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The world continues to turn as we bid farewell to 2024 and enter a new year. The arrival of 2025 brings a new class of political leadership in democracies (and some authoritarian states) around the world, clouding our 2025 crystal ball. Yet, as we do every year, we use our best efforts to formulate our outlook for the new year by addressing what we see as the good, the bad and the ugly for the US outlook 2025.
The Good.
US stocks reigned supreme in an uncertain world, leading to a solid US market in 2024. US GDP maintained strong growth while inflation slowly cooled providing a tailwind to US markets. The US labor force continued to add jobs at a decent clip, with many job openings and low levels of layoffs. This unfolded as the rest of the world also continued to grow, with varied growth between developed economies and developing economies. Developed economies experienced slower paced growth compared to the US, while developing economies grew at a faster pace. With a new administration targeting decreasing regulation and with ample liquidity available, higher rates notwithstanding, 2025 begins with a tailwind for US markets.
The Bad.
With inflation still above target in most of the developed world, more opposition parties won elections in 2024 and will likely continue in 2025. Substantial government spending, with no end in sight, creates unique challenges for leadership around the world, and actions taken by governments will be closely watched by the market. As the new administration takes power in the US, a severe storm is brewing fueled by the clash of fiscal challenges and inflationary pressures. None of this is new information, yet the rates for long-dated US government bonds have recently been ticking up at an accelerating rate, nearing 5%. Hopefully, the new US administration can construct a budget to shrink the deficit over the next few years, allowing breathing room for rates to move lower. While this goal is certainly possible and desirable, it is politically challenging, as every Congressional district receives some benefit from the large deficits (a primary source of the challenge).
The Ugly.
Unfortunately, trade wars, ignited by tariffs, have been the hot topic as of late. Economically, a trade war makes no sense because, essentially, a trade war is nothing more than two sides trying to bleed the other dry. There is no net benefit to any party if major countries attempt to bleed each other dry. In fact, the ugly results with the entire world becoming poorer and creates painful unintended consequences. History is fraught with tragic reminders of the consequences of trade wars. Taking a step back in time reminds us of the agonizing lessons the world seems too often to forget yet provides insight into how future trade wars could evolve.
Lessons from a Step Back in Time
EU and Russia: Invasion of Ukraine. When Putin ordered his soldiers to cross the frontier into Ukraine in February 2022, he thought he would have a quick victory and glory. Now, three years later and he has achieved neither; but a lesson about trade wars exists in the invasion. Soon after the invasion, the EU levied sanctions on the Russian economy with the expectation that the financial damage caused by a reduction in trade would hurt Russia and hopefully force it to the negotiating table. Instead, the Russian economy, while weakened, continued and Russia responded with countersanctions to hurt the economy of the EU and force them to give up supporting Ukraine. Like Russia the economy of the EU took a hit, but it too continued in a weakened state. The EU and Russia plummeted from $300 billion in total trade in 2021 to around $90 billion in trade in 2023. Europe is now willingly paying more for energy and Russia has willingly given bigger discounts on energy to trading partners. The result: three years into a true trade war with each side economically weakened yet with heightened resolve to continue. The only side that could be viewed as a winner would be the other trading partners of the EU and Russia who have benefited from the drop in competition. The lesson: Populations are willing to sacrifice if they feel a nation is under economic threat. It is no different for the populations in Canada, Mexico, and the EU. While not the scale or challenge of the threat of China, it still would be unsettling to markets.
China, Nanjing (Nanking) Massacre Memorial: Japan’s 1937 Invasion of China (Alex Chapman July 2024 Personal Perspective from China.) The US has not experienced a trade war with China. In our recent past, we have only experienced a small tariff scuffle. Yet, a July 2024 visit to my wife’s family in Singapore, Indonesia, and China was illuminating in ways that relate to the current political situation in the US. During my recent visit to the Nanjing (Nanking) Massacre Memorial in China, I stood with my father-in-law on his first ever visit. He looked upon the excavated mass grave, paying his respects to his older brother who perished in the massacre (at age 4) and who is buried in one of the countless unmarked mass graves of the victims. The Nanking Massacre Memorial is in remembrance of the 300,000 victims of the Rape of Nanking when Japan invaded China in 1937 and the 20-50 million Chinese who perished in the war against Japan during WWII. As we stood there together, it was a sobering personal moment, but also a cautionary warning for the US. As we spent time at the Memorial and traveled throughout China during July 2024, it became clear that the Chinese domestic view is that these horrors occurred all those years ago because China allowed itself to be bullied by a foreign power and was weak. Those convictions run deep in China including with the current leader of China, Xi Jinping. It was under his leadership that the National Memorial Day for the victims of the Nanjing Massacre was created in 2014. The current Chinese mindset will make a trade deal for the US more complicated and challenging.
The US experience in the 2019 trade negotiations with China could be providing a flawed sense of security because there was a willingness to settle for a very watered-down deal. In that deal, the US claimed that the Chinese must buy a certain dollar amount of goods, and the Chinese claimed that they only had to buy that amount of goods if market forces permitted, allowing a deal to be reached with neither side appearing weak. Today, if we push for a deal that forces China to change domestic investment policy, it will not be a US vs Chinese Communist Party battle but a battle with 1.4 billion people in China. Many Chinese citizens do not like the communist party, but China is their country, it is the home of their ancestors, it is a country they love. They view the Communist Party as just another dynasty that will come and go as many have over the 4,000-year history of the Chinese nation. Their allegiance is to China, and it is strong.
The Chinese population would view strict trade concessions as harkening back to the unequal treaties of a century ago and to the humiliation of the Chinese people which led to the death of nearly 100 million during that century, including the tens of millions of Chinese in the war against Japan. This narrative is not to invoke sympathy but to be cleared-eyed that there would be a heavy economic cost for the US to “win” a trade war with China. China has leverage against the US. They could dump our long-term debt, confiscate US assets in China, place an embargo on all Chinese exports from China including Taiwan, etc. China would rather suffer economically as living memory still exists of a China that was weak and carved up by foreign powers and the horrors that it wrought. Tred lightly.
Staring through an obscured crystal ball
As we contemplate the outlook for 2025, the economy and inflation continue slowly moving in the right direction. The US still has some budgetary wiggle room but will require a clear pathway to shrinking deficits from some combination of deregulation, budget cuts and limited tax cuts, all of which would support the market. The big wildcard will be a possible trade war; it will not be a battle of payments but potentially a much more costly fight this time around. We remain optimistic but much more vigilant and have been preparing for potential surprises. During 2024, we leaned into our deep and long investment experience by resurrecting our research from decades past into haven currencies, commodities and countries that could benefit from increasing trade (Indonesia) in 2025. Our toolbox is ready if needed but remain optimistic for markets that most of the headlines are bluster; after all, rocking the boat benefits few.
As the first quarter unfolds, simultaneous tangible progress on fiscal sustainability and increasing deregulation would serve as a strong tailwind for US markets and the US economy; thus, allowing the US to decrease inflation and continue to attract investment. A focus on tariffs and trade wars will increase tail risks. We hope and expect that cooler heads will prevail, but we will remain vigilant. As always if you have any questions or concerns feel free to contact us.
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