2025 Q2- 2025 Q3
June 1st 2025
Our quarterly S&P 500 forecast for 2025 Q2 (average price returns) is a 3 percent drop over the first quarter. We expect a 5 percent growth in 2025 Q3 over Q2. Our monthly forecast for June is also higher than May’s average. The volatility concerning frequent changes in tariff rates and timings, and geopolitical problems such as the war in Ukraine cannot be captured in a forecast model. Thus, any uncertainty concerning these issues makes the 95 % confidence interval around the point forecast rather wide.
Investors’ appetite for ‘TACO’
Investor and consumer sentiment deteriorated significantly in April after President Trump announced his ‘Liberation Day’ tariffs that would hit “all countries”, not only the ones 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.
Normally, in times of stock market turmoil, investors flee to safe-haven assets such as the Swiss Franc or US treasuries. However, after the ‘Liberation Day’ tariffs announcement, investors have started dumping the US treasuries, hence weakening the value of the USD against other currencies. The USD index has lost about 7 percent of its value since the beginning of the year.
Following the stock and bond market sell-off, President Trump backed off a little by imposing a 90-day pause in the tariff implementation. The S&P 500 index moderated some of its losses.
President Trump has started tariff negotiations with various countries hoping to reverse the stock market rout and rescue the dollar’s value. Trump also softened automotive tariffs. Currently, it is impossible to guess what his next move may be. Forecast models can predict when certain policies had precedence in the past. Trump’s strategy has recently become an endogenous rather than exogenous factor for the stock market performance. When the markets slump, the president appears to backtrack and reevaluate some of the tariffs. “Trump always chickens out”, or ‘TACO’, is becoming a catchphrase for market investors. This makes stock market predictions more difficult than usual, as the underlying economic factors keep changing depending on how investors behave.
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 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.
The tariffs already imposed and scheduled to take effect will bring in just $170 billion in annual revenue. The federal government raises about $3 trillion a year from income taxes (see Chart above). Despite the big contribution by tax receipts, the budget deficit continued to grow in the post-pandemic era, and so did the interest payments on the US borrowing. Currently, it is mathematically unrealistic to expect that the US government can significantly cut income tax and make the budget deficit disappear by just relying on tariff receipts.
In May, Moody’s downgraded the US from ‘AAA’ to ‘Aa1’, emphasizing the unsustainable debt load. “Successive US administrations and Congress have failed to agree on measures to reverse the trend of large annual fiscal deficits and growing interest costs,” the agency said. This latest development, coupled with the USD’s weakness, is increasing the pressure on the US policy makers as the USD’s global reserve status may be in danger. Some economists may argue that making the USD weaker was one of Trump’s objectives to start with, but this may go too far. More expensive imports would outweigh the benefits of increased US exports and curtail consumer spending.
Negative GDP growth in 2025 Q1
The United States’ Gross Domestic Product (GDP) fell at an annual rate of 0.2 percent in the first quarter of 2025, according to the second estimate (Source: the Bureau of Economic Analysis (BEA)). Although this was a slight upward revision (0.1 %), economists surveyed by Dow Jones were expecting 0% growth. The GDP growth in 2024 Q4 was 2.4 percent. The drop in GDP was driven by a whopping 42.6 % surge in imports ahead of President Donald Trump’s tariffs.
A slowdown in consumer spending and a sharp decline in government spending also contributed to the weak GDP number. US consumer spending slowed down to 1.8 % after a robust 4% growth in Q4. Federal government expenditures declined 4.6 % for the quarter. Final sales to private domestic purchasers rose at a 2.5 per cent rate, the slowest in nearly two years.
Consumer spending is related to job creation. The April 2025 jobs report came in above expectations. The U.S. economy added 177,000 jobs. Despite being lower than March’s job creation number (185,000), this was above the Dow Jones consensus forecast (133,000 jobs). The labor market is not yet raising alarm bells.
Although the Q1 GDP is disappointing, it is too soon to conclude that the US economy is inevitably heading for a hard landing. The stock market is forward-looking, and the deteriorating investor sentiment is based on the fears of recession in the face of looming tariffs and a global trade war. A US recession would require a negative GDP growth for two quarters in a row. Currently, as things stand, the probability of a recession has gone up. We see a 30 % chance of negative GDP growth in two consecutive quarters, with a recovery in the second half of the year.
Retail sales are stagnant and home sales dip again
Starting with the economic data, retail sales were stagnant, and home sales fell sharply..
The advance estimate of U.S. retail and food services sales for April increased only 0.1 percent from the previous month. US retail sales were up 45.2 percent (±0.5 percent) from April 2024.
The National Association of Realtors’ index of pending home sales dipped 6.3 percent in April after jumping 6.1 percent in March. The Pending Home Sales Index leads existing home sales by a month or two. The strong recovery in March was short-lived, and the US housing market continues to face uncertainty with lower economic growth and high mortgage rates.
Loosening labor market
In the week ending May 24, the advance figure for seasonally adjusted initial claims was 240,000, an increase of 14,000 from the previous week’s revised level. The 4-week moving average was 230,750, a decrease of 250 from the previous week’s revised average.
