The dynamics of the American economy and its policy directions have become a focal point for many investors and analysts.As we move toward 2025,the outlook for the U.S.economy appears to be more optimistic than previously anticipated,primarily driven by sustained consumer spending that is likely to fuel further economic growth.However,the landscape could quickly shift if the new government puts its promised policies into practice,such as adopting protectionist measures,deporting undocumented immigrants,and raising tariffs.Such moves may increase the risk of stagflation—a situation where inflation rises and economic growth stagnates.

In the lead-up to potential policy confirmations by the newly elected administration,the U.S.dollar may experience noticeable fluctuations.The anticipated inflation outlook,however,is projected to strengthen the dollar,with the dollar index inching closer to a two-year high.For investors,this is a time for caution,as valuations of American stocks are nearing highs not seen for several years,causing nervousness among those who believe that market valuations are excessively high.For them,targeting mid-cap companies represents a more direct and potentially lower-cost method of tapping into the American economy.

According to the economic research team at Schroders,the projected GDP growth rate for the United States stands at 2.5% for 2025,with a slight increase to 2.7% in 2026.This sustained growth trajectory suggests that inflation will remain elevated,higher than previous forecasts.It is expected that the Federal Reserve will cut interest rates once in 2025 and subsequently raise them in 2026,illustrating the delicate balancing act faced by policymakers in navigating economic growth and inflation.

For investors,gauging the likelihood of any specific policy implementation presents a formidable challenge.This uncertainty is likely to persist until there is greater clarity on the direction of policies.David Rees,a seasoned emerging markets economist,pointed out that financial markets may react to any announcement related to policy changes throughout 2025,even if those policies are never fully realized.This could lead to increased volatility across various asset classes.

Trade policies will undoubtedly exert a significant influence on the value of the dollar.Rees notes that the imposition of tariffs would bolster the dollar as it would,to some extent,counterbalance the impact of tariffs on trade and economic activity.Furthermore,we foresee that the differential in interest rates will also lend support,indicating that a strong dollar might persist for some time.

Indeed,the fiscal outlook will be a key driver of bond market movements as investors assess the potential implications of U.S.policies on inflation and interest rates.Recently,there have been notable shifts in the fixed-income market driven by these considerations.

According to fixed income strategist James Bilson,the bond market has seen a yield increase due to robust U.S.economic growth,recent favorable inflation data,and expectations that the new government will pursue further reflationary policies.The current bond market reflects expectations that the Federal Reserve will cut rates once or twice in 2025 by 25 basis points each time,contrasting with earlier forecasts in September 2024 that anticipated more than four rate cuts.

As with their broad interest in economic activities,bond market investors will keep a close eye on policy developments concerning trade and immigration.

From a corporate credit perspective,Lisa Hornby,Head of U.S.Fixed Income,adds that risk assets are transitioning from a costly starting point.The spread on corporate credit—essentially the premium over U.S.Treasury yields—stands at its highest level in decades.Nonetheless,the driving force behind the narrowing credit spreads stems from substantial demand for attractive overall yield.With yields remaining elevated,it is challenging to foresee a direction that would reverse the trend in credit spreads.

Can the exceptionalism of the U.S.stock market continue?

The United States maintains a dominant position in the global equity market,reaching historical highs.By the end of 2024,the MSCI U.S.index comprised 74% of the MSCI World Index and 67% of the MSCI All Countries World Index.

Moreover,excluding the dot-com bubble's peak,U.S.stocks are approaching the highest valuation levels seen in the last 143 years.Regardless of the policy directions taken by the new U.S.government,the sustainability of this valuation remains in question.

The concern surrounding high U.S.stock valuations is not a new phenomenon,as highlighted by Duncan Lamont,Head of Strategy Research.While the elevated valuation of U.S.equities and their substantial share of the global market are noteworthy,there are several inherent advantages to U.S.stocks.These include soaring productivity levels relative to other regions,robust economic momentum,and strong purchasing power of corporations.Favorable demographic trends also play a role,although any shift away from progressive immigration policies could potentially undermine this advantage.

For investors apprehensive about high valuations,one avenue for exploration involves seeking opportunities within smaller companies,as mid-cap businesses generally have lower valuations compared to larger corporations.

Bob Kaynor,Head of U.S.Small Cap Stocks,suggests that the United States benefits from a robust labor market and policies potentially designed to stimulate domestic growth.Small-cap companies are often more attractive to investors predominantly based in the U.S.Consequently,investing in mid-cap stocks might provide a more direct pathway for investors to engage with the American economy.With large-cap stock prices soaring,small-cap stocks offer a cost-efficient investment alternative.