year-over-year) earnings growth rate for the S&P 500 is 13.2%. If 13.2% is the actual growth rate for the quarter, it will mark the highest (year-over-year) earnings growth rate reported by the index since Q4 2021.
Earnings revisions have also been positive. On December 31, the estimated (year-over-year) earnings growth rate for the S&P 500 for Q4 2024 was 11.8%, compared to the current rate of 13.2%.
Bond yields settle back as US CPI comes in below expectations
The US Fed roiled markets briefly in late December, with more subdued forward guidance toward rate cuts. Bond yields climbed from late December to mid-January, but have since reversed course as inflation data for December came in below expectations. The market currently expects two Fed cuts in 2025, so the monetary backdrop remains supportive.
This mix of a still supportive macro, monetary and corporate earnings backdrop juxtaposed against a high degree of (Trump) policy uncertainty and full valuations continues to keep us relatively neutral on equities.
2025 Delivers Some Grey Swans
This year’s pick up in market volatility has attracted plenty of alarmist headlines in the financial press - most of which have been out of date within 24 hours. The volatility pick up is consistent with our 2025 outlook, where we flagged a more choppy market advance due to the interplay between a still supportive base case macro backdrop and a number of seemingly underpriced tail risks, including a “worse than feared” tariff regime and stretched valuations in the tech sector.
The specific drivers of volatility this year have been:
- A reconsideration of US big tech’s AI dominance.
- The rubber starting to hit the road on Trump’s tariff policy.
DeepSeek the disruptor?
The breakout release of Chinese developed AI assistant DeepSeek garnered significant attention for its sophistication, rivalling US mega-tech generative AI at a supposed fraction of the cost. This raised concerns over the massive spending of mega-tech companies on AI, and the stratospheric ascent of dominant chipmaker Nvidia. The market’s initial shock has been somewhat placated by suggestions that DeepSeek may perhaps be understating its dollar investment and total chip usage. Bloomberg reported that the US was investigating whether DeepSeek purchased advanced Nvidia chips through third parties in Singapore to get around the sales restrictions. This followed a separate report that Microsoft and OpenAI were investigating whether a group linked to DeepSeek had improperly obtained OpenAI data. Nevertheless, the emergence of DeepSeek has certainly provided a circuit breaker to the unbridled optimism around the US mega cap AI trades, and given the market pause for thought in respect of the consensus view from a number of perspectives.
Trumps tariff pledge starts to get real
The AI volatility spike appeared to disappear as quickly as it arrived, only to be replaced with news that President Trump was set to follow through with his threat from last November to impose 25% tariffs on Canada (except energy, which is 10%) and Mexico, as well as a blanket 10% tariff on China.
This was originally set for a 4th February start, which caused a sharp sell-off in global equity markets.
But with Trump quickly agreeing to a one-month delay for the tariffs on Canada and Mexico - subject to border and drug conditions - markets regained composure relatively quickly.
It seems quite possible that a deal may be reached to avert or cut the tariffs, but uncertainty around them and the threat of other tariffs means market volatility will likely remain high. 42% of US imports (5% of US GDP) come from these three countries. Rough estimates are that these tariffs will add 7% to average US goods tariffs, taking them to around 10%, for the highest level since 1946, and markedly larger than the 2018 tariffs.
In addition, Trump is continuing to signal even more tariffs ahead. He has ordered a review of unfair trade practices by 1st April, and continues to talk of a general tariff on all goods which in the election he put at 10% or 20%.
He has also talked about a 60% tariff on China, and is vowing to impose tariffs on the EU “pretty soon”. In total, Trump’s proposed tariffs could take the average US tariff to near 20% or more, for its highest level since the 1930s!
Of course, Trump is known to use tariffs for bargaining. We saw this with 25% tariffs recently imposed on Colombia, and Mexico in 2019, both in relation to immigration. These were quickly removed after both countries did what Trump wanted. Perhaps he feels the need to let the world know he is serious, before then making some “smart” deals.
However, the Trump administration has also referred to the aim of tariffs as being to reduce America’s trade deficit, serving to bring production back to the US, and serve as a source of tax revenue to fund personal and corporate tax cuts. Trump has indeed harked back to the 1800s, when tariffs were a much larger source of federal revenue relative to personal and corporate taxes. If this is the case, tariffs may be more of an end point rather than a case of “let’s make a deal”.
In short, it is unclear what the end game of Trump’s tariff push may be, and it is likely that we have months of volatile announcements ahead of us. We would expect a continuation of choppy conditions in the near-term, as the market remains torn between a seemingly bullish outlook for US corporate profits versus the risks and uncertainty posed by Trump 2.0.
Our central case view is that global stocks can ultimately push higher based on the growth potential of the US corporate sector, but full valuations and the not insignificant risk of a significant Trump policy misstep keep us neutral on global equities.
Australian Equities Make a Bright Start to 2025
While the global backdrop has been volatile, Australia has actually been a significant outperformer so far this year, with the market up ~4% to recently touch fresh all-time highs. Australian equities have been less impacted by the AI and trade war concerns that have buffeted the US market, while lower-than-expected inflation in January has increased hopes for a February 18th kick off to the domestic rate cut cycle.
The local reporting season is yet to move into full swing, but should reveal a relatively mixed picture, with subdued overall earnings growth. However, the market is likely to look to the impact of lower interest rates on economic activity, in continuing to price in a better earnings growth performance in FY26.
We will assess our slight underweight to Australian equities post the February reporting period. However, the prospect of an earlier-than-expected rate cut is supportive at the margin, albeit probably not enough in itself to change the view that the earnings backdrop is not as robust as implied in current valuations (particularly the banks). Small and mid-caps are areas where leverage to an improving economy appears more attractively priced. With the economy entering an easing cycle and our base case being for global equities to push higher, we expect the local market to make some moderate further gains in 2025, with stock selection likely to be the key.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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