Signs of Softening, Path Unclear
The most notable feature of the current outlook is heightened uncertainty. This can be attributed in large measure to a surprising uptick in inflation, plummeting consumer confidence, and the unknown impact of tariffs. At the same time, the US economy has exhibited remarkable resilience over the past several years and corporate earnings are poised to achieve another quarter of double-digit growth. We are disturbed by indications of an economic slowdown and share the view that escalating tariffs will net increase costs for businesses and consumers. Further, this policy could ignite trade wars, which would drive inflation higher and weigh on growth. The probability of the US approaching recession-like conditions has risen meaningfully since our last outlook. The negative side of this equation has already pushed US equity benchmarks into a correction: since the February 19 all-time high, the S&P 500 Index & NASDAQ 100 Composite have tumbled -12.2% and -17.5% respectively through April 3. We expect market volatility to remain elevated in the coming quarter. While the US economy is showing signs of softening, Europe and China – having already experienced a prolonged period of economic weakness – may be beginning to stabilize and recover. This change in fortune is still in its early stages and will not be enough to offset weakness elsewhere: prior to the recent shift in global trade, the IMF forecasted global GDP growth of 3.3% for both 2025 and 2026, below the 20-year average of 3.7%.
US Economy: Weak Sentiment, Mixed Messages
Clearly, the economy is slowing, which has led to a growing number of recession predictions. The Atlanta Fed GDPNow current projection is for first quarter GDP to show a shocking –2.8% annualized decline. These depressed economic projections coincide with an alarming drop in consumer sentiment: the University of Michigan Consumer Sentiment Index fell sharply in March, plummeting -11% month-over-month and -27% from one year ago, whereas the Conference Board’s consumer confidence component reached a 12-year low. While the survey data shows increasing gloom, key measures of economic activity remain positive, including industrial production, a stabilization in housing demand, and a labor market that continues to show underlying strength.
The Fed has expressed satisfaction with the current state of the economy. As a consequence, it has reiterated its focus on inflation, which is well below the 2022 high but remains stubbornly above the 2.0% target. In February, Core CPI rose 3.1% year-over-year and the core PCE deflator increased 2.8%, marking a slight acceleration from the previous month. Notably, inflation expectations in both consumer and small business surveys have moved substantially higher, suggesting concern about future price pressures. The “last mile” of disinflation has proven difficult to achieve. While our base case is that inflation will stay modest, albeit above the Fed’s stated target, the implications for monetary policy are increasingly ambiguous. The Fed retains flexibility, but the path forward is vastly uncertain — the next move could plausibly be a rate cut, a rate hike, or a prolonged hold depending on how inflation and economic activity evolve in the months ahead.
US Stock Market: A Sharp Correction
The weak start of the stock market in 2025 is justified by the high level of uncertainty. The sharp rotation within the market from technology and consumer discretionary stocks to more defensive utility and consumer staple stocks also seems warranted. Growth-oriented investors are recognizing a need to make significant changes to bring portfolios in line with the changing reality. A particular pain point is the sharp drop in mega-cap stocks that had previously powered much of the index gains:
Magnificent 7 1Q25 performance (total return):
| AAPL | -11.2% |
| AMZN | -13.3% |
| GOOGL | -18.2% |
| META | -1.5% |
| MSFT | -10.8% |
| NVDA | -19.3% |
| TSLA | -35.8% |
Despite the market decline, equity valuations remain elevated: the S&P 500 Index trades at a 20.5x forward price-to-earnings ratio, above its 10-year average (FactSet) and vulnerable to further downward revisions in earnings or guidance. High valuations leave little margin for error, particularly if macroeconomic conditions deteriorate or policy missteps occur. On a positive note, corporate profits have been robust, with fourth-quarter 2024 earnings surging 18.2% year-over-year, the strongest result since 2021. Looking ahead, however, estimates for 2025 are being revised lower at a faster pace than average. FactSet projects 11.5% S&P 500 EPS growth for the full year, down from 12.7% at the start of the quarter. While we continue to see long-term opportunities in US equities, especially among companies with strong pricing power and earnings visibility, near-term or risk-avoidant investors may choose to implement defensive measures.
International Markets: A Narrowing Gap
While US equities stumbled to start 2025, international stock markets have generally outperformed, led by the EU and China. This relative strength stems from a combination of lower starting valuations, easing monetary policy, and bottomed-out economic data that is beginning to improve. In Europe, activity has stabilized after a prolonged period of near-recessionary conditions. The Eurozone’s composite PMI held above 50 for the third consecutive month in March, with services leading the improvement. Inflation has declined meaningfully, dropping below the ECB’s 2.0% target in late 2024, creating room for monetary easing. In Asia, China’s consumer-targeted stimulus efforts have been gradual but consistent. While not yet producing a broad-based economic acceleration, further measures are expected as the Chinese government has made consumer strength the most important focus for their 2025 annual plan. This marks the first time in over a decade that the consumer is the primary focus. The long-term performance gap between US and international equities remains wide by historical standards, but recent price action suggests that global investors are beginning to take notice. The risks are evident — in particular, ongoing geopolitical tensions and tariff uncertainty — but the foundation for a sustained international recovery could be forming.
Bond Market: Home on the Range?
US Treasury yields moved lower in the first quarter as economic data softened and investor concerns about slowing growth increased. While the Fed left interest rates unchanged at its March meeting, the path forward remains uncertain. Until inflation and growth trends clarify, yields may remain range bound. In this environment, high quality fixed income continues to offer compelling yields relative to the post-2008 period, particularly among investment-grade bonds rated A or higher. Meanwhile, spreads on lower-rated corporate debt have widened, a signal that investors are demanding more compensation for taking on credit risk. With uncertainty rising, we believe this is not an ideal time to move down in credit quality. A laddered approach focused on short- to intermediate-term maturities remains a prudent way to capture attractive yields while managing reinvestment and duration risks.