Not So Solid
The relentless rally, not so solid growth, Fed patience or obstinance, letting the dust settle, OBBBA, mercantilist currency policies
Schwab Network appearance Friday morning
The Relentless Rally
With the first half of an eventual 2025 winding down we begin this week’s note by reviewing our macro analysis and investment strategy performance. In our 2025 Outlook: Targeting a Trifecta we detailed an optimistic outlook for equities, expecting a 10% S&P 500 return, with the equal-weight S&P significantly outperforming largely due to a 2H25 strong recovery in capital investment driven by favorable tax and regulatory policy. On February 22 in Cleaning Up the Industrial Policy Mess, we forecasted an equity market correction due to slowing growth as the economy transitioned from government spending to private sector investment. Two days later in NYC we detailed our outlook on CNBC’s Squawk Box, three days later Treasury Secretary Bessent in the same forum characterized the process as detoxing from the nation’s addiction to government spending. Our April 5 note, The Trump Trade Shock, marked a bullish turn in our tactical outlook. In short, our analysis suggested the 22% drop in the S&P 500 was discounting a recession, which provided an excellent entry point for investors.
We have been leaning into our tax and regulatory policy driven capital investment recovery theme with overweights in industrials, financials, materials and energy, as well as robust exposure to technology and communication services. We have been underweight consumer discretionary and staples, sectors that are struggling with the reduced government spending and margin pressure due to the Administration’s tax on imports (tariffs). We are also underweight healthcare as the MAHA team disrupts a sector that has had margin compression for decades and has been a drag on productivity for longer than that. For background on the drag on productivity from the healthcare sector we suggest No Recovery: An Analysis of Long-Term U.S. Productivity Decline.
We have been underweight fixed income with a short duration bias, our stock/bond asset allocation has been, and remains, 70/30 stock/bonds. Needless to say, it was a very good first half. We never changed our year-end targets for equities or fixed income, and we remain optimistic. That said, as we began discussing last week, the detox process is not complete. Slower ‘soft’ sentiment data in May evolved into a deceleration in ‘hard’ activity reports in June, and 2Q25 earnings season is likely to reflect the impact of the detox process and increased tax on imports. Meanwhile the markets are pushing the FOMC to restart the rate normalization process, however, a number of economic ideological issues including an underestimation of the impact of government spending on inflation, overestimation of the importance of inflation expectations and Fed independence have the FOMC trapped in Transitory Purgatory.
In this week’s note we discuss not so solid consumer spending, housing and labor market. We then integrate monetary and the reconciliation bill (OBBBA) into our outlook, analyzing the potential for the policy outlook to offset slowing output, income and earnings growth. We wrap the note up with a discussion of the impact of the administration’s trade policy on exchange rates.
