Market Update: Everyone take a small step forward

Markets have continued their strong and broad-based start to the year. US threats on Greenland cooled a little into the end of the week, allowing regional politics to take focus. Japan’s Prime Minister announced a snap election next month, which weakened the yen but did not stop Japanese stocks outperforming all others this week (+3.9% in sterling term). France failed to set its 2026 budget, hurting French assets but without spreading to European markets. US stocks edged forward – spurred by previously unloved parts of the market. Every sector in the S&P 500 in now trading above its 200-day moving average, according to The Daily Shot chart that follows.

Stock market positivity is a little odd, considering President Trump’s thinly-veiled attempt to remove the Federal Reserve’s independence – and the threat that poses to financial stability. Markets are betting that the system can withstand Trump’s pressure and, for now, they are right. Still, we should not underestimate the longer-term impacts, should the system buckle under that pressure.

An odd time to threaten the Fed

Global central bankers quickly came out in support of Jerome Powell, as he and the Fed face legal threats from the US Department of Justice. Republican Senators suggested they might not confirm the President’s pick for the next Fed chair, to prevent the Fed coming under his control. This resistance seems to have reined in Trump’s ambition, with president saying of the potential firing of Powell: “I don’t have any plan to do that,”

Given that Trump’s gripe with the Fed is that interest rates should fall, the timing of this latest threat is odd. The latest US CPI data shows little sign of domestically-induced price pressure, tariff impacts are waning and company employment intentions are weak. In the last three months, core US inflation has moved below 2% on an annualised basis (although the recent government shutdown is still hindering measurement). Even without political threats, Powell and his colleagues would struggle to argue against another rate cut.

Q4 earnings results from major US banks were out this week and show profits were reasonable amid decent overall lending growth. However, net interest income only just met analyst projections (with Wells Fargo clearly disappointing). Consumer loan growth could be stronger, given the low level of borrowing on which the growth is based, and the decent economic outlook. This slight disappointment was part of the reason bank stocks sold off this week. Most of the earnings positivity came from investment banks such as Goldman Sachs and Morgan Stanley.

Don’t discount disruption

The other reason bank stocks sold off was Trump’s threat to impose a 10% cap on interest rates from credit card providers. Commentators were quick to point out that the White House has no legal ability to set credit card rates, and the likelihood of getting a cap through Congress is remote. We think that rather misses the point, though: the takeaway here is that banks are now in Trump’s sights and, ahead of November’s midterm elections, he will use any means to hit his targets.

Underlying this is the fact that affordability has become the administration’s top priority, from grocery prices to housing and energy. More importantly for markets, Trump clearly has no qualms about hurting businesses, even if the effect on consumer prices is merely symbolic. In floating the idea of a credit card cap, the President declared that price controls, so hated by markets, are very much on the table.

Many Americans are struggling with affordability and, in some cases, the flipside of their difficulties  is profit for someone else. But, the attraction of US stocks, to international investors, has for many years been their world-leading profit growth. If the administration is directly challenging that profit, this could be a bad phase for US companies.

Any potential crackdown will not affect US businesses evenly. Ahead of the midterm elections, the sectors on Trump’s radar will be those whose prices most impact his voter base: property, retail, energy and banking. Meanwhile, big tech companies could once again be off the hook.

To diversify or not?

Policy risks are high this year, but growth prospects are still solid – both for the US and globally. That mix of factors leads us to the big question for 2026: will we see capital flow slowing into the US? Last week, the CIO of PIMCo, one of the world’s largest asset managers, said it was diversifying its holdings away from the US, due to policy uncertainties around the Trump administration. These fears are not yet affecting US stocks but, as we warned in previous weeks, the impacts of large structural changes can take a long time to be felt.

International investors in US assets will probably be more worried about their US holdings than Americans themselves. However, fretting over Trump is one thing; actually selling your US holdings is another. If you want to stay invested in high-growth technology stocks and the AI theme, there is little choice but to invest in US stocks. US tech is still likely to post the best profit growth this year and, in uncertain times, strong profits are likely to drive equity performance.

Profit growth outside the US still looks uninspiring. According to StreetAccount, analysts now expect a 3.9% decline in European corporate earnings for Q4 2025, worse than expected in October. Analysts became marginally negative this week, with more downward revisions (56%) than upward for the first time since early October. Earnings projections can be volatile in the short-term, but European companies will need to improve, for European stocks’ outperformance to continue.

By contrast, US company earnings look decent overall. Clearly, however, investors see US assets as more risky than they used to be. Benign inflation data should have lowered US government bond yields, for example, but yields are now more driven by politics. Moreover, higher US yields were not enough to tempt traders into buying dollar assets – a bad omen for the US. We suspect currency moves will be a key risk signal for markets this year.