2025 Q2
April 1st 2025
Our quarterly S&P 500 forecast for 2025 Q2 (average price returns) is a 4 percent growth over the first quarter. Our monthly forecast for April is also higher than March’s average. Geopolitical problems such as the Russia-Ukraine, and the Israel-Palestine conflict cannot be captured in a forecast model. Thus, any uncertainty concerning these issues makes the 95 % confidence interval around the point forecast rather wide.
S&P 500’s worst quarter since 2022 Q3
Following the 2023 performance of 24 percent gain, the S&P 500 index closed 2024 with another 23.3 percent growth. This marked the best two-year in-a-row performance since 1998. The stronger-than-expected economy, rate cuts, and the AI revolution were the driving forces of the two-year rally.
Optimism following Trump’s election victory was fuelled by the promise of lower taxation at the individual and corporate levels, and the prospect of a quick end to the war in Ukraine. After the index’s impressive 32 percent growth in 2024 Q4 over 2023 Q4, the bull market halted with dissipating investor optimism in 2025 Q1.
Investor and consumer sentiment have deteriorated after President Trump imposed tariffs on imports from Mexico, Canada, China, and European autos. Furthermore, at the end of Q1, there was still no significant progress toward peace in Ukraine. The potential inflationary impact of Trump’s tariff policy and the continuing geopolitical risks led to a market sell-off. The index ended Q1 4.4 percent lower than its value at the end of 2024.
How effective are tariffs in balancing the books?
It’s widely accepted that Trump’s tariff policy would increase the costs for corporations that rely on imported intermediate goods. The fear of forthcoming inflation would stimulate consumer spending in the short run, but sticky inflation and delayed rate cuts would take their toll on growth.
Tax cuts would increase consumer spending and help economic growth, but this is not as simple as it sounds. Cutting taxes without cutting government spending would cause the budget deficit to grow. A bigger national debt and borrowing costs would impede the US economic growth. Although the economic growth is strong and the US unemployment is low, US companies are not optimistic regarding the future earnings prospects. The chart below shows the US budget deficit grew in the last 8 years despite the first round of tariffs in 2016..
Import tariffs increase the average prices of imports of goods and services (import deflator). During his first term, Trump imposed tariffs on imported solar panels, washing machines, steel and aluminum, and billions of dollars of Chinese goods. Despite the additional tariff revenues, the budget deficit grew during the pandemic and remains 6.3 % of the US GDP.
‘Liberation Day’ and trade wars anxiety
President Trump is expected to announce new tariffs on April 2, or on what he calls ‘Liberation Day’, that would hit “all countries”. The new tariffs would not only target the countries with the largest trade imbalances with the US. The threat of a deepening trade war has created a sense of panic across the global stock markets. Gold hit a record high of $3,128 per ounce, as investors sought safe-haven assets.
The impact of the tariffs on PCE inflation might be gradual despite the possible retaliatory tariffs from the countries in question. However, the knock-on effect on production costs, business confidence, and investment (lower capex) would inevitably impact inflation and economic growth. Although the probability of a hard landing for the US economy is still small, a negative quarterly GDP growth may not be ruled out.
2024 Q4 GDP is revised up
The United States’ Gross Domestic Product (GDP) expanded at an annual rate of 2.4 percent in the fourth quarter of 2024, according to the final estimate (Source: the Bureau of Economic Analysis (BEA)). The GDP growth in Q4 was lower than Q3’s growth of 3.1 percent The increase in the fourth quarter primarily reflected increases in consumer spending and government spending that were partly offset by a decrease in investment.
For the full year 2024, GDP grew at the pace of 2.8 percent, compared with 2.9 percent in 2023. Despite the slower-than-expected growth, the GDP’s expansion remains on solid footing. The US consumer spending was robust in Q4, rising at a strong rate of 4 percent. Despite the slump in business investment (-5.7%) so long as consumer spending, which accounts for more than two-thirds of U.S. economic activity, stays healthy, the US economy avoids a hard landing.
Consumer spending is related to job creation. The February 2025 jobs report came in below expectations. The U.S. economy added 151,000 jobs. This was below the Dow Jones consensus forecast (160,000 jobs) but above January’s revised number (125,000). US unemployment edged up to 4.1 percent from the previous month’s 4 percent.
Currently, neither the economy nor the labor market is raising alarm bells. The stock market is forward-looking, and the deteriorating investor sentiment is based on the fears of stagflation in the face of looming tariffs and a global trade war.
Retail sales and home sales stabilize
Starting with the economic data, retail sales recorded a modest increase and home sales recovered slightly.
The advance estimate of U.S. retail and food services sales for February increased 0.2 percent from the previous month. This follows a 1.2 percent drop in January (both seasonally and inflation-adjusted). Despite the modest recovery, the growth was below the market forecasts of a 0.6 percent rise. US retail sales were up 3.1 percent (±0.5 percent) from February 2024.
The National Association of Realtors index of pending home sales increased 2 percent in February after slumping 4.6 percent in January. The Pending Home Sales Index leads existing home sales by a month or two. Despite the slight recovery in February, the US housing market is still struggling because of high mortgage rates. US home buyers are getting more optimistic about future lower mortgage rates.
