Outlook for the 1st quarter: Negative surprises possible on the equity markets

Equity markets: Positive outlook

Performance on the international equity markets was mixed in the fourth quarter. The MSCI Europe suffered losses of 2.8%, the MSCI Emerging Markets Index lost 4.2%, and the MSCI World gained around 2.0% – all in local currency. The reason for this was Donald Trump's election success. A pro-growth policy is expected for the USA, which will primarily benefit US companies. For companies outside the US, the environment could become significantly more difficult against the backdrop of possible tariff increases. In addition, the US shone with strong economic data, while Europe and China tended towards greater economic weakness.

US President Donald Trump only has a short window of six to twelve months to implement his political agenda due to the mid-term elections in two years. Experience shows that new presidents therefore tend to initiate the legislative process for a large part of their political plans in their first hundred days in office. So far, however, there has been little clarity about which specific measures Trump would like to see implemented. Above all, there is great uncertainty as to what tariff and immigration policy will look like. There is therefore a risk of negative surprises and a correction on the equity markets in the first quarter.

In principle, however, we have a positive outlook for equity market performance in 2025 as a whole. The US economy should grow solidly and Europe and China could also enter an upswing and catch up with the US thanks to fiscal stimuli. If a controlled devaluation of the US dollar is even achieved over the course of the year, the financing conditions for the emerging markets would improve significantly and enable an upturn in this region as well.

However, geopolitics remains the biggest uncertainty factor. If the situation in the Middle East and Taiwan calms down and it even proves possible to end the war in Ukraine, Europe would benefit particularly. The currently still very high risk premium for European equities could fall, allowing Europe to outperform. Mid and small caps in particular are valued very low in Europe and could benefit disproportionately from positive surprises.

Euro zone economy: Chances of recovery are good

The fourth quarter revealed two different developments in the euro zone. Gloomy signs dominated in Germany in particular as the largest economy in the currency area stagnated – at best. Industry remained deep in recession, with no discernible signs of a sustainable recovery. As a result, companies announced increasing job cuts. However, there was a glimmer of hope in the services sector, which picked up slightly in December and has potential for sustained recovery. Other countries in the euro zone performed much better. An analysis by the British Economist made this impressively clear: seven European countries were among the ten best-performing economies in the OECD in 2024. Spain led the ranking – with economic growth of 3.5 percent, low core inflation, declining unemployment and a government primary deficit of just 0.6 percent of gross domestic product. Surprisingly, Greece was in third place.. Overall, the euro zone is likely to have achieved growth of 0.8% in 2024 – close to estimated potential growth. There has also been progress in terms of inflation as the inflation rate fell to 2.4% over the course of the year and reached a level close to the European Central Bank's (ECB) target. This enabled the ECB to make four key interest rate cuts, reducing the interest rate from 4.0% at the beginning of the year to 3.0% by the end of the year.

Easing monetary policy is already having an effect as lending picked up noticeably in the second half of 2024, particularly for private households. This positive credit impulse is likely to significantly boost economic momentum in the euro zone in the first half of 2025. The services sector, which traditionally reacts particularly sensitively to improved financing conditions, already benefited visibly in December. The purchasing managers' index for this sector rose significantly, as did the ZEW index – a reliable leading indicator of economic sentiment. The ECB is likely to continue to support this upward trend. Further key interest rate cuts in January, March and April could provide an additional boost to growth. We expect economic growth of 1.5% for the euro zone in 2025. In addition, declining wage momentum suggests that inflation will fall to 1.9% in 2025 – a figure that creates scope for the economy to continue growing. However, many framework conditions are fraught with uncertainty. For example, it is still unclear what US President Donald Trump is planning, but there are rays of hope here too. A possible easing of tensions in the Ukraine conflict could significantly reduce the geopolitical risks for Europe. Under these conditions, there would be a chance for sustainable economic recovery – with more tailwinds than headwinds.

