2025 Q1 -2025 Q2
March 1st 2025
Our quarterly S&P 500 forecast for 2025 Q1 (average price returns) indicates a 1.2 percent growth over the previous quarter. For 2025 Q2 , we anticipate 3.5 percent growth over the first quarter. Our monthly forecast for March is lower than February’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 volatile start to 2025 Q1
After the impressive 2023 performance of 24 percent growth, the S&P 500 index closed 2024 with another remarkable 23.3 percent gain over the previous year. 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.
Following Trump’s election victory, investors generally felt optimistic despite the sticky inflation and the prospect of looming tariffs on US imports. Trump’s election promises such as lower taxation at the individual and corporate levels, and reduced regulation were fuelling the optimistic sentiment. Although the Fed’s cautious stance about the rate cuts in 2025 inevitably dampened the mood, the y-o-y performance of Q4 was very impressive. The index recorded 32 percent growth over 2023 Q4.
After President Trump’s inauguration on January 20, the US stock markets were hit by fresh worries about a potential disruption to the AI revolution. Chinese AI company DeepSeek’s release of AI models to compete against OpenAI’s, at a lower cost, caused panic. Many analysts interpreted DeepSeek’s success as a game changer for the AI revolution. These fears have calmed somewhat as AI scientists assure the American AI industry still has advantages over China’s despite Deepseek’s lower price tag for its model. Both Nvidia’s shares and the S&P 500 recovered and the latter ended January at 6041.
Investor sentiment weakened in February after President Trump confirmed 25 percent tariffs on European autos. Starting from March 4, tariffs on imports from Mexico and Canada are expected to take effect. Trump also announced additional 10% tariffs on China imports. Potential inflationary impact of Trump’s tariff policy led to a sell-off. The S&P 500 index ended February at 5955.
Trump’s economic agenda, tariffs and beyond
It’s widely accepted that Trump’s tariffs policy would increase the costs for corporations that rely on imported intermediate goods. The fear of forthcoming inflation would stimulate the 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. 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.
Tariffs intensify
President Trump has already imposed 25% across-the-board tariffs on Mexico and Canada and a 10% tariff on all goods from China at the beginning of February. He also confirmed 25 percent tariffs on European autos. The tariffs on imports from Mexico and Canada were announced to be effective from March 4. An additional 10 % tariff on Chinese imports is also expected to be imposed from that date. The impact of these tariffs on PCE inflation might be gradual despite the possible retaliatory tariffs from the countries in question.
Overall, it remains to be seen if the tariff revenues would outweigh the gap from cuts in corporate tax. We believe, without curbing government spending, there is not much wiggle room for cutting taxes and keeping the budget deficit low. If business investment after tax cuts increases the productive capacity, the overall impact on inflation may not be as bad as first feared. If a peace agreement is reached soon in the Russia-Ukraine conflict, falling energy prices would partially compensate the inflationary impact of tariffs.
GDP slows down in Q4
The United States’ Gross Domestic Product (GDP) expanded at an annual rate of 2.3 percent in the fourth quarter of 2024, according to the second estimate (Source: the Bureau of Economic Analysis (BEA)). The GDP growth in Q4 was lower than Q3’s growth of 3.1 percent and also below the market’s anticipation of 2.5 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, GDP’s expansion remains on solid footing. The US consumer spending was robust in Q4, rising at a strong rate of 4.2 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 January 2025 jobs report came in below expectations. The U.S. economy added 143,000 jobs after creating 256,000 jobs in December. This was below the Dow Jones consensus forecast (175,000 jobs). US unemployment slowed down to 4.0 percent from last month’s 4.1 percent.
Retail sales edge down, home sales slump further
Starting with the economic data, retail sales dipped in January and home sales slid further
The advance estimate of U.S. retail and food services sales for January were down 1.2 percent from the previous month (both seasonally and inflation-adjusted). This estimate was 4 percent (±0.5 percent) above January 2024.
