2025 – is the future DIGITAL?

Last year we asked, in our annual acronym, if any market recovery would reach MATURITY or whether there could be even further to go?

We noted the factors of M(&A)/AI/Turbulence/UK market/Recession/Inflation/Technology’s “Magnificent Seven” and Yields as potentially being the year’s main drivers.

And, indeed, not only did most of those factors have a large part to play - but there was even further to go.

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This was achieved despite increasing geopolitical tensions and, in the UK, some fallout from the strict measures announced in the Budget.

At the time of writing, the Dow Jones Industrial Average in the US has risen by 17.8% in the year to date, the S&P500 by 26.9% and the Nasdaq by 31.5%, with each having tested record highs on many occasions during the year.

In the UK meanwhile, the FTSE100 has added a more modest 7.5%, while the more domestically focused FTSE250 is 6.5% ahead during the year.

This year we ask, in our annual acronym – in 2025, is the future DIGITAL?

Dollar

Inflation (again?)

Growth

Interest rates

Tariffs/Trump/trade wars

AI reckoning – or more to come?

Large caps versus small caps (including M&A)

These factors are most likely to influence investors and are as follows -

Dollar

A delicate balance between growth and inflation, and the greenback’s perception of having haven status has kept the dollar high.

Should the new administration deliver on pre-election promises, one of the outcomes could be a reduction in the pace of interest rate cuts (see below) which, all things being equal would be supportive for the dollar.

Conversely, a de-escalation of geopolitical tensions could work against the dollar, although on balance the foreign exchange market expects further strength next year.

There could also be an indirect benefit to FTSE100 companies, where around 70% of earnings are derived from overseas, and much of that from the US. A weaker sterling should, in theory, benefit dollar-earnings companies whose profits become more valuable on repatriation.

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Inflation (again?)

At a time when the battle against inflation seems almost won, any aggressive Trump tariffs (see below) could rekindle upward pressure on prices.

Should the President elect deliver his campaign rhetoric, this could result in higher inflation through those tariffs (by way of reminder, tariffs are paid by the importing company and not the company which exports those goods and services), as well as tighter immigration measures and tax cuts.

Such pressures could surface almost immediately, which implies an inflationary spike in the second quarter of next year post-inauguration.

Growth

Set against the concerns, the likely measures which are largely US-centric (at the expense of other countries if necessary) could turbocharge what has already proved to be a robust domestic economy, with a strong consumer and manageable levels of unemployment reducing any recession risk.

Investors have been chasing growth, particularly of course through mega cap technology shares, but a rising tide could lift all boats, including those companies further down the food chain.

In the UK, the growth potential is perhaps more nuanced.

While the economy could suffer from both the measures announced in the Budget, let alone any tariffs coming across the pond, the UK market is still being seen as having room for appreciation.

At undemanding valuation levels, the raft of strong, stable companies with relatively high dividend yields has yet to be fully recognised. While this has been the case for some time, the day of reckoning may well be edging nearer, especially if volatility elsewhere results in an overseas investor move towards the perceived defensive haven status of the UK market, as evidenced earlier this year when the FTSE100 hit a record level in May.

Interest rates

Higher interest rates make it more difficult to justify higher valuations, since they reduce the present value of future profits and because they may also limit smaller companies’ propensity to borrow and thus grow their businesses.

As such, the likely downward path of rates, especially in the US, was a main theme of 2024 and an upward driver on share prices.

Expectations for the pace of rate cuts in 2025 have already been dialled back both in the UK and the US, for slightly different reasons but both connected to a resurgence of inflation.

The UK Budget measures, such as the increase of National Insurance contributions, have already been widely bemoaned in industry, especially in the retail and hospitality sectors.

Such companies need to replace this lost income and could decide to either reduce investment, including new staff or simply to pass on any increased costs to consumers.

In the US, the potential for new inflation and interest rates remaining “higher for longer” is not a mantra which investors will wish to hear.

Tariffs/Trump/trade wars

Indeed, President elect Trump has already announced that he intends to introduce swingeing tariffs on imported goods, which he believes are essential in an effort to reduce food prices and the federal deficit, while also boosting domestic manufacturing.

These range from 20% to Europe (there would be a large impact on the UK, whose second largest export destination is the US), 25% to Mexico unless the illegal drugs inflow is stemmed and 60% on China, where relations are already fractious.

Trump is a known negotiator and these comments may prove to be his opening gambit rather than the real figures he may have in mind.

In any event, progress will be closely watched for extra pressure on supply chains, inflationary impact and even derailing the Federal Reserve’s plans to reduce interest rates.

AI reckoning – or more to come?

Any caution does not relate to the unquestionably seismic impact which the technology is already having across most areas of business activity, but rather whether the AI incumbents can continue to match ever-rising expectations. Valuations are currently rich, although the main AI beneficiaries have continued to confound doubters with revenue and profit figures which have propelled several mega cap tech stocks, most notably the current market darling NVIDIA Corp (NASDAQ:NVDA).

More broadly, big tech is expected to continue to top estimates over the coming year, which of course comes with some danger should any number of those companies fail to meet expectations.

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Large caps versus small caps (including M&A)

Companies wishing for a quick route to AI exposure and without their own in-house development skills could well decide to snap up existing AI products and experts.

Recent bank results have also shown something of a return to “deal making” (M&A and new issues) which has boosted investment banking returns. This could continue to play out next year.

The potential tariffs as mentioned above could impact US companies with supply chains in China, for example, while also being seen as positive for smaller and mid-cap companies.

In the UK, according to a PWC report in July 2024, the first half of the year saw £68 billion of M&A, an increase of 66% from the previous year, far outstripping global activity which grew by a more pedestrian 5%. The third quarter showed a relative decline, with 435 combined domestic and cross-border mergers comparing with 479 the previous quarter.

However, the well-recognised relative cheapness of the UK market compared both to historic and other developed economies could yet result in approaches for UK companies at current levels turning out to be the thin end of the wedge.