Chart of the month: US economic consensus 2025 less good than expected

US economic consensus 2025 less good than expected

Donald Trump’s November 2024 election victory sparked optimism for a revitalized US economy, with expectations of good GDP growth and a reduction in the hefty budget deficit inherited from the Biden administration. Equity markets soared after Election Day, signaling confidence in Trump’s economic agenda. The initial Bloomberg Consensus for 2025 projected GDP growth at 2.2%, with hopes of fiscal discipline to tackle the long-standing deficit challenge.

Yet, Trump’s tariff obsession, marked by “Tariffs Day” in April 2025, defied David Ricardo’s free trade principles, creating a lose-lose scenario. The updated 2025 consensus reveals a GDP growth drop to 1.4% and a core PCE inflation spike to 3.0%, reflecting expected short-term inflationary pressures. This tariff-driven approach has disrupted global trade, stifled growth, decreased corporate profits and raised consumer costs, undermining the early economic optimism.

The situation deteriorated further with the first draft of Trump’s “Big Beautiful Bill,” which unexpectedly widened the budget deficit disappointing investors who anticipated fiscal restraint. While tariff revenues may partially offset the deficit, the bill has hampered DOGE’s (Department of Government Efficiency) efforts to curb spending. Rising concerns over sustained borrowing have caught the attention of bond vigilantes, pushing US 30-year government bond yields to 5.0%.

The 2025 consensus now paints a less rosy picture: GDP growth at 1.4%, higher inflation (set to ease in 12-18 months), and a persistent -6.5% budget deficit. This has weakened the dollar, driven interest rates higher, left equity markets flat, and fueled uncertainty among consumers and corporations.

However, Trump has shown a willingness to pivot when needed, so we may see tariff reductions and a revised “Big Beautiful Bill” that better aligns with market expectations, potentially easing some of these economic strains.

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instrument referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the FINMA cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners Group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request.
© NS Partners Group

Time to Take Profits in the SP500

Introduction to the Current Economic Climate and Stock Performance

The U.S. economy is demonstrating robust health, with GDP growth exceeding 2%. Following a series of interest rate hikes, the GDP core deflator has significantly decreased from 5.6% to 2.8% as of March 2024, with projections suggesting a further dip to 2.6% by year-end. Coupled with an exceptionally low unemployment rate of 3.8%, the economic environment seems favorable. Additionally, the surge in Artificial Intelligence technologies is profoundly influencing the S&P 500, driving profits which are expected to sustain a growth rate of over 10% for the next three years. This ensemble of positive developments naturally underpins the impressive performance of the S&P 500.

Evaluating Valuations and Strategic Alternatives

However, valuations remain a critical consideration. The current 12-month forward P/E ratio of the S&P 500 stands at 20.9, reflecting a 27% premium over the 15-year average of 16.5. This premium is even more pronounced when juxtaposed with current 10-year bond yields of 4.3%, significantly higher than the 15-year average of 2.4%. The optimism embedded in these valuations, fueled by AI’s transformative impact across several sectors such as software, semiconductors, and communications, brings to mind the adage, “This time is different.” Despite this new paradigm, we believe that the S&P 500’s valuation has stretched too thin.

For investors seeking to remain engaged in the market while adopting a conservative stance, there are several strategies to consider. One approach involves shifting part of the S&P 500 investment towards high-quality corporate bonds offering a 5.8% yield with a 3-year maturity. Alternatively, investors might consider the S&P 500 Equal Weight Index, which trades at a P/E of 17.2, closer to its 15-year average of 16.1, thereby reducing exposure to overvalued megacaps. The S&P 400 Midcap Index, with its more reasonable P/E of 15.5, presents another viable option. For those concerned about potential economic downturns, the Swiss Market Index (SMI), with its defensive positioning in pharmaceuticals, consumer staples, and insurance, and a P/E of 17.6, offers a safer haven.

Innovative Financial Instruments and Risk Mitigation

More sophisticated alternatives include investing through reputable long/short managers who can navigate market volatility more adeptly, or engaging in structured products like capital-protected notes or semi-protected “Airbag” notes, with maturities ranging from 18 to 24 months. These products allow participation in market gains while shielding against severe downturns. Additionally, advanced investors might consider protective options strategies such as the Seagull strategy; buying a Put option for December 2024 with a strike of 5300, while selling a Put at 4750 and a Call at 5725, can create a cost-neutral position with an attractive asymmetric risk profile.

Conclusion

Despite the stretched valuations, the equity market is ripe with opportunities for discerning investors. By carefully selecting investment alternatives, one can adhere to the prudent maxim of “buy low, sell high,” optimizing returns while mitigating risks in a potentially overvalued market. This balanced approach will allow investors to navigate the current economic landscape with confidence and strategic foresight.

US economy: landing at last?

At the beginning of the year, there were fears of a sharp slowdown, but the US economy has proved surprisingly resilient.

