US stock market outlook 2025: sectors to own and avoid

At least we know where we stand. Instead of getting a close race in the American elections with the prospect of weeks of legal wrangling, we got a clear victory for the Republicans with Donald Trump as president and control of both houses of Congress. With right-wing judges dominating the Supreme Court and any vacancies that may arrive to be filled by Trump, the concept of balances in the United States Constitution has gone out of the window, for the next couple of years at least.

Markets hate uncertainty, so the saying goes, which should mean that the markets love the situation in the US. Alas, life is never so easy.

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For a start, Trump has already had to drop one of his controversial appointments, Matt Gaetz as attorney general, in the face of unexpected opposition among Republican senators. It seems the president-elect may not be able to steamroller the Senate after all.

Second, we do not know whether Trump will carry out his threats to impose widespread tariffs against foreign friends and foes alike, or whether he's using the concept to bring potential targets to heel.

The idea that tariffs are a negotiating ploy has been strengthened by proposals so far. While Trump has threatened import tariffs of 60% against China, where there is a genuine case for arguing that the government is subsidising production at unrealistically low prices, the incoming US president has talked of 25% tariffs against Canada and Mexico, neighbouring countries that form with the US the North American free trade area. The noise from Trump is that these tariffs will be imposed on all products on the first day of his presidency. This would be a remarkable about-turn for Trump, as he negotiated the current trade agreement with Canada and Mexico during his first term of the US presidency.

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This imposition, if it happens, would be punishment for Canada and Mexico failing to stop the free flow of drugs into the US and, in the case of Mexico, the flow of illegal immigrants. In neither case is it about trade, but it is trade that will be disrupted, probably with serious repercussions for the American economy, if the tariffs are imposed. China, Canada and Mexico account for more than 40% of all imports into the US, totting up to $1.5 trillion (£1.1 trillion) a year.

Furthermore, many American car companies have inter-dependent plants either side of the Mexican border. Claudia Sheinbaum, the Mexican president, has warned that her government could respond by imposing similar tariffs, saying: “One tariff would be followed by another in response, and so on, until we put at risk common businesses.”

Sheinbaum and Trump have held a telephone conversation that both sides claim is victory for them. An uneasy truce will continue until Trump takes over from Joe Biden on 20 January. A similar situation exists with Canada, whose prime minister, Justin Trudeau, has held inconclusive telephone talks with Trump.

Meanwhile, President Xi Jinping of China is also expecting negotiations to take the place of rhetoric, and he may be a tougher nut to crack. He does not have to worry about democratic elections if his subjects suffer in a trade war. Verbal noises from Beijing have been remarkably toned down so far, but that could be the calm before the storm.

Domestically, Trump again inherits a stable economy, although not quite as healthy a one as he took over eight years ago. While economic growth, employment and wage rates have held up remarkably well since the Covid pandemic, inflation remains stubborn and hopes of a rapid fall in interest rates may prove to be over optimistic.

American producer price inflation, a measure of the pressures that are working their way through the system, rose to 0.2% in October month on month, not in itself a worrying figure but one that was higher than in September. Core inflation, which records underlying pressures and discounts volatile factors, rose by 0.3%, which is the equivalent of nearly 4% on an annual basis, well above the target rate for consumer prices.

In addition, there are concerns over the impact that Trump’s threatened tariff increases will have. Sizeable tariffs will inevitably force up the prices of imported products. These price rises are far too hefty to be absorbed by importers, and American companies cannot step in and fill the gap at a moment’s notice. They will also come on top of a strengthening of the value of the US dollar against other major currencies that accompanied the results of the US elections.

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Federal Reserve Bank officials have indicated that even if inflation moves sustainably down to the 2% target level, there is no guarantee that official interest rates will fall further while full employment persists.

There have already been two reductions from the peak range of 5.25-5.5% as the Fed has moved faster than usual to react to changes in the economic environment.

However, the Fed has indicated that it is aiming for a neutral stance, in other words to establish the official rate at a level that neither encourages nor chokes off economic growth. At least that implies stability, although sceptics believe that the finest economic brains in the United States have no more idea than the rest of us how the American economy will pan out over the next 12 months.

The best educated guess is that the economy is likely to slow a little without nosediving, and the unemployment rate is likely to rise equally slowly without increasing alarmingly. That is perhaps less than ideal but it is not at all a bad situation for any country to be in.

More worrying is the ballooning of government debt. The Federal deficit is around $1.8 trillion a year with neither Republicans nor Democrats showing much interest in curbing government spending and even less inclination to raise taxes. The national debt is heading above 100% of gross national product, which would have been regarded as disastrous just a few years ago but which is now greeted with a shrug of the shoulders.    

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So far the dollar has been protected by its role as a reserve asset in most countries of the world, but economists are watching to see what happens when a raft of corporate tax cuts made during the first Trump administration expire next year. No one knows whether they will be scrapped or extended, with the latter looking more likely.

Hobson’s choice: American stocks are generally most favoured by British investors seeking overseas exposure, and that will probably be the best policy in the coming year. Energy, defence and manufacturing are sectors to consider.

On the downside, higher inflation that could well result from Trump’s policies would hurt retailing, luxury goods and car makers. The tech sector could see its bubble burst in any tariff war because computer chips and other materials used in computers come from China.

Larger companies with an international footprint are naturally more attractive because of their familiarity, but this could be a good time to consider smaller, domestically oriented firms that may benefit from tariffs, or from Trump’s avowed intent to cut corporation tax for companies making products in the US.

Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.