2025 Equity Outlook: Policy Clarity Brings Fundamentals to the Fore

• We believe 2025 could be a year of relative clarity in global equity markets. The resolution of the US election and other key global elections has removed some critical policy question marks that had hampered investment, and pandemic-era shifts in supply chains have now solidified into a new post-Covid normal.

• Companies that held off on capital expenditures during 2024 may now have the foundation of policy insights needed to start planning and spending again.

• We believe key long-term structural trends – including innovations in technology and healthcare, increasing automation, and rising net-zero and green spending – along with the ongoing near-shoring movement, remain key factors to consider when assessing companies’ potential over time.

• We expect a return to fundamentals in 2025, with the macro stories that dominated markets in 2024 giving way to a focus on companies’ individual strengths and weaknesses – and whether they will benefit from enduring structural trends such as those noted above.

Macro conversations dominated equity markets in the second half of 2024, with headlines surrounding the Federal Reserve, China policy, Japanese interest rates, and the US and other global elections making for volatile markets. We expect a reversal of this trend in 2025: The resolution of the US election in particular has mitigated a key source of uncertainty that caused many companies to put capital expenditures on hold in much of 2024 (see chart) and confounded investments among institutions and individuals.

Companies Postponed or Scaled Back Capex Plans Due to Election Uncertainty

Around 40% of firms surveyed in the third quarter reported postponing, scaling down, canceling, or delaying investment plans indefinitely due to uncertainty around the upcoming election. Firms listed regulatory and monetary policy as the top policy topics most important to their firms.

Source: Duke University, FRB Richmond, and FRB Atlanta. The CFO Survey – Q3 2024 (19 August-6 September 2024). Q2 results provided for comparison.

Greater policy certainty has created a baseline from which companies can start to make decisions again, potentially launching a new cycle of capex and investment. US President-elect Donald Trump has been clear about his policy priorities, which include a mix of widespread tariffs on imports to the US and more severe tariffs on Chinese imports (with the possibility that tariff threats could be used as a bargaining tool), along with mass deportations of immigrants believed to be in the US illegally; these are balanced with prospects for lower corporate tax rates and deregulation, and the extension of individual tax cuts. While certain policies could have an inflationary impact and potentially affect the arc of Federal Reserve rate cuts, we believe the global easing cycle will continue.

A clearer view into policy, paired with the resolution of the trailing effects of Covid on supply chains, could also signal a return to focus on fundamentals. This is in contrast to what we saw during and after the Covid crisis, when destocking and inventory normalization made it tough to determine which companies were winning and which were losing amid all the noise. What we see ahead is a return to a version of normal, with “good” companies being recognizably good, “poor” companies demonstrably poor, and much clearer distinctions between the two.

That said, we expect no return to the old (pre-Covid) status quo. The near-shoring/friend-shoring trend has permanently altered many supply chains, and continued innovation is reshaping industries across the globe. Here we discuss what we see coming for equity investors in the year ahead, including areas of opportunity and risks we’re watching.

Developed market (DM) equities are trending up again

After bouts of volatility leading up to the US election, DM equities have rallied strongly, with the S&P500 reaching new highs and the STOXX Europe 600 also registering a bounce-back. US labor markets have been holding up well, and inflation has been coming down (for now). Meanwhile, European equity investors continue to digest what Trump’s presidential win will mean for stock markets – most notably, his across-the-board tariff proposals and the indirect hit from higher tariffs on China – though markets appear more focused on central bank policy in the region.

In the days following Trump’s win, European automakers’ stocks climbed and miners also outperformed, while health care, personal care, and telecom shares lagged. Mixed earnings reports out of Europe also moved markets, with some tech stocks falling on misses and some key healthcare-related tech stocks making gains. German markets, meanwhile, are moving in step with shifts in confidence among the nation’s leaders.

Looking out over the next year, if the broad economic and policy backdrop boosts equities as a whole, positioning discussions could become less about which sectors are benefiting and more about the quality of individual companies and their ability to pass on potential inflationary pressures. That said, we do expect certain sectors to be more affected by the shifts in policy:

Financial companies may feel the strongest tailwinds. Under Trump we would expect deregulation, lower taxes, and a potential relaxing of anti-trust regulation to offer clear benefits to banks. Indeed, bank stocks have already rallied strongly since the news of Trump’s win.

Industrials could be headed for a golden era. US industrials in particular will likely benefit from Trump’s “Made in America” policy leanings, and the overweight to industrials that we had already favored could provide a rare opportunity over the next year: Given weak purchasing managers’ indices (PMIs) over the past two years and the chilling impact of election uncertainty on capex, it’s not unreasonable to expect a spring-loaded rebound among industrials as the fog clears. At that point, the “mega themes” of automation, green spending, and near-shoring will come further into the limelight (as we discuss in more detail below). A potential bottoming of interest rates could also encourage companies that it is the right time to borrow – and to spend those borrowings to enhance their businesses and operations.

Will Big Tech remain on the ‘naughty list’? Trump has generally been unfriendly toward Big Tech (with at least one notable exception). While he is likely to take a much more hands-off and deregulatory stance than President Biden has, with the Justice Department and the Federal Trade Commission (FTC) aggressively blocking mergers and acquisitions in Biden’s term, Trump could very well remain wary of consolidation in the tech industry.

Emerging market (EM) equities face headwinds under a second Trump term

As noted, while Trump’s win is supportive of US industrials, it is a net negative for industrials in the rest of the world – and his clear protectionist stance on tariffs and trade will likely pose particular challenges for companies in China and Mexico.

