The year of trading dangerously

The article was first published in The Business Times on 17 January 2025.

Over the past few weeks, I’ve been busy meeting clients and sharing our investment outlook for 2025. In a nutshell, we believe continued consumer spending and investment in the US are likely to support both the economic growth cycle and the attendant investment opportunities. However, as always, we remain vigilant and mindful of potential risks that could sour our cautiously optimistic outlook.

Last month, I explored “Where to Put Your Money in 2025”, outlining the top 10 investment ideas aligned with – and flowing from – our Lombard Odier house view. This month, it’s time for a reality check, meaning I’ll discuss and dissect the top five risks that could undermine our base case, thereby providing a balanced perspective and informed opinion. Bear in mind, this is not our house view; but as investors, being cognisant of risk better prepares us for opportunity.

As investors, being cognisant of risk better prepares us for opportunity.

Trade war

In 2025, we should accept the possibility of a trade war, particularly between the US and China. The threat of Donald Trump’s infamous tariffs and trade restrictions on surplus trading partners should be considered as tensions over technology, intellectual property, and geopolitical influence likely escalate. If a conflict were to erupt, disrupted global supply chains could increase production costs and, subsequently, consumer prices.

While the repercussions of a trade war could be profound and lasting, I believe the risks are diminishing. It increasingly seems that the threat of tariffs is being wielded more as a form of political leverage, encouraging possibly recalcitrant trading partners to support Trump’s “America First” domestic agenda. That’s not to say trade conflicts won’t occasionally flare up; almost certainly, they will. But my risk assessment of an all-out trade war is low.

Resurgent inflation

Should it manifest, a second wave of inflation in the US would pose a significant risk to both financial markets and the global economy. Possible causes could include the fiscal consequences of a Trump presidency, trade-war-related supply chain disruptions, increased energy prices from geopolitical tensions, and/or rising labour costs due to heightened border controls. The likely consequence would be a reversal in the easing of interest rates, leading to at best a pause, or at worst, rate hikes.

Crucially, the risk of a “second wave” is non-trivial; even in early January, Fed officials warned that inflation could remain higher in 2025 than their 2 per cent target. While the causes of the recent rise in US long bond yields (alongside those of the EU and Japan) are complex, the expectation of higher (future) inflation is a contributing factor.

Despite a likely modest and temporary spike in inflation due to Trump’s tariff, tax, and immigration policies in the second half of the year, we think growth challenges elsewhere in the world (particularly China) will limit the duration and spillover of US price pressures. However, this risk will certainly be the focus of financial market participants this year.

Sharp China slowdown

A sharp – rather than gradual – slowdown in China’s economy in 2025 would pose a significant deflationary shock to both global markets and economic stability. The recent and relentless decline in China’s long-term government bond yields underscores the risk of the economy tipping into a worrisome, extended downturn.

As the world’s second-largest economy, China’s growth directly influences global demand for commodities, technology, and manufactured goods. However, the meltdown of its property sector, the accumulation of (non-financial) debt equivalent to about 300 per cent of GDP, rampant over-investment, and troublesome demographics pose structural challenges that the government is finding hard to resolve.

That’s not to say it isn’t trying. Almost weekly, we read about a range of monetary and fiscal stimulus measures designed to return the economy to health. Given the significant control the government exerts over the economy, I believe an uncontrolled economic crisis can likely be avoided. More likely – in my view – is a Japan-style, multi-year deceleration of growth during which China gradually repairs and reinvents its economic growth model.

Bubble trouble

Psychologically, it is difficult to experience – or even enjoy – a bull market in equities without a commensurate fear that a price bubble is forming and could burst at any time. The current bull market is no different. Investor sentiment is euphoric, market breadth is narrow, valuations are stretched, and markets are posting record highs. But could the power of momentum overwhelm these sell catalysts and push markets even higher in the months and quarters ahead?

Despite an unpredictable policy environment in 2025, we still think there are good reasons to maintain a tactical allocation towards risky assets such as US stocks. Although we are mindful of the negative impact of global decoupling that may accelerate under Trump’s second administration, we still see a solid basis for economic expansion underpinning the uptrend in the earnings cycle and favourable equity market performance. Even if there are bouts of volatility, we anticipate the US equity market will deliver an approximate 15 to 17 per cent total return by year-end.

We still think there are good reasons to maintain a tactical allocation towards risky assets such as US stocks.

Geopolitical crisis

Geopolitical crises are inherently unpredictable, particularly in terms of timing, due to the complex human factors involved. However, they rightly remain a key concern for investors due to their potential to disrupt markets. In 2025 – counterintuitive as it may sound – I believe geopolitical risk may actually moderate under a Trump presidency.

Trump’s “America First” approach emphasises domestic interests and stability in international relations, which could ease tensions as involved parties seek negotiated, transactional advantages over military action. There is growing hope that the situations in Ukraine and the Middle East will stabilise under a Trump administration, thereby reducing geopolitical volatility and benefiting investors.

 

Source: The Business Times © SPH Media Limited. Permission required for reproduction.