The National Association of Realtors index of pending home sales slumped 4.6 percent in January after falling over 5 percent in December. The Pending Home Sales Index leads existing home sales by a month or two. The latest figure shows that the US housing market is still struggling because of high mortgage rates. US home buyers are getting more optimistic about future lower mortgage rates. However, the interest rate cuts in 2025 are not expected to arrive in 2025 Q1.
Signs of loosening in the labor market
In the week ending February 22, the advance figure for seasonally adjusted initial claims was 242,000, an increase of 22,000 from the previous week’s revised level. The 4-week moving average was 224,000, an increase of 8,500 from the previous week’s revised average. The advance seasonally adjusted insured unemployment rate was 1.2 percent for the week ending February 15, unchanged from the previous week’s unrevised rate
The US unemployment dropped to 4.0 percent in February from 4.1 percent in January. That said, the initial jobless claims approached the critical 250,000 mark. The latest figure was the largest weekly spike in claims in more than four months, indicating considerable loosening in the labor market.
PMI improves from January but consumer outlook deteriorates
The Chicago Purchasing Managers’ Index (PMI) increased to 45.5 in February from January’s 39.5. This was well above the market anticipation of 40.6. 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 7.0 points in February to 98.3 (1985=100). The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—fell sharply to 136.5 (1985=100) from 139.9 in January. Furthermore, the Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—fell to 72.9 (1985=100) from 81.2 in January
A reading below 80 for the Expectations Index would indicate that consumers are concerned about a recession. The index was over 80 in the last couple of months, so the latest monthly deterioration is significant. The recent fall in consumer confidence indices reflects concerns about the business conditions coupled with the weakening in the labor market.
Inflation stabilizes in January
The annual inflation rate in the US accelerated to 3 % in January 2025, compared to 2.9 % in December, in line with market expectations. January’s data marks the fourth consecutive month of increases in the annual inflation rate
The Federal Reserve’s preferred metric — the personal consumption expenditures price index rose 2.5 percent in January, edging down from 2.6 percent in December, in line with the market analysts’ projection. Core inflation, which excludes food and energy, showed an annualized rate of 2.6 percent in January, after climbing 2.9 percent in December. Overall, the inflation news that came out in February showed that US inflation is still not near enough 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 first meeting of 2025. The decision followed three straight cuts since September 2024.
The Fed did not meet in February, but despite the slightly cooler inflation, we do not expect a rate cut on March 19. We believe the 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 are seen, 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. Inflationary impact of Trump’s tariff policy, coupled with the solid GDP growth and falling 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 February at 4.24, down from 4.53 in January. This can be explained by the investor flight to safety. Normally, higher inflation expectations lead to rising yields.
US corporate earnings were stable in Q3
The US corporate earnings with inventory valuation and capital consumption adjustments (domestic industries) were stable in Q3, slightly edging up over Q2. The recovery owed to lower production costs, as a result of the cooling inflation. The earnings were up 0.8 percent from the previous quarter and 9.3 percent over 2023 Q3.
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 2024 Q4 is stable corporate earnings, with a 1.2 percent growth over Q3. We expect the earnings to be 4.7 percent higher over 2023 Q4. We expect the earnings in 2025 Q1 to be 1.9 percent higher than 2024 Q4 and 8.9 percent higher than 2024 Q1.
The historical data from January 28th, 2025
The S&P 500 remains overvalued
According to Factset Insights from February 28, the forward 12-month P/E ratio for the S&P 500 is 21.2. This P/E ratio is above the 5-year average (19.8) and above the 10-year average (18.3).
For the fourth quarter, Factset estimates the blended (year-over-year) earnings growth rate for the S&P 500 as 18.2%. If 18.2% is the actual growth rate for the quarter, it will mark the highest (y-o-y) earnings growth rate reported by the index since Q4 2021.
Market analysts believe that earnings growth outside of ‘Magnificient 7’ companies will significantly improve in 2025. They expect earnings growth for those companies to be around 13 percent in 2025. 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 continue its upward trajectory in 2025. We don’t anticipate a major correction in Q1. Consumer spending may go up further as consumers worry about the prospect of rising prices due to tariffs. This would support economic growth in the short run. If inflation remains tame, a rate cut in the second quarter is likely to give a lift to the stock market.