Will President Trump’s Proposed Policy Initiatives Drive More US Large-Cap Equity Outperformance?

No, we don’t think so. President Donald Trump made numerous campaign pledges, including additional corporate tax cuts and deregulation, which could be seen as beneficial for US large-cap stocks. On Inauguration Day, he acted on some of these pledges with a wave of executive orders, addressing topics from more lenient AI regulation to accelerating energy production and exports. However, valuations for these stocks already price in a lot of good news and face challenges from stickier inflation and less favorable elements of Trump’s policy agenda. US large-cap stocks, particularly expensive growth stocks, will need more than policy shifts to outperform US small-cap stocks in 2025.

The S&P 500 Index has posted modest gains year-to-date after a 25% return in 2024. Over the last five years, investors in the index have almost doubled their money. Returns have bested those in other equity markets but outpaced earnings growth, leaving valuations stretched. Our preferred valuation metric—the cyclically adjusted price-earnings ratio (P/E)—has only been this high 2% of the time since 1980, and the 22x forward P/E looks similarly rich.

Elevated valuations may reflect optimism around certain items on Trump’s agenda. Reducing corporate tax rates and cutting regulatory burdens could boost companies’ bottom lines. Lighter-touch antitrust enforcement could also mean a rebound in deal making and add an acquisition premium to some targets. To the extent that efforts to accelerate economic growth are successful, there will also be follow-on benefits for US companies.

Of course, investors should consider that other aspects of Trump’s platform are less favorable to US companies. On Inauguration Day, he threatened to impose 25% tariffs on Canada and Mexico on February 1, which could raise prices for some companies or reduce demand if passed on to consumers. Trump also declared a national border emergency to reduce immigration, which could curb labor supply and lower demand for goods and services. At the same time, the Federal Reserve and bond markets have been struggling to digest recent economic releases, which show stronger-than-expected growth and inflation. This could continue to keep yields high, challenging valuations for expensive parts of the market.

Delivering robust earnings growth across a broader range of companies and sectors will be key for US large-cap stocks to reach new heights this year. S&P 500 earnings are expected to have grown 10% in 2024. However, in 2024, earnings growth for the S&P 493 (ex the Magnificent 7) was just 6%. As earnings growth for these companies accelerates to 11% in 2025, out-of-favor sectors and styles should see increased investor demand. Lower taxes could create some upside potential for estimates, though policy measures such as tariffs could serve as a counterweight.

The so-called Magnificent 7, which generated more than half of the S&P 500’s total return in 2024, are likely to again have a disproportionate impact on index returns. Earnings growth for this group are expected to decelerate this year to around 20% but should still support performance. Demand for their products remains robust, though a key question is the level of investment these companies are making and whether payoffs will be similar to their previous cap ex cycles. How this plays out may impact US equity returns more this year than Trump’s policies. Investors lack cushion if anything goes wrong; the weighted average forward P/E for the Magnificent 7 is around 32x, or more than 46% above the index average.

Investors should lean modestly into equity segments where valuations are attractive and policy shifts may provide further upside. US small-cap stocks trade at significant discounts to large-cap peers in part due to recent earnings weakness. Looking forward, they offer a favorable set-up in terms of higher rates (benefiting financials), healthy economic growth (boosting operating leverage), and rising small business confidence. While small-cap earnings are already expected to rise 16% in 2025, tax cuts—if they are enacted—should disproportionately benefit them, given more of their revenue is domestic compared to their large-cap peers. More domestic revenue would also insulate them from other countries retaliating against January 20’s tariff threats.

Similar arguments could be made about value stocks, which have also underperformed, given weaker earnings and an out-of-favor sector mix. Sectors like healthcare, materials, and industrials are expected to see earnings rebound in 2025. There is further upside for these sectors from promises of deregulation (especially for energy and financials) and support for American manufacturing. Trump’s initial salvo of executive orders, which included support for offshore drilling and restrictions on offshore wind, underline his support for the traditional energy sector.

Ultimately, Trump’s policies will support large-cap US equities, but their relative outperformance is likely to fade, given stretched valuations. Investors should focus on other areas of the market where Trump’s policies, combined with attractive valuations, are likely to generate more attractive returns.

Wade O’Brien, Managing Director, Capital Markets Research