Financial markets have tended to do well in the year after US elections, as they have in the year after the Fed initiates easing (so long as there is no recession).
We boost allocations to IG, REITS and commodities (all Overweight) and HY (remaining Underweight), while reducing cash (to zero) and government bonds (to Neutral). Bank loans remain our favourite asset class (from a risk-reward basis) and we remain Underweight equities.
From a regional perspective we prefer European and emerging market assets. We also seek exposure to an appreciating yen, which we do partly by maintaining the partial hedge out of USD into yen.
US assets usually perform well in the year after an election. Hence, given that we expect less inflation, easing central banks and more growth, we think 2025 should be a good year for financial markets. However, we embrace risk cautiously after strong price gains in 2024.
Apart from stretched valuations for some assets, there a number of other reasons for the cautious approach: fiscal consolidation is needed in many countries and this could dampen growth; the global economy may be too fragile to shrug off a potential trade war; inflation may pick up earlier than expected as economies accelerate and, finally, a worsening of an already extreme fiscal position in the US could push treasury yields even higher and weaken the dollar (especially if the Fed’s independence is called into question).
The chart shows that inflation continues to decline across major economies and that, therefore, central banks have been easing throughout 2024 (the 20 economies featured are expected to account for 86% of global GDP in 2024, according to the IMF). Importantly, the Fed is now among the almost 60 central banks that have cut rates during 2024, which paves the way for further easing elsewhere. We expect the Fed policy rate will be around 3.50% at the end of 2025 (versus the current 4.75%), with a similar reduction expected from the BOE but slightly less from the ECB. The BOJ is the obvious exception, and we expect 50 bps of rate rises by the end of 2025.
Based on monthly data from April 2001 to September 2024 (as of 30 September 2024). “GDP-weighted interest rate” is a weighted average of central bank policy rates and “GDP-weighted inflation rate” is a weighted average of consumer price inflation. Based on the 20 largest economies during each calendar year, according to nominal GDP in US dollars (based on data from the IMF World Economic Outlook April 2024).
Source: IMF, LSEG Datastream and Invesco Global Market Strategy Office
Even before these interest rate cuts, there were signs of improving monetary conditions in both the U.S. and the Eurozone. Although money supply growth remains modest, it is trending in a positive direction. The combination of falling inflation, central bank easing, and an increase in money supply suggests that the risks of an economic accident are diminishing. In the absence of significant shocks, we anticipate that recession will not be a concern in 2025, with economies more likely to be in recovery mode. However, the critical question remains: what has already been priced into financial markets?
While inflation has faded as expected, the post-pandemic surge in prices leaves us wary of a potential recurrence. Current data shows that headline inflation is still declining across the largest economies, including the U.S. and Europe. Also, there appears to be no upward pressure from commodity prices or supply chain disruptions now. It is surprising how little effect Middle East tensions have had on either energy prices or trade flows. That may not always be the case, and tariffs could also boost headline inflation. Of course, it is the path of core inflation that is more important, and we believe that wage inflation will be an important factor. Wage inflation is trending lower on both sides of the Atlantic but a pick-up in economic growth could reverse that.
Historically, U.S. asset returns have tended to improve in the year following elections compared to the year before. Although fixed income results can be erratic, equity returns have consistently outperformed in the post-election period. The exception was the election of 2000, which serves as a cautionary reminder given that it coincided with the bursting of the internet bubble.
Notes: Past performance is no guarantee of future results. The chart shows total returns in US dollars. “Govt” is based on the ICE BofA US Treasury Index; “IG” is based on the ICE BofA US Corporate Index and “HY” is based on the ICE BofA US High Yield Index. Based on monthly data from 31 October 1987 to 31 October 2024 and shows average returns in presidential election years since 1988 (with years defined as running from 31 October in the preceding year to 31 October in the election year, excluding 2024), compared to the returns in the year after the election (defined as being from 31 October in the election year to 31 October in the following year). “All years” shows the average return across all years since 1988 (with years running from 31 October, starting on 31 October 1987). “2024” shows the return from 31 October 2023 to 31 October 2024.
Source: ICE BofA, S&P Dow Jones Indices, LSEG Datastream and Invesco Global Market Strategy Office
While we are cautious about inferring causality, data suggests that U.S. stocks have generally performed better under Democratic presidents. However, one of the most favourable environments for stocks has been when Congress has been supportive of a Republican president, a scenario expected to continue for at least the next two years (based on data since 1853).
Asset allocation is the process of dividing an investment portfolio among different asset classes, such as stocks, bonds and cash and so on. Bonds generally tend to be ‘safer’ investments than stocks and are, for example, seen as more defensive. Assets are allocated based on economic and monetary expectations.
Spreading the risk and number of potential opportunities across various asset classes, such as equities, fixed income and commodities. The aim of diversification is to reduce the overall risk of the portfolio.
Central banks can ‘tighten’ policy by raising interest rates. This is done to curb inflation or an overheating economy. After the pandemic, inflation rose as pent-up demand was released and supply chains issues were cleared. Russia’s invasion of Ukraine further spurred inflation due to higher energy costs. Central banks responded with a series of rate hikes, which is the tool generally used to moderate inflation.
When an asset is assigned Overweight, an analyst or investor typically thinks that it will outperform others in the market, sector, or model. Underweight is indicative of the opposite.
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