President Trump has now taken office for his second term. He is once again taking over an economy that has been on a solid growth trajectory. The U.S. economy has demonstrated two years of impressive growth, with real GDP expanding at an annualized rate of 3.0% over the last two years through Q3 2024, outpacing the 2.8% growth from 2017 to 2019. After adjusting for inflation, the economy has exceeded pre-pandemic projections by 2.6%, despite aggressive interest rate hikes by the Federal Reserve from 0.25% to 5.5%.
The big question is how President Trump might change the economy’s trajectory. The short answer is “not much.” Key underlying strengths supporting the economy include strong income growth, healthy household balance sheets, and robust labor productivity. Aggregate income growth is running at 5.1% year-over-year [Chart 1], exceeding the pre-pandemic rate of 4.8%. Rather than employment growth, wage growth should be the primary driver moving forward.
Another positive is the inflation picture, projected to stay near the Federal Reserve’s 2% target. The Federal Reserve has reduced rates by 1.0% since September. While this offers some relief, continued high rates threaten growth. However, with headline inflation at 2.3%, the Fed is well-positioned to prioritize employment concerns rather than the inflation side of the dual mandate (low unemployment, low inflation). Markets anticipate another 0.50% reduction in rates through 2025.
Aggregated Income Growth Remains Strong
Year-over-year change in aggregate weekly payrolls
CHART ONE: Source: Carson Investment Research, FRED 11/30/2024
Households Better Positioned Financially
Household net worth as percent of disposable income
CHART TWO: Source: Carson Investment Research, Federal Reserve 11/30/2024
Deregulation could also provide a market tailwind, particularly in the energy and financial sectors. A more business-friendly regulatory environment may encourage higher merger and acquisition activity, IPOs, and innovation. Easing energy and food prices should also support strong real wage growth and consumer spending. Household net worth has reached 755% of disposable income [Chart 2], driven by rising home values and stock prices. This financial stability should help sustain spending, even if income growth moderates. With consumer spending making up around 70% of the economy, these trends should put a floor under economic activity in 2025.
Productivity growth has been remarkable, with a 2.6% annualized pace over the past six quarters, surpassing the pre-pandemic trend of 1.6%. The labor market has been very strong, and worker productivity has improved following hiring surges in 2021-2022, along with increased entrepreneurship. Notably, the rise in productivity does not yet appear driven by artificial intelligence, though AI may further bolster productivity in the future.
While we remain optimistic overall, we are monitoring risks. High interest rates have slowed housing, manufacturing, and investment spending. Mortgage rates near 7% have strained housing affordability, dragging on GDP growth. Residential investment has fluctuated but remains a weak spot. Similarly, higher borrowing costs have dampened business investment in structures and equipment.
On the fiscal side, the 2017 Tax Cuts and Jobs Act (TCJA) presents opportunities and challenges. Many provisions are set to expire at the end of 2025, but with a Republican majority in Congress, extensions or further tax cuts are likely. The corporate tax rate could be further reduced to 15%, potentially boosting S&P 500 earnings per share by about 4%. However, legislative hurdles remain, given the slim Republican majority.
Another risk to the economy in 2025 could be tariffs. President Trump has proposed substantial tariffs on Chinese and other imports, which could drive inflationary pressures. However, the market reaction to extreme tariff proposals may prompt a more moderate approach. Tariffs could also shift trade patterns without significantly reshoring production. The historical example of Christmas tree lights illustrates how tariffs redirected imports from China to Cambodia without significant price changes. While tariffs could cause market volatility, we remain skeptical of sustained inflationary surges resulting from them, particularly given current disinflationary trends.
Additionally, geopolitical tensions and policy shifts warrant close monitoring. Trade negotiations, regulatory reforms, and fiscal strategies could all significantly affect market confidence and economic growth.
The U.S. dollar remains a wildcard. It has appreciated 7% since September 2024, driven by growth expectations and higher rates. A strong dollar can dampen exports and reduce revenues for U.S. companies with international exposure, as 40% of US revenues come from overseas. Due to increased debt servicing costs, emerging markets are particularly vulnerable to a strong dollar.
Market Update
We have just had an incredible two years for the US stock market, with back-to-back years of 20% growth. While this may feel unsustainable, historically, the rally continues in these cases.
As you can see from Chart 3, the S&P 500 has been up 9.5% on average since 1950. The year after a 20% gain is better than the average at 10.6%, and after back-to-back 20% years, the average is a 20% gain with a 100% hit rate.
Solid Returns are Normal After a 20% Gain
S&P 500 Annual Returns (1950-2024)
CHART THREE: Source – Carson Investment Research, FactSet 01/04/2025
However, we expect much more volatility in 2025 than we’ve experienced recently. In 2024, we did not experience a 10% pullback, but on average, the market experiences one 10% pullback per year. Also, the average annual pullback since 1980 has been 14.1%, even with the market annualizing a 10.6% return. Be prepared to feel that pain, but as Kerry likes to say, “It’s not a loss unless you sell.”
Overall, we are optimistic about 2025, but we will continue to diligently watch portfolios for potential moves to smooth the ride. Diversification is still a key component of our philosophy, so owning smaller US stocks, international stocks, and bonds will contribute to that smoothing. Remember, diversification means accepting good enough while missing out on terrific but avoiding awful.
If you want to hear more about our 2025 Outlook, please watch our recent Outlook webinar replay (https://youtu.be). As always, if you have any questions or your financial situation has changed (beneficiaries, income needs, investment objectives, time horizon, risk tolerance, etc.), don’t hesitate to contact our office. Thank you for your continued confidence in KWB Wealth.
The representatives of KWB Wealth are registered representatives with, and securities are offered through LPL Financial, Member FINRA/SIPC. Investment advice offered through KWB Wealth, a registered investment advisor and separate entity from LPL Financial.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which investment(s) may be appropriate for you, consult your financial advisor before investing. All performance referenced is historical and is no guarantee of future results. Market conditions are subject to change, and indices are unmanaged and cannot be invested into directly.
The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. Indices are for illustrative purposes only and do not reflect the performance of any specific investment.
Investing involves risk, including loss of principal. Diversification and asset allocation strategies do not guarantee profits or protect against losses in declining markets.
No strategy assures success or protects against loss. The economic forecasts set forth in this newsletter may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