Signs of loosening in the labor market
In the week ending March 22, the advance figure for seasonally adjusted initial claims was 224,000, a decrease of 1,000 from the previous week’s revised level. The 4-week moving average was 224,000, a decrease of 4,750 from the previous week’s revised average. The advance seasonally adjusted insured unemployment rate was 1.2 percent for the week ending March 15, unchanged from the previous week’s unrevised rate.
The US unemployment edged up to 4.1 percent in February from 4 percent in the previous month. That said, the initial jobless claims are still below the critical 250,000 mark. Although the labor market is slightly loosening, it has not reached the extent to raise concerns for a US hard-landing.
PMI improves but consumer outlook deteriorates further
The Chicago Purchasing Managers’ Index (PMI) increased to 47.6 in March 2025 from 45.5 in February. This was well above the market anticipation of 45.2. The index’s long-term average from 1967 to 2024 is 54.7. Hence, the current value still indicates a contraction in business activity.
The Conference Board’s consumer confidence index declined by 7.2 points in March to 92.9 (1985=100). The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—decreased to 134.5 (1985=100) from 138.1 in February. Furthermore, the Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—dropped sharply to 65.2 (1985=100) from 74.8 in February. This was the lowest level in 12 years.
A reading below 80 for the Expectations Index would indicate that consumers are concerned about a recession. The index was over 80 at the beginning of the year, so the latest monthly deterioration is significant. Consumers’ gloomy expectations reflect pessimism about the worsening business conditions coupled with worsening employment prospects.
Inflation was stable in February
The annual inflation rate in the US fell to 2.8 percent in February, compared to 3 percent in January, below the market expectations of 2.9 percent.
The Federal Reserve’s preferred metric — the personal consumption expenditures price index rose 2.8 percent in February, up from 2.6 percent in January, above the market analysts’ projection of 2.7 percent. Core inflation, which excludes food and energy, showed an annualized rate of 3.1 percent in February, down from 3.3 percent in January and below the market prediction of 3.2 percent. Overall, the inflation news that came out in March showed that US inflation remains tame but still not close to the Fed’s 2% goal.
The first rate cut may come at the end of Q2
As widely anticipated, the Fed left its key interest rate unchanged (in a range between 4.25%-4.5%) in its Q1 meetings. The decision followed three straight cuts since September 2024.
The Fed chairman Jerome Powell appears so far cautious despite Trump being eager for interest rate cuts to come sooner. Fed will evaluate the impact of the US tariffs and the loosening in the labor market before going ahead with further loosening in monetary policy. If the imposed tariffs are expected to significantly increase inflation, the Fed may choose not to cut its rates before June. As things stand, the policy interest rate may remain above 3.5 percent in 2025. One cannot foresee the impact on inflation as other factors such as corporate taxes and energy prices, are at play.
We see the likelihood of a rate cut before June rather small. The inflationary impact of Trump’s tariff policy, coupled with the so far solid GDP growth and low unemployment, makes that a safe bet. Investors are currently worrying more about future inflation than the current inflation. The 10-year U.S. Treasury Bond yield ended March at 4.27, not a big change from February (4.24). This can be explained by the investor flight to safety. Normally, higher inflation expectations lead to rising yields.
US corporate earnings increased in Q4
The US corporate earnings with inventory valuation and capital consumption adjustments (domestic industries) were up 3.6 percent from the previous quarter and 7.2 percent over 2023 Q4.
Our consumer sentiment indicators are based on our ‘keyword’ algorithm related to ‘Google Trends’. Accordingly, these indicators are among the explanatory variables that predict US corporate profits. Our prediction for 2025 Q1 is stable corporate earnings, with a 2.4 percent growth over 2024 Q4. We expect the earnings to be 12 percent higher over 2024 Q1. As corporate earnings are nominal numbers, the strong growth is partly due to inflation, where the wage costs lag the increases in producer prices.
The historical data from March 31st 2025
The S&P 500 approaches fair valuation
According to Factset Insights from March 28, the forward 12-month P/E ratio for the S&P 500 is 20.5. This P/E ratio is above the 5-year average (19.9) and above the 10-year average (18.3). Although still overvalued, the index is closer to its 5 year average than the last few months.
For Q1 2025, Factset’s estimated (year-over-year) earnings growth rate for the S&P 500 is 7.3%. The number of companies issuing negative EPS guidance is above the 5-year average of 57 and the 10-year average of 62. Factset reports that at the sector level, the Information Technology sector has the highest number of companies issuing negative EPS guidance.
Despite the earnings concerns for Q1, market analysts believe the S&P 500 will see a price increase of 21.3% over the next twelve months. We believe these forecasts are on the optimistic side, especially if sticky inflation gets in the way of further monetary policy loosening. It remains to be seen if the overvalued stock market can recover its upward trajectory in 2025. Consumer spending in the short run may go up further as consumers worry about the prospect of rising prices due to tariffs. This would support economic growth in the near term. If April 2’s tariffs do not start an outright global trade war, a hard landing for the US economy would be unlikely. Overall, it is also unlikely that the Fed would cut the rates before summer.