A 60% tariff on Chinese exports would have a material impact on China’s GDP, though the impact on Chinese equity markets could be limited, given that only a small percentage of corporate revenue for listed Chinese stocks is tied to exports to the US. Also in China, after reacting positively to the country’s first stimulus announcement, local equities have been trailing off, with the second stimulus proving disappointing. We believe that given this reality, along with potential US trade challenges, investors should remain focused on companies whose business models are resilient to a low-stimulus outcome.

Beyond China, risk premiums are likely to rise across EM and particularly Mexico under Trump’s trade policies. Some Mexican consumer goods, commodities, and cement companies could pass tariff costs on to consumers (potentially hurting sales) while others may try to absorb the costs (thus tightening margins). Tariff-related uncertainties could cause some EM companies to buck broader the trend we expect in 2025 by delaying investments, potentially slowing the near-shoring trend.

Outside of China and Mexico, in Taiwan, upbeat guidance and a strong third quarter boosted sentiment in Taiwan semiconductors and eased concerns about demand. In India, we’ve seen cooling in high-ticket discretionary purchases such as cars and travel and lodging. At the same time, global demand for IT services seems to have reached a bottom, and management commentary has now turned cautiously optimistic. We believe EM financials still look attractive.

Spotlight on key secular trends driving global equities

We believe companies that are forwarding or benefiting from innovations in technology, automation, and healthcare along with rising net-zero and green spending will continue to drive the global equity markets.

The AI era. Artificial intelligence remains a powerful driver for quality businesses and products, though concerns have emerged about concentration risk and overheated valuations, along with the potential for a turn in sentiment. These worries are amplified by the lack of AI revenue in recent software earnings, which could signal a potential overbuild of AI infrastructure. Despite these challenges, increased spending by cloud service providers indicates ongoing investment in AI capabilities. While the lack of recovery in IT spending is disappointing, we view this as a temporary phase associated with the evaluation and development stages of AI implementation. Companies are still exploring how to integrate AI most effectively and to navigate challenges around security and privacy, but we expect a recovery in spending as they transition into broader implementation.

Our 2025 outlook for AI-related semiconductor and hardware spending has become more optimistic following third-quarter earnings results, driven by raised capex forecasts from hyperscale companies and rising demand from enterprise and government verticals. However, we continue to approach these investments with a careful eye toward each company’s stage in our Lifecycle Categorization Research (LCR) model, which helps to determine our view of its prospects over the medium to long term. A leading electronic design automation (EDA) software company provides a good example of this approach. The company benefits from the increased spending on AI and semiconductors, but it also offers more resiliency through potential inventory or economic cycles due to its reliance on R&D budgets, which tend to remain stable even during downturns. While we remain positive on other more cyclical semiconductor firms, we believe companies that also benefit from these longer-term themes can help balance a portfolio’s risk profile while enhancing return potential.

Healthier returns? In healthcare, advances in the treatment for obesity, diabetes, cancer, and rare diseases remain a key source of growth. Demand for obesity drugs continues to rise sharply, and the market sees great long-term commercial potential despite near-term supply constraints and high prices. We maintain exposure to the innovators in drugs and devices treating unmet needs as well as the life sciences companies that supply them with cutting-edge new technologies.

Healthcare could experience competing headwinds and tailwinds, at least in the US. The US Inflation Reduction and Jobs Act (IRA)’s clampdown on prescription drug pricing is set to continue, putting a damper on some healthcare stocks with older drugs. Offsetting that could be a more pro-business administration that might spur investment as well as provide a backdrop for increased capital funding and M&A activity in the healthcare sector.

Green is still a “go.” Net-zero and green energy spending remains a key theme, and we are maintaining exposure to companies that benefit from these trends and are helping to move them forward. In the US, we generally have not seen companies retreating from their net-zero commitments despite red state/blue state divides. In Europe, perhaps counterintuitively, we have seen headlines about a potential pullback, though this is more a function of budget constraints bumping up against ambitious plans. Companies are still spending significantly on the implementation of net-zero and green initiatives, by our analysis – the pullback reflects a dose of reality, but spending plans are still very strong. In short, we still believe in the longevity of this theme, but the discussion has become more nuanced.

Electric vehicles make inroads. China has taken a strategic stance that electric vehicles (EVs) are an area where it can essentially leapfrog everyone else: as the rest of the world pulls back a bit, China is moving at full tilt on producing both the vehicles and the batteries that power them. That theme is also reflected in companies globally that provide the connectivity inside of EVs: these businesses are going strong because of their proportional exposure to China, with Korea another notable player in EV battery production. The market has noted concerns about EV penetration slowing as automakers in Europe and the US pull back on ambitious plans. But we believe this has affected sentiment more than reality, since Asia is the dominant market for EVs and developed market EV penetration is still growing, just not as robustly as expected.

Toward equity market clarity in 2025

All told, we expect to move from what has been a highly macro-focused story in 2024 to a more nuanced and fundamental-driven backdrop for global equity markets in 2025. We believe that the new post-Covid normal, characterized by ongoing innovations and supply chain changes, brings with it a ripe hunting ground for global equities – one in which longer-term secular trends will drive the success of companies over time, and where short-term fluctuations in a given sector will create opportunities to acquire quality names.

With greater policy clarity, market watchers may be tempted to breathe a sigh of relief. But change is of course constant, and with corporate spending ramping back up, industrials rebounding, and inflationary policies in the offing, it’s possible that we could find ourselves back in a place where we're running too hot again.