2025 Global Outlook: Clearing the Hurdles

Fortunately, there are reasons to believe this extreme tariff scenario won't be implemented in full. Despite the president-elect's threats of implementing across-the-board tariffs on China and ending a trade agreement with Mexico and Canada during his first presidential term, Trump not only forged a Phase One trade deal with China but also successfully renegotiated the United States-Mexico-Canada Agreement (USMCA), formerly the North American Free Trade Agreement (NAFTA). He also renegotiated existing free trade agreements with South Korea and Japan. If history is any indication, the extreme tariff threats may simply be negotiation tools leading toward agreements with China and other countries, and potentially much less disruptive to economic growth, inflation, sales, and operations of multi-national corporations.

This negotiating tactic is not unique to the U.S. Recently in Europe, a 45% tariff imposed on some Chinese made electric vehicles on October 29 was rapidly followed by five rounds of talks between European and Chinese trade representatives from November 2 to 7 of 2024. While not yet a final agreement, the negotiations led to a "technical consensus" that scraps the tariffs in exchange for a minimum selling price, according to comments by the chairman of the European Parliament's trade committee.

An even more recent example is last week's announcement of 25% tariffs on Mexico and Canada and an additional 10% tariff on China to be implemented on President-elect Trump's first day in office unless these nations take further steps to address drug trafficking and illegal border crossings. The threat echoes May 2019, when President Trump announced 25% tariffs on Mexico, with 5% to be imposed on June 10 and 5% increases each month until reaching 25% unless it stopped the flow of illegal immigration into the United States. The tariff threat was never imposed, but rather dropped by the president shortly after Mexico agreed to pursue an enforcement surge to curb irregular migration. In response to last week's announcement, Mexican President Sheinbaum sent a letter to President-elect Trump last week, according to media sources, seeking a meeting to cooperate on the stated issues of drug trafficking and illegal border crossings.

Nevertheless, tariffs may still rise to some degree, which poses a downside risk to economic and earnings growth. But the impact may be less than feared, as noted in our article Five Investing Impacts of a Trade War. The latest World Economic Outlook published in late October by the IMF takes a deep dive into the growth and inflation impacts of a potential trade war in 2025. They examined a trade war scenario that assumes 10% U.S. tariffs on all imports, plus full-scale retaliation by Europe and China equivalent to 10% tariffs on U.S. exports, and on all trade between China and the European Union implemented by mid-2025. In this scenario, the IMF projects that the tariffs would result in a reduction of only -0.1% for global GDP growth in 2025, lowering their base case forecast to 3.1%. The estimates also include a larger, but still modest, -0.4% hit to U.S. growth, but negligible drags on Chinese and European growth for 2025. The magnitude of the impact would not be near enough to tip any major economies into a recession next year—even when accounting for the added trade policy uncertainty. These overall numbers may be important to keep in mind should some trade-impacted companies grab headlines with dire warnings.

Europe

Europe (excluding the U.K., described separately below) stocks represent the largest weighting in the international developed market MSCI EAFE Index at 54% (as of November 2024). The combined economy of the European Union is the world's second largest, after the United States, and accounts for one-sixth of the global economy.

Economic and earnings downturns in Europe in 2023-24 were followed by economic stimulus in the form of interest rate cuts, so a strong rebound in growth might be expected for 2025. But the acceleration is likely to be mild with economic and earnings growth improving yet remaining below average.

• Improving but below average economic growth - A slow recovery in global manufacturing and lingering softness in exports combined with a drag of about 0.5% on GDP from tighter fiscal policy (see Pivot to Fiscal Policy) is likely to result in below average growth as Germany, France and Italy cut government spending. However, there is a chance that the drag may be less: Germany's government coalition collapsed in November over budget issues leaving spending to track last year's pace on an interim basis until a new government is formed. An offset to any fiscal tightening may be sustained wage growth (real wages have risen for four straight quarters) amid disinflation, helping eurozone workers recoup some two-thirds of the real income losses they suffered in the post-pandemic inflation bubble. The latest economic forecast from the International Monetary Fund, published in mid-October, estimates eurozone GDP growth at 1.2% in 2025. That would be better than 2024's 0.8% and 2023's 0.4%, but below the 30-year average of 1.5%.

• Improving but below average earnings growth – We expect earnings per share growth somewhat below the FactSet-tracked consensus analyst estimate of 8%. The weak earnings growth is due in part to slow domestic growth in Europe's largest countries coupled with soft demand for exports like autos and luxury brands. The rebound is likely to be much softer than seen during 2022 after the 2020-21 downturn.

