An out of consensus outlook for 2025

At present, the consensus outlook of the investment community is for the S&P 500 to rise a further 10% in 2025, ending the year between 6,500 and 6,800 – see Figure 1. In our view, the global economy is already skating on thin ice as of late 2024, and Trump’s trade war and rising government deficit will only serve to push the economy over the edge. As a result, we concur with BCA Research’s Chief Strategist, Peter Berezin, that the hoped-for soft landing may never arrive. Instead, the US may enter a recession in Q2 of 2025. For equity markets, this will likely lead to the S&P 500, which is currently above 6,000, falling to below of 4,200 in Q4 after which the index could recover somewhat by year end – still registering a deep decline for 2025.

Figure 1 – Average consensus target for the S&P 500 expects growth of 10%

A US labour market on thin ice

To understand why we believe the economy is weaker than many expect, one only needs to look at metrics from the job market. Back in 2022, there was an extremely high level of job openings as reported by JOLTS, Indeed, and others – see Figure 2. However, by the second half of 2024, the job openings had retreated to pre-pandemic levels and by October 2024 the official job openings stood at 4.6%. Just 10 basis point away from the 4.5% rate that US Federal Reserve (“Fed”) Governor Christopher Waller identified as the point at which any further decline in job openings would trigger a self-reinforcing cycle of rising unemployment.

 

Figure 2 – Falling US job openings persist

Further evidence can be seen in the number of people who were unemployed because they lost a permanent job, which was 48% higher in November 2024 than prior to the pandemic. In addition, the median length of unemployment has climbed materially since prior to the pandemic to 10.5 weeks, and the number of people collecting unemployment benefits in mid-December 2024 was 14% higher than at the same time of the year in either 2018 or 2019. At some point, the continuing weakening in the labour market will spill over to other areas of the economy.

Unemployment to hit consumer demand

We expect that the depletion of pandemic savings and weakening of the labour market will lead to slow consumer demand. With the most stress likely to be experienced at the bottom end of the income distribution for consumers as they have the least savings. Already in 2024, credit card and car loan delinquency rates have reached their highest levels since 2011, a year in which the unemployment rate was materially higher at 9%.

The higher interest rate environment will also play its part in squashing consumer disposable income. In early 2022, less than 4% of US home loans carried an interest rate above 6%, now, 16% of home loans are above 6% – see Figure 3.

Figure 3 – Interest rates have a lagged impact on home loan interest payments

The higher rates make buying a home less affordable, and as a result, demand for the existing supply dries up. In fact, there are already nearly 50% more newly built vacant homes for sale than in 2019. In turn, the number of US housing units under construction in October 2024 was down 13% from the year prior. The housing market has long been viewed as a leading signal of the broader economy, and we would not recommend investors ignore the warning signs going into 2025.

Trump’s trade war

In a December 2024 interview, President-elect Trump said that “tariffs are the most beautiful word” and that he “never really got the chance to go all out” on tariffs during his previous term because of the pandemic.

Clearly Trump is focused on implementing a raft of material tariffs in his second term. We believe that he may begin the trade war by raising tariffs on Chinese imports by roughly 10%. In response we think that Chinese authorities may, in turn, avoid retaliating through tariffs as the US imports $520 billion in goods and services from China while China imports just $160 billion from the US. Instead, they could opt to subject US companies with operations in China to export taxes and may even reduce exports of key rare earth minerals to the US.

There are many possible permutations for how the trade war could escalate. In our view, regardless of how it develops, it will lead to elevated US trade uncertainty, and if Trump’s first trade war is anything to go by, companies tend to make more conservative capital expenditure commitments in such an environment. This will ultimately place further strain on the US corporate sector.

Fed trepidation to cut rates

While we have highlighted several signs that the US economy is slowing, we believe the Fed will still wait for indisputable evidence of a recession before they cut rates. Why? Towards the end of 2024 inflation continued to rise modestly and may even remain sticky into early 2025. The Fed does not want to cut prematurely as a resurgence in inflation would call into question their efficacy. Especially given the potential for the upcoming trade war to add further inflationary pressure. As a result, the Fed may assume a more cautious stance towards cuts than previously expected by the market.

The bond market’s reaction to an unsustainable fiscal debt

Finally, Trump’s tax cuts could include the extension the 2017 Tax Cuts and Jobs Act (“TCJA”), lower corporate tax rates, increasing the State and Local Tax (“SALT”) deduction, or eliminate taxes on tips, overtime pay, and social security benefits. The combination of which will lead to an increase in the federal debt by more than $7.75 trillion over the next ten years. While higher federal debt due to tax cuts did not upset the bond market during Trumps first presidency, we believe the context is different this time around.

In 2016, the federal budget deficit stood at 3.1% of GDP, now it has more than doubled to 6.4% of GDP. Furthermore, real bond yields were around zero when Trump first took office in 2017, now they are close to 2%. Meanwhile, the debt-to-GDP ratio has risen to 123%, up from 105% in 2016. As a result, interest payments on federal government debt have risen to 3.1% of GDP in 2024, up from 1.3% of GDP in 2016. In fact, assuming the above tax cuts are implemented, interest payments could increase to a record 5.5% of GDP over the subsequent decade as seen in Figure 4.

Figure 4 – Elevated rates and a larger Federal debt will increase interest rate costs

Of course, there is the hope that Trump’s focus on cutting fiscal spending may help to offset the tax cuts. We suspect that Trump will avoid cutting the largest programs, specifically defence spending, Medicare, and Social Security. Leaving the only remaining option, federal spending. This may have little room to be cut given that it already down from 37% of total government spend in 2011 to 26% now. Meanwhile the newly established Department of Government Efficiency (“DOGE”), which is focused on federal employment, will likely struggle to eliminate a significant amount of waste in the budget. That is because the number of federal employees has barely changed in past 80 years, leaving not many employees to cut – see Figure 5.

Figure 5 – While State employment has grown, Federal jobs have remained flat

As the Federal budget deficit continues to grow, reaching untenable levels, the bond markets will eventually react. In response, the 10-year yield could jump to 4.9% and higher, causing mortgage rates to rise further into punitive territory. As US Treasuries are the main source of collateral for the global financial system, the surge in their yields will lead to US equities falling. With the S&P 500 potentially dropping below 5,000 for the first time since April 2024.

Investment takeaway

While macro-economic forecasts are hard to get right with pinpoint accuracy due to the array of external factors at play, we remain confident in our cautious stance for 2025 given the consistent weakening of both US employment metrics and the housing sector. While what exactly Trump’s tariff and tax cuts will look like in practice is yet to be seen, we believe it is more likely than not that they further dampen economic activity as 2025 unfolds.

If you are interested in finding out more about how cognisance of the macroeconomic backdrop impacts our investment decision making process, connect with Integrity Asset Management and let us help you navigate your investing journey.

For more information on this synopsis or to discuss solutions provided by Integrity Asset Management, please contact us at:

Tel: (021) 671 2112
Cell: 072 513 2684 / 084 601 1025
E-mail: nic@integrityam.co.za / herman@integrityam.co.za

Source: Bloomberg, 31 December 2024