Markets Update January 2025 - Equity markets between robust corporate earnings and high valuations

After a bumpy start to the year, the stock markets have recovered and are continuing their overarching positive trend. Forecasting the further course of the market is made more difficult by the fact that two opposing factors are currently affecting the markets: On the positive side is the good start to the reporting season. US companies continue to report robust earnings growth in aggregate. The earnings of financial companies in particular are exceeding expectations in view of the good situation on the stock markets in 2024 and the steeper yield curve. The markets therefore have a fundamental basis that argues against sustained downward corrections.

On the negative side, there is a valuation problem caused by years of AI hype. Together with interest rate pressure, the high valuations represent a real risk factor for stock markets around the world. This is because the stock markets are not only highly valued relative to their own history, but also in comparison to the bond markets. In particular, the valuations of the globally trend-setting US markets are not compatible with long-term interest rates, which are dangerously close to the 5% mark. The further course of the AI megatrend is also particularly relevant for the US stock markets. Investors are currently concerned that AI business models are rapidly becoming “commoditized” and will not meet the high profit expectations. Although the recent related market turbulence seems exaggerated, it is an impressive illustration of how dependent the markets have become on the topic of AI. A sustained positive market trend is therefore only realistic if there is a (moderate) easing of interest rates and the AI hype is not completely shelved.

US fiscal policy under Trump sets the direction

Whether and for how long the aforementioned interest rate pressure will continue depends largely on the policies of the new US administration. If US President Donald Trump pursues a reckless fiscal policy that further increases budget deficits, further interest rate rises and, in the worst-case scenario, massive turbulence on the bond markets are inevitable. Noticeable corrections on the stock markets would be the logical consequence in this scenario.

However, a positive scenario is also conceivable if the fiscally sensible faction in Trump's cabinet prevails. One of its most important representatives is Treasury Secretary Scott Bessent. He is in favor of the business-friendly elements of the Trump agenda, consisting of deregulation and tax cuts. At the same time, sound public finances and a moderate (non-inflationary) customs policy are important to him. Ideally, the forces around Bessent will succeed in adequately balancing the stimulating and restrictive elements of the Trump agenda. The result would be stable economic growth in combination with falling inflation rates and thus decreasing interest rate pressure. In this sweet spot environment, both equity and bond markets would benefit in the long term. It is not yet clear which scenario will establish itself on the markets in the medium term. Until then, professional investors should maintain a neutral risk appetite.