The advance seasonally adjusted insured unemployment rate was 1.3 percent for the week ending May 17, an increase of 0.1 percentage point from the previous week’s unrevised rate. The U.S. unemployment rate was 4.2 percent in April 2025, unchanged from the previous month. The labor market is loosening as the latest initial jobless claims were well above the market forecast of 230,000. This may speed up further as companies reduce capital spending amid the tariff-war uncertainty.
PMI deteriorates further, and consumer confidence rebounds
The Chicago Purchasing Managers’ Index (PMI) fell to 40.5 in May 2025 from 44.6 in April. This was below the market anticipation of 45.0. The index’s long-term average from 1967 to 2024 is 54.7. The current value is the sharpest decline in four months, and the contraction in business activity continues.
The Conference Board’s consumer confidence index increased by 12.3 points in May to 98.0 (1985=100). The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—rose 4.8 points to 135.9. The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—increased 17.4 points to 72.8.
After five consecutive months of decline, consumer confidence improved in May. The rebound is owed to the US-China trade deal, but there is still uncertainty about how the deal may play out in the coming months. Furthermore, despite the latest moderation in consumer pessimism, the Expectation index is still below 80, indicating that US consumers still worry about the business conditions and the likelihood of recession.
Inflation continues to cool down
The annual inflation rate in the US cooled down to 2.3% in April 2025 from 2.4% in March. The inflation number was below forecasts of 2.4% and the lowest since February 2021. Energy cost declined 3.7%, more than a 3.3% fall in March
The personal consumption expenditures price index, the Federal Reserve’s key inflation measure, increased 0.1 % in April, making the annual rate 2.1%, the lowest since March 2021. The monthly reading was in line with the Dow Jones consensus forecast, while the annual level was 0.1 percentage point lower.
Excluding food and energy prices, the core PCE showed readings of 0.1% and 2.5%, against respective estimates of 0.1% and 2.6% by market analysts.
“Difficult trade-offs”
Despite the cooler inflation numbers, neither the Fed nor investors are comfortable about the future inflation prospects given the uncertainty about Trump’s looming tariffs. The Fed left its key interest rate unchanged (in a range between 4.25%-4.5%) in its May meetings.
President Trump’s claim of the violation of the preliminary trade deal with China and a U.S. Court of International Trade ruling questioning Trump’s authority on the tariff matter make the inflation outlook rather hazy. Overall, if the current tariffs policy goes ahead, it would be realistic to assume the PCE inflation to rise to 3 percent.
The Fed chairman Jerome Powell appears so far cautious despite Trump being eager for interest rate cuts to come sooner. The Fed wants to make sure that any tariff-fueled boost to inflation doesn’t persist. According to minutes of the May 6-7 meeting, Fed officials acknowledged “difficult trade-offs” in the coming months in the form of rising inflation alongside rising unemployment, and increasing recession risk.
The dollar’s weakness and the timing of the rate cut
The volatility in bond markets requires “warranted monitoring” by the Fed as a possible risk to financial stability. It is clear that a change in the U.S. dollar’s safe-haven status, along with rising Treasury bond yields, “could have long-lasting implications for the economy”. Indeed, the weakness of the USD may be a contributing factor in delaying a cut to the reference interest rate. Significant depreciation of the greenback has implications for international investors who have unhedged exposure to the US equities. An untimely rate cut and further dollar weakness can trigger a flight from US securities. Therefore, despite the increasing risk of recession, the Fed may delay its first rate cut until the unemployment rate rises sharply.
In our last forecast, we pointed out the increased sense of urgency regarding the rate cuts. However, this was before the US-China trade deal, and the latest court ruling about Trump’s authority in imposing tariffs. As the oil price remains very low and the US inflation is relatively tame, now we believe that the Fed will not go for a rate cut in June, unless the unemployment rate exceeds its pain threshold of 4.6 percent.
US corporate earnings fell in 2025 Q1
The US corporate earnings with inventory valuation and capital consumption adjustments (domestic industries) were down 2.5 percent in 2025 Q1 from the previous quarter but up 6.7 percent over 2024 Q1.
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. In 2025 Q2, we expect the company earnings to be 5.5 percent lower than 2025 Q1 and 3.8 percent lower than 2024 Q2.
The historical data from May 31st 2025
The S&P 500 is back in the overvalued territory
According to Factset Insights from May 30, the forward 12-month P/E ratio for the S&P 500 is 21.3. This P/E ratio is only slightly below the 5-year average (19.9) and above the 10-year average (18.4).
For Q1 2025 (with 98% of S&P 500 companies reporting actual results), 78% of S&P 500 companies have reported a positive EPS surprise, and 64% of S&P 500 companies have reported a positive revenue surprise.
Despite the growing concerns for a US recession, we expect the US economy to avoid a hard landing with a 70% probability. The markets are less concerned about the negative GDP growth in Q1, as the main culprit was the tariffs-induced sharp increase in imports rather than a dramatic drop in consumer spending. If the USD weakening is contained, inflation remains cool, trade deals manage to avoid a trade war, or the most biting tariffs are revoked, both a hard landing and a stock market correction may be avoided.