Riding Red Ripples

Republicans win it all – but narrowly in the House

It’s official. According to the Associated Press, Republicans have retained their majority in the House of Representatives, but almost every result that comes in confirms it will be an exceedingly narrow one. As the dust is starting to settle, Donald Trump’s victorious third run for the presidency remains as resounding, as it initially appeared. That he won all seven of the supposed swing states, and was declared president-elect so quickly, is not surprising given how close the race looked in the pre-election polls and how polling errors tend to be correlated across the board. Much more impressive were his gains in states such as Texas and Florida, which shifted even further Republican, as well as such traditionally Democratic states as New Jersey, New York and California.^[1]

This provides Trump with a strong mandate, but governing could still prove tricky. With a slate of appointments already unveiled, his team certainly seems better prepared than in 2016. Not everyone of these will necessarily go through but the appointment of Susie Wiles as White House Chief of Staff promises stability. However, looking closely at many of the choices made or rumored so far, it is difficult to discern the ideological orientation of the new administration, beyond fealty to the president-elect. For example, Secretary of State to be Marco Rubio, along with national security adviser Michael Waltz first made their marks as interventionist foreign policy hawks. The return of Robert Lighthizer as U.S. trade representative signals that tariffs will remain a key priority as a bargaining chip, but does it also signal a full embrace of statist, industrial policies long familiar in countries like France? Trump’s choice of Elon Musk and Vivek Ramaswamy to lead government efficiency efforts would suggest that there will be plenty of libertarian leaning voices on economic matters in the next administration.

Despite winning the popular vote and the electoral college (admittedly by much smaller margins than, say, Barack Obama in 2008), Trump’s coattails proved weaker than usual for key Congressional races, notably in the House of Representatives. Votes continue to be counted and Republicans are on track towards a razor-thin majority in the House, already somewhat depleted by cabinet picks. Although many Republican law makers of recent intakes are personally loyal to Trump, there are plenty of underlying policy differences. This is likely to allow Democrats — as well as a handful of moderate Republicans — to exert some leverage even over top presidential priorities. Not being able to run for a third term usually means that second-term presidents see their authority evaporate.

Market and policy implications

We see plenty of uncertainty over future policies, especially in areas where Trump himself has embraced a variety of policy positions over the years. The realities, not least in terms of fast-moving events abroad and market reactions between now and the inauguration on January 20^th will constrain the next administration, especially on matters of fiscal policy. Keep in mind that a major priority is going to be to extend key provisions of the Tax Cuts and Jobs Act, passed during Trump’s first term, beyond their sunset in December 2025. But given that people have gotten used to those lower taxes, such extensions, perhaps paired with minor tweaks, would merely avoid fiscal drag, rather than providing new fiscal impulses.

We would also stress that as a candidate, Trump left out most of the details when he made such memorable tax promises during the campaign as "no tax on tips" and "no tax on overtime." As with his first-term slogan - "build the wall and Mexico will pay for it" - Trump will want to show voters something for the 2026 midterms, though not necessarily exactly what some advisers described ahead of November's elections. At least in the early days of the Administration, one probably should not expect much opposition on Capitol Hill, except, perhaps, on key cabinet appointments. On migration, we would expect the focus to be on comparatively doable, and easy wins, such deporting known criminals already in custody, with limited immediate impact on labor markets, although the drag is likely to grow over time. Nor would we be surprised to see policy decisions swing back and forth on a case-by-case basis, depending on public and market reaction, even on such key policy issues as migration, tariffs, antitrust, taxes and spending. Investors should be cautious about prejudging which policy positions will ultimately prevail.

Asset-class implications

Fixed Income & Currencies:

In the aftermath of the election, U.S. yields initially continued the pre-election trend - rising further, albeit with high intraday volatility. In an environment of falling interest rates - we expect the Federal Reserve (Fed) to cut rates three more times over the next twelve months – we expect the rise in yields gradually coming to an end. However, higher levels cannot be ruled out in the short term. While short maturities should benefit from further rate cuts, we believe that longer maturities will offer buying opportunities if 10-year yields in the U.S. rise above 4.50%. We expect the curve to steepen further in the course of 2025. In the eurozone, growth concerns are playing a much bigger significant role, although the market is also relying heavily on more substantial interest rate cuts by the European Central Bank (ECB). In such an environment, yields are likely to fall, especially in the shorter maturities, but also in the longer maturities. However, we do not expect any pronounced movements, as it is rather unlikely that yields will completely decouple from the trend in the U.S.