• Solid stock market performance – With the European Central Bank (ECB) widely expected to cut rates steadily through the middle of 2025, easier monetary policy could lift stock market valuation, as took place during prior rate cutting cycles. A similar period took place from late 2011 through early 2016; the ECB was cutting interest rates but economic and earnings growth was below average due to tight fiscal policy. During that period, the price-to-earnings ratio for European stocks rose from a low of 8 to a range of 13-16, measured by the Eurozone MSCI EMU Index, helping deliver double-digit annualized total returns above the 20-year average of 6%.

• Relative performance – Since the start of the bull market over two years ago, the stocks in the Eurozone MSCI EMU Index narrowly outperformed the S&P 500 Index measured in U.S. dollars, until the U.S. election on November 5, 2024. The outperformance was sizable when excluding the so-called "Magnificent 7" from the S&P 500 Index. To outperform in 2025, eurozone stocks will likely need ongoing rate cuts helping to lift valuations, modest improvement in economic activity, and broadening market performance beyond the Information Technology sector. It's worth recalling that international stocks also lagged U.S. stocks following President Trump's win in 2016 but outperformed in the first year of his term as economic and earnings growth rebounded in 2017.

United Kingdom

U.K. stocks represent the third largest weighting in the international developed market MSCI EAFE Index at 14%. The economy of the United Kingdom is the world's sixth largest and accounts for 3% of the global economy.

• Improving but below average economic growth – A continued slow recovery from recession in 2023 combined with a slight drag from tighter fiscal policy is likely to result in better, but still below average growth. Leading indicators of inflation, including the UK composite Purchasing Managers Index (PMI) input prices survey in the chart below, appear to be tame over the coming six months, keeping the Bank of England in a rate-cutting cycle. The latest economic forecast from the International Monetary Fund, published in mid-October, estimates U.K. GDP growth at 1.5% in 2025. That would be better than 2024's 1.1% and 2023's 0.3%, but below the 30-year average of 2.0%.

• Improving earnings growth close to the long-term average – The current Wall Street analyst consensus forecast is for 6% earnings per share growth, per FactSet data. Earnings were flat in 2024.
• Relative performance – The combination of mildly accelerating economic and earnings growth, tame inflation, rate cuts by the Bank of England and Brent crude oil prices remaining in this year's range of $70 to $90 per barrel, may help to deliver solid stock market performance in 2025, above the 30-year average of 6%. To outperform in 2025, U.K. stocks will likely need stock market leadership to broaden beyond a handful of U.S. mega-cap tech stocks to sectors like Energy (see Sector Views for our view on Energy sector), ongoing rate cuts helping to lift valuations from below the 20-year average, and modest improvement in economic activity.

Japan

Japan's stocks represent the second largest weighting in the international developed market MSCI EAFE Index at 22%. The economy of Japan is the world's fourth largest, behind the U.S., China, and Germany, and accounts for 4% of the global economy.

• Improving economic growth – Japan's economy could accelerate in 2025 to 1.1% from 0.3% in 2024, according to IMF estimates. While the Bank of Japan is likely to raise interest rates again in 2025, should the outlook for inflation remain above 2% supported by wage increases, the increase is unlikely to create a measurable drag on Japan's economy.
• Earnings growth close to the long-term average – The current Wall Street analyst consensus forecast is for 9% earnings per share growth, per FactSet data.

• Solid stock market performance – We continue to like Japanese stocks over the intermediate term. Two important structural changes are occurring. Japan may be putting the harmful deflationary environment of the past 30 years behind it, which is good for economic and earnings growth. Regulatory changes to enhance capital markets' transparency and to expand investment options will likely improve shareholder returns and the attractiveness of investing for individual investors. Japanese stocks remain attractively valued and have tended to perform better when the yen is weakening. Investors who are concerned about currency volatility may want to consider currency hedged investments.
• Relative performance – During 2024, Japan's stock market climbed back above the prior peak of December 1989 following strong returns in 2023. Themes such as rate hikes by the Bank of Japan, sustainable domestic inflation, and corporate reforms to boost shareholder returns are well known. For Japanese stocks to outperform in 2025, Japan will likely need to benefit from its exposure to rebounding global consumer spending (Japan has double the U.S.'s exposure to exports as a share of GDP) along with rising domestic demand. Wage growth may need to continue to outpace inflation and make up for the real wage losses the Japanese suffered in the early post-pandemic years. Rate hikes by the Bank of Japan may result in domestic investors repatriating capital as yen borrowing rates increase. While a stronger yen may pose a risk to Japanese stocks, which favor a cheaper yen in terms of translation of foreign earnings and on terms of trade, the strength of the U.S. dollar post-election may help to mitigate any rise.

