Top Five Surprises for 2025

During his first presidential term, President-elect Trump threatened implementing large across-the-board tariffs on China and ending a trade agreement with Mexico and Canada. However, 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, making the prospect potentially much less disruptive to economic growth, inflation, sales, and operations of multi-national corporations. These agreements could come quickly on the heels of new tariffs.

This negotiating tactic is not unique to the U.S. On October 29 in Europe, an eye-popping 45% tariff was imposed on some Chinese made electric vehicles (EVs). This was rapidly followed by rounds of talks between European and Chinese trade representatives. While there is not yet a final agreement, the negotiations have led to a technical consensus which scraps the tariffs in exchange for a minimum selling price on imported EVs, according to comments by the chairman of the European Parliament's trade committee.

An even more recent example is the late November announcement of 25% tariffs on Mexico and Canada and an additional 10% tariff on China to be implemented on Trump's first day in office unless these nations take further steps to address drug trafficking and illegal border crossings. The threat echoes the one in 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 Mexico stopped the flow of illegal immigration into the United States. That threat was never imposed. It was dropped by Trump less than a month later after Mexico agreed to pursue an enforcement surge to curb irregular migration. In response to the November announcement, Canadian President Trudeau met with Trump and Mexican President Sheinbaum sent a letter, both seeking to cooperate on the stated issues of drug trafficking and illegal border crossings.

Tariffs may still rise, but it seems that extreme tariff announcements may be used by Trump as a tool of statecraft to extract actions or concessions, rather than tools of economic policy. It is worth noting that Trump doesn't have a mandate on implementing tariffs, based on polling data of voters' intentions. Polling data shows voters expect Trump to focus on inflation (35%)—which tariffs might bring if implemented at the level they were proposed—not on implementing tariffs (only 1%). The uncertainty over tariffs being announced and then potentially dropped or reduced following negotiations could create market volatility.

Shifts from rate cuts to rate hikes

The market seems highly confident in rate cuts by major central banks throughout the first half of 2025. As inflation rose across most major countries in the fourth quarter, markets have reduced the amount of additional rate cuts expected over the coming two years. It is possible that by the middle of 2025, the market may anticipate a rise in policy interest rates over the coming two years, which would be a big shift from the major cuts priced in during 2024.

It is worth noting that Brazil's central bank has shifted to hiking rates in recent months. Over the past few years, Brazil has been leading other central banks—initially as the first to hike in 2021, about a year ahead of the Fed and many other central banks. And then they were the first to cut in 2023, also about a year ahead of the Federal Reserve. Recently they have started to hike once again. Inflation in Brazil bottomed in mid-2023 at 3.2% but has since climbed back up to 4.8%. Brazil may be signaling what could come if inflation creeps higher—that cutting cycles get cut short. The potential for a shift from forecasting rate cuts or even the expectation for rate hikes on the horizon as 2026 comes into view in developed market economies could result in stocks selling off.

Sentiment in Europe rebounds

Economic growth in the eurozone has been below average during the last two years, led by softness in its largest economy, Germany. Germany may post the second straight year of contraction in 2024 amid weaker global demand for manufactured goods, especially autos tied to higher interest rates, as well as the slowdown in demand from China—one of Europe's largest export destinations. As a result, sentiment by business leaders and investors has been weak.

Sentiment may be poised to shift. While on an absolute basis, sentiment remains below average, the November Ifo Business Climate survey for Germany shows that expectations for the future have climbed relative to the assessment of the current situation similar to those seen during the rebounds from both the pandemic of 2020 and Eurozone Debt Crisis of 2011. Both instances preceded a strong rebound in overall sentiment, economic growth, and stock market performance.

While recent headlines may seem worrisome with France's government collapsing over a budget impasse and Germany's minority government unable to pass a budget, each struggle may lead to fewer budget cuts that originally planned and act as less of a drag on Europe's growth in 2025.