On the credit side the outlook for USD Investment Grade Credit remains supportive on the longer-term horizon. Technicals should continue to be positive over the next year with the expectation that Fed policy normalization being a catalyst for investors to move from money markets to longer duration fixed income. Valuations and fundamentals remain neutral factors. We will look for clarity over the next two quarters on whether Trump keeps his promises on tariffs, tax policy and immigration. A resurgence of inflationary pressures could lead to some spread weakness. The outlook for EUR Investment Grade Credit on a twelve-month horizon is positive as well. Supporting factor for the asset class remain strong fundamentals and a healthy technical backdrop.

Looking at currencies, the outlook for the U.S. economy had already brightened before the U.S. election, leading to some dollar strength. Now that Trump's economic policies are getting clearer, we expect this will tend to lead to higher inflation and higher yields. U.S. exceptionalism is likely to continue. At the same time, economic growth outside the U.S. might be negatively impacted due to possible tariffs against the G10 countries and China. All this could result in an even stronger dollar.

The defense of the independence of the Fed, which was already a central theme at the latest Fed's press conference, should support the dollar in the medium to long term. In the short term, the lack of strong and consistent political voices in Europe might weaken the euro further. The market is already long the dollar and has built up an even larger position via options recently. From a technical perspective, the euro could go lower against the dollar.  

Equities:

We expect the U.S. equity market to remain well supported over the medium to longer term, even if a continuation of the Trump trade is unlikely to have the same momentum as in the immediate aftermath of the election. For investors, a number of question marks will only be resolved in the coming weeks and months, and it remains to be seen whether the early optimism about the likely pro-business policies of a Trump administration will prove to be justified.

There are many indications that not only will there be no tax increases for individuals or corporations in the U.S. starting next year, but that corporate tax cuts or special tax deductions for domestic production may materialize. We increase our earnings per share assumptions for the S&P 500 by $5 as a placeholder for potential corporate tax cuts. We also currently expect the tariffs to be selective and limited. Most importantly, there should be some movement in this direction on China as soon as Trump takes office. We still think tariffs on all imports to be unlikely, although this cannot be ruled out. Among U.S. small caps, we are selective, favoring industrials. Whether there will be a sustainable rally for small caps will critically depend on Treasury yields receding.

Uncertainty about the future U.S. deficit therefore remains a major risk factor for Wall Street. The key indicator will be the reaction of the bond market going forward. We believe that the yield on the 10-year Treasury note may need to stay below 4.5% in the coming weeks to avoid spooking the equity markets.

For European equities, we have reassessed our previous Outperform call in light of the US election results and decided to tactically downgrade European equities to Neutral for the time being. Our fundamental view on the European equity market has not changed significantly. We continue to believe that the lost decade of earnings growth in Europe is behind us and that European equity markets could deliver mid-to-high single-digit returns to shareholders over the next few years at attractive valuations. However, the clean Republican win is likely to shift sentiment, the near-term earnings outlook and capital flows in favor of the U.S. equity market. We also remain neutral on Germany, where risks and opportunities are balanced. On the positive side, sentiment should not only stabilize but improve in the medium term on hopes of a new, more business-friendly government.

For Chinese equities, the big question remains: Can Chinese stimuli trump Trump? China's stimulus surprised to the upside in September but has been underwhelming since. The focus of policymakers is still on the supply side, leaving consumer sentiment in the doldrums. In the meantime, we expect China to remain a range-bound market as it has been in the recent past. We do not expect valuations to become "dirt cheap", but investors could see rallies in the shadow of modest support programs and high geopolitical risks. A stabilization in Chinese earnings would be the strongest factor for renewed optimism but given the lack of significant reforms and consumer spending, we prefer to wait for more details before getting more bullish on China.