China

China is the world's second largest economy and accounts for about 18% of the global economy, although it is considered an emerging market due to the country's per capita national income level being below the threshold set by the World Bank. China's stocks represent the largest weighting in the MSCI Emerging Market Index at 27%.

• Slower and below average economic growth – China's growth has been hindered by a government-induced property market slowdown, low business confidence due to abrupt policy changes and consumer sentiment that never really recovered from the zero-COVID lockdowns of 2022. Chinese policymakers are providing support to reduce downside risks in its economy but have not yet shifted decisively to demand-oriented stimulus and appear to lack the sense of urgency initially indicated at the end of September. China's economy could pick up in the near term due to recent acceleration in fiscal spending and front-loading of exports but is likely to continue to decelerate in 2025.
• Lackluster earnings growth – The weakening outlook for China's economy combined with trade risks to export growth may mean earnings growth falls short of the Wall Street analysts' consensus forecast for 9% earnings per share growth for the companies in the MSCI China Index, per data from FactSet.
• Chinese stocks trade at a below historical average valuation – The MSCI China Index bounced off its multi-year low of September 2024 on the announcement of new stimulus. But the gains faded as China failed to deliver the amount or type of stimulus the market was hoping for. Chinese stocks may continue to trade on prospects for stimulus, rather than company fundamentals.

• Relative performance – China's stocks may continue to suffer from a below average domestic and global growth environment, but with valuations reflecting the weak outlook there is the potential for outperformance should stimulus be provided that improves growth sufficiently. Since election day, we've seen the market interpret President-elect Trump's "America First" policies as good for U.S. small cap stocks followed by U.S. large cap stocks and bad news for international stocks and even worse for emerging market stocks. Market behavior mirrored performance seen right after Trump's win in 2016, when U.S. small caps led the gains and emerging markets, including China, suffered the most. However, that quickly changed. During the first year of Trump's term, 2017, emerging market stocks were the best performers—with China leading the way with a total return of 56%, followed by developed international stocks then large cap U.S. stocks and bringing up the rear were U.S. small caps. The main reason? Economic and earnings growth were improving for most countries in 2017 and, as we often point out, economics have more of an impact on elections than elections do on economics. In 2025, we expect economic growth in most countries to reaccelerate, providing a boost to more economically sensitive companies, which are more prevalent in non-U.S. markets, especially emerging markets like China.

Additional risks

Our outlook for improving global growth and contained inflation in 2025 does have some additional risks beyond the tariffs we already addressed. While we will explore the potential surprises of 2025 in a future article, these three risks to our base case stand out and bear watching the most closely:

• Geopolitical conflict – While the conflicts surrounding Ukraine and Israel continue to exact an immeasurable human toll, the market and economic impacts have been limited, with oil prices wrapping up the year close to their lows. While ceasefire agreements may take place in 2025, the conflicts could linger on or even expand. Should oil facilities in Russia or Iran be targeted, oil prices may surge and act as a drag on growth and a boost to inflation.
• Inflation and rate cuts – The market seems highly confident in rate cuts by major central banks throughout the first half of 2025. Brazil's central bank has been hiking rates in recent months. Over the past few years, Brazil has been leading other central banks as the first to hike in 2021, about a year ahead of the Fed. And the first to cut in 2023, also about a year ahead of the Fed. Recently they have started to hike again. Inflation in Brazil bottomed in mid-2023 at 3.2%--it's now back up to 4.7%. While inflation rose across most major countries in the latest readings, the market seems to be confident that major central banks will continue to cut rates until mid-2025. Brazil may be signaling what could come if inflation creeps higher and hiking cycles get cut short.

• Second wind – While investors still seem enamored with Artificial Intelligence (A.I.) stocks, we've seen broader outperformance in the stock market lately with a shift to the Financial sector taking the lead among developed international markets (MSCI EAFE Index) in the second half of 2024 from the Information Technology sector. Stocks rising on broadening participation of sectors outside just the handful of stocks tied to A.I. is overall good news and may suggest a second wind is coming for the two-year-old stock bull market in 2025 as sectors that have lagged begin to lead and help to deliver stronger gains than our base case.

Our base case is for economic and earnings growth to clear the hurdles its faces and improve. Faster, though still below average, growth may combine with rising valuations, supported by central bank rate cuts, to boost returns for stocks in the developed market international MSCI EAFE Index. But heightened volatility could result from risks, both foreseen and unknown, in 2025. Investors may want to consider diversified portfolios across sectors and countries to help manage the potential exposure to volatility.

Michelle Gibley, CFA^®, Director of International Research, and Heather O'Leary, Senior Global Investment Research Analyst, contributed to this report.

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