With Republicans set to occupy the White House and to hold the majority in both houses of Congress, investors are busy trying to divine how the incoming administration’s policies will impact the U.S. economy and global financial markets.  In general, we believe investors are better served not to make major changes to their investment strategies because of shifting politics.  Markets have historically done well regardless of which party holds the most power in Washington D.C.

Here are our expectations for several themes to watch as we enter 2025.

Corporate Earnings to be Resilient

We expect public companies in the U.S. to generate high-single digit earnings growth in 2025.  Companies will face lower regulatory hurdles and costs under the new administration, which may result in rising profit margins.  Mergers and acquisitions activity will also probably pick up in the new year, as more companies will be emboldened to merge and acquire under the new administration’s lighter regulatory framework. Many analysts have penciled in double-digit corporate earnings growth for 2025, but typically these forecasts will drift lower as the year progresses.

Tariffs Could Dampen Growth Trajectory

The incoming administration has promised to impose tariffs on imports, but exactly how much and on which countries is still unclear.  Tariffs could be imposed at the country level (say a levy of 20% for all goods imported from China) or at the product level (for example on cars made in Europe but sold in the U.S.). Many are unaware that foreign companies and foreign countries do not pay a cent in tariffs to the U.S. Treasury.  In fact, it is U.S. companies that pay tariffs to U.S. Customs and Border Protection when they import goods, then those companies attempt to pass the extra costs along to their U.S. customers.  For example, if Walmart imports a TV from China worth $100, and the U.S. government imposes a tariff of 20% on Chinese imports, Walmart will pay U.S. Customs and Border Protection the $20 tariff, then probably mark up the TV in its store to try to recoup some or all of the tariff cost. Tariffs can also, and probably will, invite retaliatory responses, which can hurt the businesses of U.S. exporters.  This is why tariffs and trade wars often end up keeping inflation higher and economic growth lower for all parties involved. That being said, imposing tariffs on industries or countries that employ unfair trade practices seems equitable and reasonable.

Inflation Not Dead Yet

Inflation is still edging down toward the Fed’s 2% target, but at a slower pace than several months ago.  We would not be surprised to see the Fed reduce its projected frequency and number of interest rate cuts if inflation remains sticky around the 3% level.  With the economy still on a solid growth trajectory despite all the rate hikes over the past two years, the Fed will have to be vigilant for signs of resurgent inflation.  Also, the incoming administration’s plan to reduce taxes will be an inflationary boost to the economy that the Fed will have to watch. In the 1970s, the Fed made the mistake of lowering rates too much before inflation was truly tamed.  This Fed does not want to make the same mistake.

Equity Valuations Remain High

By nearly all measures, U.S. equities are expensive.  Stocks, as measured by the S&P 500, are trading at 22 times consensus earnings estimates for 2025, considerably higher than the 10-year average of about 16 times.  High valuations by themselves do not portend an imminent and significant decline in stock prices, but they usually do require the good news to keep flowing for stocks to stay aloft.  Meanwhile, Warren Buffett’s Berkshire Hathaway has amassed the largest cash position in its history:  $325 billion.  One of his favorite valuation metrics, the ratio of the total capitalization of the stock market relative to the size of the U.S. economy, is at an all-time high.  It’s no secret: after two years of strong returns, U.S. stocks are a bit pricey.

As always, we welcome your comments and feedback.  Please contact us know if there is anything you would like to discuss about your investments or the markets.