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Summary

As we come to the end of the year, with US equities having risen 27% through the year it is worth noting that very few people, whether ‘professional’ or ‘non-professional’, had such an upbeat view of the potential for US equities at the start of the year. Just like now, most commentators appear to hold US equities with some element of caution.

We accept that the elevated valuations of US equities, in particular large cap technology stocks, pose a challenge to many investors. However, whilst they continue to deliver robust earnings growth, the valuation risk may not materialise. In contrast, non-US equities struggle to generate profits growth (when denominated in US Dollars) in part due to US Dollar strength, which explains the continued outperformance of US equities.

The US Dollar strength is driven by the relative change in bond yields as the economic growth paths of the US and Europe diverge, with strength in the former and weakness in the latter. The strength in US economic growth is having an impact on interest rate expectations for 2025, with only two to three interest rate cuts expected in the US. Whilst in Europe, which is beset by recessionary conditions and political turbulence in France and Germany, interest rates are expected to fall further and faster in 2025. This has caused bond yields in the US to rise while those in Europe have fallen, leading to strength in the US Dollar.

Interest rates in the US may not fall by as much as had previously been expected but rate cuts are still on the cards. Whilst rates are being cut and if economic and profits growth remain upbeat, US equities are likely to rise further through 2025 despite the valuation hurdle. However, as readers will know, a Trump presidency may contain shocks both positive and negative that will shape investor appetite in coming months. A known risk is the inflationary impact of his tariff and immigration policies, which may in turn limit the extent to which the Federal Reserve can cut interest rates. If rates stop falling due to higher inflation rather than stronger economic growth the support for US equities may fade, but for the time being that isn't being forecast.