European, Japanese and emerging market stocks can all prove attractive for allocators currently weighted towards an over-invested and inflation-prone US economy.
Those experienced in asset management typically look for ‘out of consensus’ ideas. This is generally a good way to avoid big losses and/or make large profits. As 2025 starts, the consensus expects inflation to fall, central banks to ease, the dollar to strengthen and US equities to outperform. Those views on the dollar and US stocks appear to have been reinforced by beliefs about what Donald Trump may do during his second presidency.
So it is not a difficult choice to go against recent momentum. Interestingly, the US dollar strengthened after the first election victory of Donald Trump but fell 10 per cent during 2017 (the first year of Mr Trump’s first term), judged by the DXY index.
There is a reasonable chance the same thing will happen this time. First, the dollar is expensive, when judged by real trade-weighted indices. Second, the US budget deficit is already around 7 per cent of GDP — enormous for a growing economy — and Mr Trump’s polices could exacerbate the shortfall, which would likely be dollar negative. Third, global investors are willing to hold the dollar because they have faith in the Federal Reserve. But Mr Trump may undermine that confidence as he tries to exert control over interest rate decisions. Finally, he has said at various times that he wants a weaker dollar.
Inflation speculation
There is a common belief that US stocks will continue to outperform. However, the US market is very expensive, suggesting good news is already in the price. European, Japanese and emerging market stocks are more aligned with historical norms and likely to benefit more than the US from the expected upswing in global growth during 2025. A lot of bad news is in the price of these other markets, especially China, as a result of fears about tariffs. Interestingly, US stocks underperformed the MSCI EAFE index (World ex-North America) in 2017, despite enthusiasm about the new Trump presidency. I suspect the same will happen in 2025.
Of course, a rise in inflation could upset all markets and the risks are greater in the US. First, US core CPI inflation has remained stubbornly above 3 per cent and headline inflation has climbed from 2.4 per cent in September to 2.9 in December. Second, commodity prices have started to rise, especially energy, with this expected to feed through to headline inflation over the coming months. Third, if tariffs are imposed, that is likely to boost US inflation, just as a reduced labour supply, resulting from deportations and less immigration, could boost wage growth. Upward pressure on commodity prices and wages could be exacerbated by the aftermath of the Los Angles wildfires. Indeed, US headline inflation could breach 4 per cent at some stage during 2025.
European dreams
Interestingly, German stocks have outperformed US stocks since the US election, based on MSCI country indices. Not only are European indices cheaper than US counterparts, but European indices contain more cyclical stocks, expected to benefit as the global economy accelerates. And the price of EU carbon could also benefit from any cyclical upswing.
There are, however, clear risks in Europe. First, the new US administration appears to be no fan of the EU and tariffs could be imposed. Second, Europe will see important elections during 2025 — including Germany and possibly France — and the discord between EU members is likely to rise, with a central European bloc being more friendly towards the US and Russia. That discord could lead to widening of peripheral European bond spreads versus German yields, an outcome further encouraged if stalemate in the French parliament forces President Macron to resign, which is a strong possibility.
All of this could trigger a big change in direction of investment flows. First, higher inflation could make life difficult for most investors, as a broad range of assets would suffer. Second, a switch to outperformance by non-US assets would make life doubly difficult for many. Rather than flows being towards US assets, there would be a swing to non-US assets as investors scramble to catch up with the new trends.
This could be an interesting year for Europe versus the US. Not only in terms of geopolitics and market performance but also in the sphere of sport, and golf in particular. The Ryder Cup takes place in the US in September and home advantage has proved decisive since Europe won at Medinah in 2012. Despite the US also appearing to have an advantage in terms of player rankings, I suspect the team spirit and motivation shown by Europe at the last Ryder Cup match in Italy will take them to victory, in a year when it could prove symbolic.
Paul Jackson, global head of asset allocation research, Invesco
