What's next for US equities?
The US economy and equity markets show continued signs of strength, even amid concerns about tariffs and Fed policy. As always, investors may benefit most from focusing on company fundamentals and not trying to gauge the impact of short-term trends.
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A still robust outlook for the US economy
Even amid all the setbacks that had concerned investors earlier in 2025—including heightened tariffs, a weakening dollar and the flow of global capital away from the United States—the growth outlook for the US economy remains robust. Two major US stock indices—the S&P 500, representing large caps, and the technology-laden NASDAQ—have soared to record highs. The Federal Reserve’s (Fed’s) rate cuts could also benefit markets, as history suggests that cuts into a growing economy, rather than a recessionary one, can be positive for equities.
Two potential risks loom: Higher tariffs and a Fed policy mistake
Some observers have expressed concerns about the US labuor market, with recent evidence of some softness in hiring. The US labour market remains tight, however, and conditions appear to be stable. The uncertainty about trade and the potential for further tariff increases could pose greater risks for the economy and markets. Before President Trump began his second term, the US’ effective tariff rate was about 2%, which was low by historical standards. By early autumn, it had risen to about 12%. If the 100% tariff President Trump had threatened to impose on China were enacted, the effective tariff rate would rise to 23%. Economists have estimated that every 10% rise in the tariff rate typically adds about 1% to inflation and subtracts one half of a percentage point from gross domestic product (GDP) growth.
Another key risk would be the Fed making a policy mistake. Some observers could question whether the Fed needs to be cutting interest rates, given that the US economy has had solid growth in 2025, even with relatively high rates. That suggests the Fed’s estimates for its neutral rate – a rate that would neither be too stimulative nor too restrictive for the economy – may be too high. Its median neutral rate projection is now around 3%, but with interest rates currently above 4% and 5%, and the US economy still continuing to show strong growth, aiming for a 3% rate could be too accommodative. Sticking to that view and cutting rates further could bring a spike in inflation and, hence, a Fed policy mistake.
Inflation still a potential risk
Inflation could become a greater cause for concern because markets currently appear to be underpricing that risk. While dollar weakness also presents challenges, US companies with international businesses could see more revenue as that weakness brings lower prices for their goods and services in non-US markets.
Stock pickers with a long-term view need not fret about current market conditions
In our view, investors can fare better over the long term by focusing on company fundamentals and not being too concerned about the current market climate. Over the long term, equity prices follow corporate earnings, and the best companies benefit from characteristics like operating in an industry with high barriers to entry, superior product offerings, market share gains and pricing power, which support strong earnings delivery through the market cycle.
Searching for growth gaps
We believe returns that beat benchmark indexes can be achieved by looking for “growth gaps” that arise with companies whose long-term growth prospects are being underestimated by the broad market. For many companies, the consensus views seem right, but there are still situations that can be found when other analysts do not appear to have fully recognised the long-term potential benefits of a competitive advantage. Some of that stems from short-term thinking, which has become even more prevalent because of technologies like algorithmic trading, as well as the increasing participation of retail investors in markets.
We believe the core of a portfolio focused on identifying growth gaps can be built with companies that have exceptional competitive advantages. Those could be a structural advantage like a unique distribution channel or a long-term incumbency in an industry with regulatory advantages that newer entries find difficult to obtain. Or, the company might have an advantage because of intellectual property or a dominant brand with customer loyalty that competitors can’t match. “Opportunistic” positions for such a portfolio include companies who might be on the upswing of their business cycle or recently downtrodden firms with new management teams or approaches that could set the stage for a significant turnaround.
Case study: Streaming service with a potentially virtuous circle
Netflix provides a good example of a company with a distinct long-term advantage. The costs of providing great content don’t change, depending on how many people may view it, but as Netflix’s subscriber base grows, its per-subscriber cost of producing great content continues to decline. That helps the company benefit from a virtuous circle—customers sign up for Netflix because it offers great content. That helps Netflix afford to develop more exceptional series and movies, and that keeps attracting more subscribers. We believe the market has not fully recognised the full benefits of that advantage for Netflix.
An alternative to chasing market returns
Chasing broad market performance poses a risk because all the gains realised during a rally can be quickly given away during a downturn. Looking for outstanding individual companies and diversifying across a range of firms with distinct and differentiated competitive advantages have the potential to deliver much better risk-adjusted returns.
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