Energy and Commodities:

After the initial knee-jerk selling of crude oil following the U.S. election, oil prices recovered slightly for a short period but then continued to fall. Gasoline prices outperformed the rest of the complex as markets took stock of potential upside in economic activity as well as potential easing of environmental regulations for the U.S. Although Chinese consumer demand remains flat, recent data showed an increase in crude oil imports, consistent with stockpiling for additional refining capacity coming online.

Although there is much speculation about Trump's energy policy, U.S. production is likely to remain flat in the short term. The U.S. exploration and production sector has announced very cautious and restrained capital expenditure programs, and the market continues to favor management teams that can deliver better cash flow returns and cash flow margins. OPEC+ cuts were extended through the end of 2025, but total output is set to increase beginning January 2025. If the rising OPEC+ output in 2025 is not offset by higher growth, crude markets risk being oversupplied.

We anticipate a near-term adjustment in gold prices, driven by heightened Fed Funds rate expectations following the election and rising real yields, although we have to say that this correlation has not really worked out in the recent past. A strengthening US dollar is expected to exert downward pressure on gold prices in the short term. However, this potential price decline may trigger increased demand from price-sensitive buyers in Asia. Meanwhile, the long-term outlook remains supported by the ongoing trend of central banks retaining gold as a strategic reserve asset.

Alternatives:

Yields and interest rates are at the top of the list of concerns, but this will be mitigated if a slower pace in rate cuts primarily reflects increasing optimism about the U.S. economic outlook. Additional upside is possible for the U.S. real estate sector if Trump's policies end up further constraining construction in the medium term, for example through tariffs on key construction materials such as steel and a reduced supply of immigrant labor.

For listed real estate, the U.S. election brings a degree of uncertainty, which is in turn overshadowed by monetary policy. Both, growth, and inflationary pressures are easing which give the Fed the optionality for further rate cuts. Sector fundamentals are slowly improving, with lower interest rates providing a tailwind to earnings estimates. Private market values have risen on lower borrowing costs and transaction volumes are accelerating. Bank lending is easing, while public REITs retain access to the capital markets, with unsecured debt being a competitive advantage. Companies are increasingly tapping the equity markets to fund attractive development and acquisitions, with the prospect of more listings in 2025. While broader sector-level themes may influence regional property market performance, we believe stock selection will be the key driver going forward in this market. A focus on real estate securities with high-quality assets and sustainable business models should provide the most favorable risk-to-return profile.

When looking at infrastructure, we think it is important to assess whether the U.S. power market will continue its path to a lower carbon mix over the long term, with renewables driving this change. We believe the gas sector will continue to see support for development, while coal is unlikely to see a recovery. However, the permitting and financing reforms that Trump may seek to implement will be critical to the market's trajectory. A reversal of streamlined permitting processes for renewable energy projects could lead to delays and increased costs.

The renewables space has also transformed dramatically since Trumps last term in office, with the segment’s share of the total power mix doubling from 9.1% to just below 20%. This entrenchment might not be something Trump could be able to work around and not something the industry would like to uproot.

Donald Trump's stance on nuclear energy has been mixed. While he has previously supported nuclear power, he has recently expressed concerns about its complexity and cost outlining that the federal government should not support traditional large-scale projects. Despite these reservations, we expect private sector and Republican support for nuclear power to grow, particularly for mini reactors. Trump could favor these as a new growth area for investment. Trump has also announced plans to issue a National Emergency Declaration to increase domestic energy supply, promising to accelerate plans for new drilling, new pipelines, new refineries, and new power plants and reactors. This approach could potentially accelerate the development of nuclear power.

The sector most at risk is arguably the offshore wind industry, a key pillar of the energy transition under the Biden administration. Trump's stance on offshore wind is clear; he has vowed to scrap offshore wind projects through an executive order on his first day in office, citing environmental concerns and their impact on wildlife. This policy shift could undermine federal support critical to the sector's growth and reverse Biden's goal of developing substantial amount of Energy offshore wind capacity. In addition, federal reviews and permitting processes, which were accelerated under Biden, could slow significantly under Trump, leading to delays and increased costs for offshore wind projects. However, ultimately, market forces such as corporate demand and government mandates are expected to continue to drive growth in solar, onshore wind, and energy storage, regardless of national policies.