US economy: Solid economic growth but risks of sustained high inflation

2024 was a solid year for the US economy. With expected growth of around 2.7%, the economy proved robust overall, even if the summer months were overshadowed by a short-term increase in fears of recession. A weak labor market report in August fueled doubts about economic stability and prompted the US Federal Reserve to take decisive action. In September, it made a surprisingly significant interest rate cut, lowering the key interest rate from 5.35% to 4.85%. Two further moderate rate cuts followed in November and December, and by the end of the year, the key interest rate stood at 4.35%.

However, the development of core inflation, as measured by the consumer price deflator, was atypical for a cycle of interest rate cuts. Core inflation rose from 2.6% in June to 2.8% in November, moving slightly away from the Federal Reserve's inflation target of 2.0%. Easing of monetary policy was apparently based on the expectation that the economy would cool down and inflation would drop again in 2025.

Recently, however, the economic picture has brightened noticeably. The latest economic data points to a recovery driven by several factors. On the one hand, many companies appear to have postponed decisions on investments and new hires in the run-up to the US presidential election. Secondly, the clear election victory of Donald Trump and the Republicans triggered optimism among many companies. Deregulation and tax cuts are considered likely, which will improve growth prospects in the short term.

For 2025, we expect solid economic growth of 2.4% with an upturn as early as the first quarter. However, the resurgent economy also harbors risks. Inflation could prove to be stubborn and remain above the target value in the long term. In this environment, further easing of monetary policy by the Federal Reserve seems unlikely. At the same time, the forecast is characterized by considerable uncertainty. It remains to be seen what steps President Trump will take in terms of immigration and trade policy. A restrictive immigration policy, combined with drastic tariff increases and a targeted weakening of the US dollar, could significantly fuel inflation. In such a scenario, interest rate hikes could even become necessary, which would bring the Federal Reserve into potential conflict with the government. It also remains to be seen whether and how successfully the planned government austerity measures can be implemented. The question of whether the government deficit can actually be significantly reduced remains a key uncertainty factor.

Asian economy: Moderate interest rate hike possible in Japan; China looking for the best way to boost its economy

The Bank of Japan's (BoJ) decision to leave interest rates unchanged in the fourth quarter may come as a surprise at first glance, but it was made against the backdrop of tense financial markets. Monetary policy adjustments had already led to considerable turbulence in August. The BoJ evidently wanted to prevent these uncertainties from flaring up again. Nevertheless, the need for action remains obvious. The yen is showing renewed weakness and is approaching potential record lows – a development that could trigger currency turbulence and jeopardize confidence in economic stability. The macroeconomic conditions speak in favor of a moderate interest rate hike. With stable inflation of just over 2.0% and economic growth of more than 1.0%, there is a solid foundation for raising the key interest rate by 0.25 percentage points in the first quarter of 2025. This would allow the BoJ to support the exchange rate and counteract the population's concerns about a devaluation of the national currency without jeopardizing market stability.

The situation in China is more complex. Economic momentum remained weak in the fourth quarter and the focus shifted increasingly to currency developments. There are two opposing schools of thought and it will be interesting to see which path the Chinese government takes.  

One school of thought suggests the government should fire up the printing press on a large scale to combat deflation. Historically, currency weakness would be the natural consequence of this massive monetary expansion.

Others argue the country already has a trade surplus in goods of over USD 1.0 trillion – out of a total global aggregate trade surplus of USD 1.6 trillion. A currency weakness would significantly improve the competitiveness of Chinese industry even further, threatening many non-Chinese industrial companies with bankruptcy. However, the high trade surplus is a signal that the currency is already too weak. China should therefore revalue its own currency. Domestic consumers would benefit from this, as imported consumer goods would become significantly cheaper. In addition, the Chinese government should address the weakness in consumption directly. Higher wages for civil servants and significantly improved employer-financed social security systems could significantly increase consumption. China could also turn on the printing press despite an appreciation of the currency, as the country has capital controls and can therefore restrict the flow of Chinese money abroad. In addition, China has considerable foreign exchange reserves, which it could use to stabilize the exchange rate at a high level.

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