Energy costs could also be poised to fall. The poll-leading Christian Democratic Union of Germany (CDU) party is moving away from its opposition to nuclear energy, which could provide a longer-term benefit to the German economy in terms of lower costs. In the near term, Europe's access to low-cost energy is set to surge as liquified natural gas (LNG) import capacity is set to outpace demand growth in 2025, according to the U.S. Department of Energy. Additionally, the Trump administration may lift the pause on LNG export permits that was put in place during the Biden administration as way to rebalance trade between Europe and the U.S., further boosting natural gas supply to Europe. This increase in supply could reduce overall energy prices in the continent.

Valuations for eurozone stocks remain depressed, trading at a price-to-earnings ratio of 13 times next 12 months consensus expected earnings and at a 40% discount to the S&P 500. This is a much bigger discount than the historical average. Any rebound in sentiment could boost valuations, with each one point of increase estimated to boosting returns by 7%.

Supply chains could be disrupted

The supply shortages experienced during the pandemic were a lesson in the interconnectedness of the global economy and how disruptions in one part of the supply chain can ripple through to other areas. Supply chain disruptions no longer dominate the headlines but have crept up from time to time. In the past couple of years, shipments in the Panama Canal were slashed due to a drought that reduced the necessary water to move ships through the locks. Droughts in Europe disrupted trade on the German Rhine River. Houthi attacks on ships in the Red Sea have diverted trade. Not to mention the collapse of the Key Bridge in the Baltimore port causing shipments to be redirected. Other weather impacts have included excessive rain, freezing cold, and fires. While none of these caused rebounding inflation or materially impacted production, a more significant supply disruption would be an unwelcome surprise.

Supply chain disruptions are most often unpredictable, but there are some signs of vulnerability.

• Policy risks - Deportation of Mexican-born population from the U.S. could disrupt supply chains on labor shortages in some industries and global increases in tariffs could result in diversions in trade.
• Weather risks - Hurricane Helene flooded Spruce Pine, NC in September 2024, the location of nearly the entire global supply of high-purity quartz—the kind needed to make the crucibles that hold the molten silicon as it is formed into a silicon wafer. Luckily the mines were brought back online after just four weeks and the world dodged a potentially severe disruption of the global supply chain for semiconductors.
• Geopolitical risks - 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 on supply shocks and act as a drag on growth and a boost to inflation.
• Technology-related outages - The cyberattack on the Colonial Pipeline in the U.S. in 2021, and IT outages such as the CrowdStrike faulty system update in July 2024, could derail the flow of energy or information.

With global trade volumes having recently climbed to new all-time highs after two years of stagnation, supply chains may be more vulnerable to any disruption. Where and when these disruptions could occur are naturally unpredictable and could come out of seemingly nowhere to surprise markets, reduce growth and boost inflation.

China recovers

Strong performance by China's stock market in 2025 might surprise many investors given the weakening outlook for GDP growth and Trump's "America First" policies. Since election day, markets have seen leadership led by U.S. small caps while international stocks and especially emerging market stocks lagged badly. That is exactly what happened after Trump won in 2016. But, surprising to many, market behavior completely reversed in 2017, the first year of Trump's term. Despite risk of tariffs and the uncertainty of a Trump administration, emerging market stocks rose nearly 40% in 2017, led by 56% gains in China. This was followed by outperformance of international stocks with U.S. small caps being the worst performers in that year.

In 2017, China implemented a fiscal stimulus package that amounted to roughly 10 trillion yuan (approximately $1.4 trillion), primarily focused on addressing local government debt issues and boosting a slowing domestic economy through infrastructure spending and other measures. This package was considered a significant effort to counter potential economic volatility and was equivalent to a whopping 12% of China's economy at the time.

Despite China's government announcing a flurry of measures in September to reinvigorate economic growth, the missing piece has been fiscal stimulus. Policy meetings in the months following produced only vague references to new measures yet to come, resulting in the stimulus-driven stock market rally to fade. It is possible China's government may be waiting to have better visibility on the extent and timing of U.S. tariff increases and could provide fiscal stimulus details at the March National People's Congress. Policy meetings in October, November, and December have suggested additional fiscal measures in 2025, including increasing the fiscal deficit and boosting consumption.