At the beginning of the year, US GDP growth for 2023 was forecast at 0.3% according to the Bloomberg consensus. The question was not whether the US economy would slow down, but rather whether its landing would be soft or hard. Interest rates had risen sharply and the yield curve had inverted. But the US economy proved these pessimistic forecasts wrong, surprising everyone with its robustness (see table below). Today, the consensus forecast is for GDP growth of 2.2% in 2023.

How could the market have been so wrong? Firstly, because consumption has remained very strong, thanks to additional post-Covid household savings and an unemployment rate that has remained very low. In addition, the US government stimulated the economy thanks to the various programs approved by the Biden administration in 2022, such as “The Chip Act” and “The Inflation Reduction Act”. These two major forces offset the negative impact of rising interest rates. Indeed, the FED cited the strength of the US economy as one of the reasons for persistently high interest rates.

And what happens now?

But that’s in the past. Let’s look to the future. On the consumption side, households have used up all the extra savings accumulated during the Covid. What’s more, students began repaying their loans in October, which could further reduce their purchasing power. Lastly, rising interest rates are likely to have an impact on purchases of durable goods. As for the Government, the situation has also changed. The House of Representatives is now controlled by the Republicans, who are seeking to force the Biden administration to cut spending. We may also see government shutdowns if Congress and the White House fail to pass the legislation needed to raise the debt ceiling. According to Goldman Sachs, each week of government shutdown could reduce GDP growth by 0.2%. Finally, the “bond vigilantes” continue to put pressure on the government to spend less.

In view of these factors, our outlook for US GDP growth over the next three quarters could be similar, if not a little more pessimistic. In fact, we expect a significant slowdown over the next few quarters. But this time, we think the US economy is ready for a landing, probably a soft one.

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of the date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instruments referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the Finma cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request.

Towards a slowdown in the US economy at the end of the year

At present, the US economy appears to be in good health: growth is approaching 2%, core and underlying inflation are falling, unemployment is low and oil and petrol prices are lower than this time last year. What’s more, corporate profits are starting to rise and artificial intelligence could lead to an unprecedented increase in productivity. However, there are some challenges on the horizon.

A few clouds in a blue sky
The Core PCE, the inflation indicator favoured by the Federal Reserve (FED), presents a major challenge. Despite a target of 2%, this index is still at a worrying level of 4.6%. In order to rectify the situation, the FED is considering raising rates one or two more times this year, which could hamper economic growth and investment.
Another potential slowing factor is the exhaustion of the surplus savings accumulated during and after the Covid-19 pandemic. According to several estimates, this surplus savings could dry up by the fourth quarter of 2023, considerably limiting the support that consumers provide to the economy.
Admittedly, after two disappointing seasons in 2020 and 2021, the tourism sector rebounded in 2022 and 2023 thanks to the desire of American families for holidays. However, this momentum is expected to run out around September-October this year, marking the end of the peak tourist season.
Another worrying phenomenon is the clear inversion of the US yield curve. Historically, this phenomenon has always been a precursor to recession or a period of virtually zero growth. Monetary policy, which operates with a certain time lag, could therefore begin to reflect this economic reality in the months ahead.
In addition, the US government is facing a substantial budget deficit, exceeding 5.5% by 2023. Maintaining this level of public spending is unsustainable for the country’s economy.
As a result, the valuation of the US stock market is starting to look a little high, at around 19 times projected earnings for 2024. However, investors do not seem to be worried about the economic situation.

A similar situation in Europe
Although we have mainly been talking about the US, similar observations can be made for the European economy, including the UK, except that company valuations in Europe are more moderate than in the US.

Given these factors, it seems likely that we will see a significant slowdown in the economy between now and the fourth quarter of 2023, which could go as far as a moderate recession or very weak growth of around 0.5%. Against this backdrop, defensive growth sectors (such as healthcare and staples), as well as quality investment bonds with maturities of 3 to 5 years, appear to be wise choices.
It’s a good time to take a break, just like the summer break we’re all taking.

Past performance is not indicative of future results. The views, strategies and financial instruments described in this document may not be suitable for all investors. Opinions expressed are current opinions as of the date(s) appearing in this material only. References to market or composite indices, benchmarks or other measures of relative market performance over a specified period of time are provided for your information only. NS Partners provides no warranty and makes no representation of any kind whatsoever regarding the accuracy and completeness of any data, including financial market data, quotes, research notes or other financial instruments referred to in this document. This document does not constitute an offer or solicitation to any person in any jurisdiction in which such offer or solicitation is not authorized or to any person to whom it would be unlawful to make such offer or solicitation. Any reference in this document to specific securities and issuers are for illustrative purposes only, and should not be interpreted as recommendations to purchase or sell those securities. References in this document to investment funds that have not been registered with the Finma cannot be distributed in or from Switzerland except to certain categories of eligible investors. Some of the entities of the NS Partners group or its clients may hold a position in the financial instruments of any issuer discussed herein, or act as advisor to any such issuer. Additional information is available on request. © NS Partners Group