Equity Outlook: The ride just got rougher

Healthcare, in particular, looks promising given its strong earnings expectations, attractive valuations, and structural tailwinds such as aging demographics and advancements in medical technology. Industrials and materials are poised to gain from continued investment in AI-driven industrial processes and infrastructure projects. Energy companies, including those tied to power generation for AI, could also see renewed investor interest.

That said, tech isn’t going anywhere. The next leg of tech leadership is likely to focus on firms demonstrating real-world AI adoption. The sector’s future performance will hinge on its ability to transition from hype-driven valuations to delivering measurable results through AI-driven efficiencies.

Look beyond the U.S. shores for value opportunities

With portfolios concentrated in U.S. equities, particularly in the Magnificent Seven, investors may benefit from looking beyond the U.S. if looking for diversification or new avenues for explosive growth. European and Asian markets, while facing their own set of challenges, offer compelling value opportunities relative to the U.S.

European equities are trading at a significant discount to the U.S., reflecting concerns over a weak Eurozone economy, tariff risks, and ongoing geopolitical and political tensions.The region’s own ‘Seven Wonders’, which includes Hermès, Novo Nordisk, Siemens, LVMH, SAP, ASML, and Schneider Electric, have outperformed the broader market, though not as dramatically as their U.S. counterparts. Every sector in Europe trades at a higher than historic average discount to the U.S. Looking ahead, MSCI Europe earnings are projected to rise 1.3% in 2024 and accelerate to 6.6% in 2025, led by IT, consumer discretionary, and healthcare. Key growth areas also include electrification, renewable energy, and industrial innovation, where European firms are global leaders.

Meanwhile, in Asia, China presents potential for sharp rebounds, as Chinese equities are attractively priced, and any signs of demand-driven fiscal easing or dealmaking with Trump on tariffs could spark a swift rally. However, this remains a tactical rather than structural opportunity. Persistent issues such as deflation, high debt, and weak consumer confidence continue to weigh on the long-term outlook. Additionally, the significant role of government intervention in the economy and markets creates uncertainty, making Chinese equities less appealing from a structural investment perspective unless meaningful reforms are implemented.

Japan, on the other hand, presents a more selective opportunity. Following the Bank of Japan’s (BOJ) policy pivot in July, Japanese equities saw a brief correction before recovering again. Valuations have become less attractive, and the broader market faces risks of deteriorating global demand and a stronger yen. However, sectors like banking, which benefit from rising interest rates, and industrial firms tied to government industrial policy could offer targeted opportunities. Corporate governance reform remains another long-term tailwind for Japanese equities, particularly for companies improving shareholder returns.

Investors seeking exposure to emerging markets may find value in countries like Vietnam, which stands to gain from global supply chain realignment as companies look to diversify away from China amid trade war risks.

Trump 2.0 is a wild card

The return of the Trump administration brings with it a mix of policy risks and tactical opportunities. Markets will likely grapple with greater uncertainty as the administration focuses:

• Tariffs and Supply Chains: New tariffs on imports, particularly from China, could disrupt supply chains, raising costs for firms reliant on offshore production. High-beta sectors like tech and small caps may see increased volatility.
• Deregulation: Industries like energy, financial services, and manufacturing could benefit from reduced compliance costs, driving efficiency and profitability.
• Immigration Reform: Tighter policies could strain industries like technology, healthcare, and construction, which depend on foreign labor. Labor shortages may push wages higher, fueling inflation.

Key sectors that could be impacted from Trump 2.0 include:

• Energy: Trump’s “Drill Baby Drill” policy aims to expand domestic oil and gas production, but U.S. oil producers could face mixed prospects as oil prices could be capped hurting profitability. Renewable energy producers may face policy pressure, though global demand and cheaper financing could help.
• Healthcare: Aging demographics and medical innovation remain strong tailwinds, but regulatory risks, particularly on drug pricing, pose challenges. A potential Robert F. Kennedy Jr. appointment could add uncertainty. Despite short-term volatility, attractive entry points may arise for long-term investors due to solid fundamentals and low valuations.
• Financials: Deregulation could boost bank profits by easing capital and lending rules. However, performance will hinge on economic growth and interest rate trends, as a slowing economy could weaken loan demand and squeeze margins.

What do higher bond yields mean for equities?

Despite the Fed cutting interest rates by 100 basis points since September, long-term yields have moved in the opposite direction. The 10-year Treasury yield has risen by roughly the same margin, hovering around 4.60%. With a strong U.S. economy and increased fiscal risks following the Republican election sweep, there’s a real possibility that yields could retest the 5% level.

Why does this matter for equities? Rising bond yields increase borrowing costs for companies, which can squeeze profit margins and dampen corporate earnings. Sectors with high leverage or significant sensitivity to interest rates—such as real estate, utilities, and small caps—are especially vulnerable.

However, there are two key scenarios to consider:

1. If the economy remains strong, companies may be able to offset higher borrowing costs through robust sales growth and pricing power. In this case, the market impact of rising yields could be limited.
2. If economic growth slows, elevated yields are unlikely to persist for long, as the Fed may step in to ease financial conditions further.