Chinese stocks have surprised to the upside–and downside–in the past. While a fiscal stimulus equal in size to the 2017 package is unlikely, stocks may rise on a much smaller package if it includes concrete measures to boost consumption and halt the property market downturn. However, stocks could slip again if hopes fade and China under-delivers on its promises.

Be prepared

While we highlighted our top five, there are many other potential surprises for 2025 including those that are an ever-present part of investing and not unique to the outlook for any particular year. These include rising fiscal sustainability concerns as debt and deficits continue to spiral ever higher, another pandemic could emerge that evades existing vaccines, the outbreak of wars, among many others.

Whether or not these particular surprises for 2025 come to pass, a new year almost always brings surprises of one form or another. Having a well-balanced, diversified portfolio with a risk profile consistent with your goals and being prepared with a plan in the event of an unexpected outcome are keys to achieving goals.

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

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness, or reliability cannot be guaranteed. Examples provided are for illustrative purposes only and not intended to be reflective of results you can expect to achieve.

Please note that this content was created as of the specific date indicated and reflects the author's views as of that date. It will be kept solely for historical purposes, and the author's opinions may change, without notice, in reaction to shifting economic, business, and other conditions.

All corporate names and market data shown above are for illustrative purposes only and are not a recommendation, offer to sell, or a solicitation of an offer to buy any security. Supporting documentation for any claims or statistical information is available upon request.

Performance may be affected by risks associated with non-diversification, including investments in specific countries or sectors. Additional risks may also include, but are not limited to, investments in foreign securities, especially emerging markets, real estate investment trusts (REITs), fixed income, municipal securities including state specific municipal securities, small capitalization securities and commodities. Each individual investor should consider these risks carefully before investing in a particular security or strategy.

Currency trading is speculative, volatile and not suitable for all investors.

Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

Past performance is no guarantee of future results and the opinions presented cannot be viewed as an indicator of future performance.

Investing involves risk, including loss of principal.

International investments involve additional risks, which include differences in financial accounting standards, currency fluctuations, geopolitical risk, foreign taxes and regulations, and the potential for illiquid markets.

Investing in emerging markets may accentuate this risk.

Diversification strategies do not ensure a profit and do not protect against losses in declining markets.

The policy analysis provided by the Charles Schwab & Co., Inc., does not constitute and should not be interpreted as an endorsement of any political party.

Indexes are unmanaged, do not incur management fees, costs, and expenses and cannot be invested in directly. For more information on indexes, please see schwab.com/indexdefinitions.

Futures, and Futures options trading involves substantial risk and is not suitable for all investors. Please read the Risk Disclosure Statement for Futures and Options prior to trading futures products.

BLOOMBERG^® is a trademark and service mark of Bloomberg Finance L.P. and its affiliates (collectively 'Bloomberg'). Bloomberg or Bloomberg's licensors own all proprietary rights in the Bloomberg Indices. Neither Bloomberg nor Bloomberg's licensors approves or endorses this material or guarantees the accuracy or completeness of any information herein, or makes any warranty, express or implied, as to the results to be obtained therefrom and, to the maximum extent allowed by law, neither shall have any liability or responsibility for injury or damages arising in connection therewith.

The MSCI EMU Index (European Economic and Monetary Union) captures large and mid-cap representation across the 10 Developed Markets countries in the EMU, covering approximately 85% of the free float-adjusted market capitalization of the EMU.

The Global World Trade Volume Index is published by the CPB Netherlands Bureau for Economic Policy Analysis World Trade Monitor (WTM) on behalf of the European Commission. The WTM tracks the trade volume of over 80 countries, which represents almost 99% of world trade and uses 2010 as its base year.

1224-BU3K

---

A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent white papers.

© Charles Schwab

More Small Cap Topics >