2025 Q2
May 1st 2025
Our quarterly S&P 500 forecast for 2025 Q2 (average price returns) is a 1.7 percent drop over the first quarter. Our monthly forecast for May is higher than April’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.
After the 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. The index ended Q1 4.4 percent lower than its value at the end of 2024.
Investor and consumer sentiment have deteriorated further after President Trump announced new tariffs on April 2. His ‘Liberation Day’, tariffs 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. Gold hit record highs as investors sought safe-haven assets.
The sell-off in the US Treasuries deepens the panic
Normally, in times of stock market turmoil, investors flee to safe-haven assets such as the Swiss Franc or US treasuries. However, after the tariff announcement, investors have started dumping the US treasuries, hence weakening the value of the USD against other currencies.
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 recovered slightly. However, the rumours regarding the president’s dislike of the Fed‘s Chair Jerome Powell caused further volatility. Investors were not happy about the possibility of the Fed losing its independence in setting the monetary policy. At the end of April, the news of a possible upcoming recession made things worse. The S&P 500 index ended April at 5569, 0.7% below the end of March.
President Trump has started tariff negotiations with various countries in the hope of reversing the stock market rout and rescuing 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. This makes predictions of the stock market 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.
Negative GDP growth in 2025 Q1
The United States’ Gross Domestic Product (GDP) fell at an annual rate of 0.3 percent in the first quarter of 2025, according to the advance estimate (Source: the Bureau of Economic Analysis (BEA)). The largely unexpected drop was driven by a whopping 41.3% surge in imports ahead of President Donald Trump’s tariffs. Economists surveyed by Dow Jones were expecting a gain of 0.4%. The GDP growth in 2024 Q4 was 2.4 percent. For the full year 2024, GDP grew at the pace of 2.8 percent, compared with 2.9 percent in 2023.
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 5.1% for the quarter.
Consumer spending is related to job creation. The March 2025 jobs report came in above expectations. The U.S. economy added 228,000 jobs. This was above the Dow Jones consensus forecast (140,000 jobs). Although April’s job numbers are expected to be much lower than the March job report, the labor market is not yet raising alarm bells.
Although the stocks sold off after the advance estimate for Q1 GDP was revealed, 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 40 % chance of negative GDP growth in two consecutive quarters, with a recovery in the second half of the year.
Retail sales and home sales stabilize
Starting with the economic data, retail sales recorded a modest increase and home sales had a strong recovery.
The advance estimate of U.S. retail and food services sales for March increased 1.4 percent from the previous month. US retail sales were up 4.6 percent (±0.5 percent) from March 2024. The increase was mainly driven by a 5.3% rise in motor vehicle sales before auto tariffs became effective.
The National Association of Realtors’ index of pending home sales jumped 6.1 percent in March after increasing 2 percent in February. The Pending Home Sales Index leads existing home sales by a month or two. Despite the strong recovery in March, the US housing market is facing uncertainty with lower economic growth and high mortgage rates. Although the consumer confidence about the economy is low, US home buyers anticipate lower mortgage rates in the face of lower inflation and growth. The Fed may indeed cut the rates earlier, given the worrying first-quarter GDP growth.
Loosening labor market
In the week ending April 26, the advance figure for seasonally adjusted initial claims was 241,000, an increase of 18,000 from the previous week’s revised level. The 4-week moving average was 226,000, an increase of 5,500 from the previous week’s revised average. The advance seasonally adjusted insured unemployment rate was 1.3 percent for the week ending April 19, an increase of 0.1 percentage point from the previous week’s unrevised rate.
The U.S. unemployment rate rose to 4.2% in March 2025 from 4.1% in the previous month. The labor market is slowly loosening as the latest initial jobless claims were well above the market forecast of 224,000. This may speed up further as companies reduce capital spending amid the tariff-war uncertainty.
PMI and consumer outlook deteriorate further
The Chicago Purchasing Managers’ Index (PMI) fell to 44.6 in April 2025 from 47.6 in March. This was below the market anticipation of 45.5. The index’s long-term average from 1967 to 2024 is 54.7. Hence, the current value continues to indicate a contraction in business activity.
The Conference Board’s consumer confidence index fell by 7.9 points in April to 86.0 (1985=100). The Present Situation Index—based on consumers’ assessment of current business and labor market conditions—decreased 0.9 points to 133.5. The Expectations Index—based on consumers’ short-term outlook for income, business, and labor market conditions—dropped 12.5 points to 54.4, the lowest level in 13 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. Nearly one-third of consumers expect fewer jobs in the next six months. This ratio is as high as it was in 2009, in the middle of the Great Recession.
Inflation was tame in March
The annual inflation rate in the US cooled to 2.4 percent in March, compared to 2.7 percent in February, below the market expectations of 2.6 percent.
The Federal Reserve’s preferred metric — the personal consumption expenditures price index rose 2.3 percent in March, down from 2.6 percent in February but above the market analysts’ projection of 2.1 percent. Core inflation, which excludes food and energy, showed an annualized rate of 2.6 percent in March, down from 3.1 percent in February but above the market prediction of 2.5 percent. Overall, the inflation news that came out in April showed that US inflation remains tame but still not close to the Fed’s 2% goal.
The first rate cut may arrive sooner than June
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. 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.
We believe that there is currently an increased sense of urgency regarding the rate cuts. As the oil price remains very low and the US inflation is relatively tame, the latest GDP data is likely to push the Fed toward a 25 bp rate cut at the upcoming May 6 meeting.
Previously, we saw the likelihood of a rate cut before June as rather small. The solid GDP growth made 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 April at 4.15 after reaching 4.5 on April 11.
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 0.9 percent growth over 2024 Q4. We expect the earnings to be 10.4 percent higher than in 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. In 2025 Q2, we expect the company earnings to be 6.7 percent lower than 2024 Q2.
The historical data from April 30th 2025
The S&P 500 approaches fair valuation
According to Factset Insights from April 25, the forward 12-month P/E ratio for the S&P 500 is 19.8. This P/E ratio is only slightly below the 5-year average (19.9) and above the 10-year average (18.3).
For Q1 2025, FactSet’s estimated (year-over-year) earnings growth rate for the S&P 500 is 10.1%. If 10.1% is the actual growth rate for the quarter, it will mark the second-straight quarter of double-digit earnings. For Q1 2025 (with 36% of S&P 500 companies reporting actual results), 73% 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 60 % 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 the falling consumption. Currently, the price of oil is very low, the WTI crude is hovering below 60 USD per barrel, and this is an important factor for future inflation expectations. When the inflation remains tame, the Fed can cut the interest rates in May to prevent an outright recession.