Schroders: The resilience of the U.S. economy remains, but policy risks need to be monitored; small and mid-cap U.S. stocks may present investment opportunities

According to the Zhitong Finance APP, Schroders Investment stated that with Trump taking office again, the U.S. economy and policy direction have once again become the focus. The firm believes that entering 2025, the U.S. economy will be more optimistic than expected, with consumer spending sustainably driving economic growth. However, if Trump implements his campaign policies, such as protectionist policies, deporting illegal immigrants, and raising tariffs, the risk of stagflation in the U.S. will increase. Before the new government confirms trade policies, the dollar may experience some fluctuations, with inflation prospects prompting a stronger dollar, bringing the dollar index close to a two-year high. In terms of investment advice, U.S. stock valuations are nearing multi-year highs, which is concerning; for investors worried about high U.S. valuations, choosing small and medium-sized companies is a more direct way to invest in the U.S. economy and is also lower in cost.

Schroders Investment's economic research team predicts that the U.S. GDP growth rate will be 2.5% in 2025 and rise to 2.7% in 2026. This will keep inflation persistently above previous forecast levels, with expectations that the Federal Reserve will cut interest rates once in 2025 and then raise rates in 2026.

For investors, assessing the likelihood of any specific policy implementation is a major challenge, and this challenge will persist until the policy direction becomes clear. Senior emerging markets economist David Rees stated that throughout 2025, financial markets may be influenced by any policy news, even if these policies are never actually implemented, leading to increased volatility across various assets.

Trade policies will have a significant impact on the dollar. David Rees noted that any imposition of tariffs would support the dollar, as this measure would, to some extent, balance the impact of tariffs on trade and economic activity. We also expect interest rate differentials to provide support again, so a strong dollar is likely to persist for some time.

Fiscal outlook is a key factor affecting bonds

As investors assess the likelihood of Trump's policies and their potential impact on inflation and interest rates, there have been some significant movements in the fixed income market recently.

Fixed income strategist James Bilson stated that with the second Trump administration approaching, due to strong U.S. economic growth, recent robust inflation data, and expectations that the new government will adopt further reflationary policies, bond market yields have already been adjusted upward. Currently, the bond market reflects that the Federal Reserve will cut rates once or twice in 2025, each by 0.25%, whereas in September 2024, it was expected to cut rates more than four times.

Just as they are broadly concerned about economic activity, bond market investors will closely monitor policy actions regarding trade and immigration.

From the perspective of corporate credit, U.S. fixed income head Lisa Hornby added that risk assets are entering the current period from an expensive starting point. The corporate credit spread, or the excess premium relative to U.S. Treasury bonds, is at its highest level in decades. However, the driving force behind the tightening of credit spreads comes from the substantial demand for attractive overall yields. With yields remaining high, it is difficult to see anything that could reverse the direction of credit spreads Can the Exception Theory of the U.S. Stock Market Continue?

When it comes to the stock market, the United States' dominant position in the global stock market is at a historical high. As of the end of 2024, the MSCI U.S. Index accounts for 74% of the MSCI World Index and 67% of the MSCI All Country World Index.

Moreover, except for the peak of the tech bubble, U.S. stock valuations are nearing their highest levels in the past 143 years. Regardless of the policies of the new U.S. government, whether this valuation can be sustained remains a question mark.

U.S. Valuations Are Unsettlingly High

Duncan Lamont, head of strategy research, stated that the high valuation of U.S. stocks and their relatively high share in the global market is not a new phenomenon. However, U.S. stocks also have many advantages, including a surge in productivity compared to other regions globally, better economic momentum, and higher corporate purchasing power. More favorable demographic forecasts are another advantage, but this benefit will disappear if the lenient immigration policies shift.

For investors concerned about high U.S. valuations, one option is to look for opportunities among smaller companies, as small and mid-cap companies are valued lower than large companies.

Bob Kaynor, head of U.S. small and mid-cap stocks, noted that the U.S. benefits from a strong labor market and that the second Trump administration may introduce policies to support domestic growth. Small and mid-cap companies are more likely to attract investors primarily based in the U.S. Therefore, investing in small-cap stocks allows investors to invest more directly in the U.S. economy. Given the currently high prices of large-cap stocks, small and mid-cap stocks offer a lower-cost investment option