12/14/25
S&P 500: 6827
Nasdaq: 23,195
10 Year Treasury: 4.1%
David R. Snyder, CFA
The economy has slowed in 2025 with real GDP growing only 1.5% in the first half vs. almost 3% in 2023 and 2024. Third quarter is expected to be about 3% but the average forecasts for 2025 are about 1.9% GDP growth. This is a result of both reduced immigration and effects from the tariffs. According to a recent paper (10/31/25) from the Minneapolis Fed, declining net immigration only accounts for about half of the recent drop in US job growth over the last year. The other half is likely the result of declining labor demand, resulting in lower labor force participation as workers become frustrated in their job searches. The authors note that median real wages in 2025 are growing close to half the rate of 2023 and 2024 (1.7 times slower growth) that is most pronounced for low wage workers (2.5 times slower growth). They don’t opine on the cause of lower wage gains or labor demand other than lower immigration, but the obvious culprit is tariffs.
Tariffs actually have a bigger impact on the economy than inflation and we are seeing evidence of that this year. Not that it hasn’t increased inflation as well. Since Trump took office in late January, the PCE inflation rate has increased from a 2.6% to a 2.8% year over year rate and estimates are that the tariffs so far have increased the PCE inflation rate by about 50 basis points (the PCE inflation rate would have declined this year if not for tariffs). Imports account for only 12% of GDP in the US and only about 50% of goods imports are subject to steep tariffs. Thus only 6% of GDP is directly affected by tariffs. That understates tariffs effects on inflation somewhat because tariffs give a price umbrella for competing American producers, which results in higher prices for goods that compete with tariffed imports. But expectations for a dramatic surge in inflation were misplaced, but still I was expecting an increase closer to 100 basis points in the PCE instead of 50 basis points. US manufacturers have eaten the tariffs so far more than expected. But usually the consumer bears more of the cost in the second year as inventory pre-tariffs is depleted. We do know that the foreign exporters have not lowered prices much to offset the tariffs, bearing less than 20 to 30% of the tariff costs. Thus, the tariffs are clearly taxes on both US businesses and the consumer.
Approximately 45% of imports to the US are from US subsidiaries or affiliates, thus US companies ultimately bear the cost if the exporter lowers prices in response to the tariffs.
If the tariffs are really slowing the economy this year why are S&P 500 profits expected to increase 10 to 15% this year? First S&P 500 profits can diverge from GDP growth in the short term, especially with massive buybacks. Second, 35% of S&P 500 profits are from overseas. Third, small and mid-cap earnings are only increasing at a low percentage rate this year. According to a large private equity firm, the 100 largest US companies have improved profit margins from 14 to 19% over the last five years while the next 1400 largest have not increased margins. This is especially true this year as the larger companies have more flexibility to offset tariff costs. The tariffs are disproportionately negatively affecting small and midsize businesses.
According to Federal Reserve data, US corporate profits declined 9% in the second quarter of 2025 vs. the fourth quarter of 2024 (seasonally adjusted) and declined 3.3% year over year. This is in contrast to the 10% gain in S&P 500 second quarter 2025 earnings per share. The 9% decline from two quarters prior is the worst since the 12% drop in the first two quarters of 2020, during the Covid recession. Corporate profits before taxes and including inventory and capital consumption adjustments, declined 0.6% in the second quarter of 2025 from the fourth quarter of 2024 (seasonally adjusted), the first decline from two quarters prior since 2021. On a year over year basis, these profits increased only 4.3%.
The divergence between the top 20% of wage earners and the rest of the population regarding real income and spending growth has reached extreme levels. Real income and spending growth has been minimal for the lower income cohorts over the last couple of years. US real income and real disposal income have actually declined since the tariffs took effect in April. In fact, real consumer spending has increased more than real income on a year over year basis every month since November of 2024.
This K-shaped economy is not a stable economy. Recent all-time highs in assets (equities, crypto, gold. housing as well as near record low high yield spreads) has buoyed the upper income groups. Any significant decline in these assets will negatively affect the economy more than in the past, making the economy very dependent on asset appreciation.
The economy will get a boost from the tax cuts of the bill passed this year. In the first quarter there will be significant increases in tax refunds to individuals as well as tax relief from tips, interest on car loans, and social security. The bonus depreciation will spur more capital investment especially relating to AI. However, the tax relief combined with lingering tariff effects will most likely not allow the Fed to lower rates as much as expected next year and long term Treasury yields could rise. Europe and Japan will most likely be raising rates (an ECB board member said that the next interest rate move in Europe is likely higher) which will limit the US ability to lower rates. If the yen surges in response to higher Japanese interest rates, the carry trade could further erode, causing dislocation and liquidation in the US financial markets. These factors would also raise longer term rates in the US. If the economy does surge there will likely be wage pressure as there are not enough available workers to meet the demand, resulting in higher inflation, especially with a negative output gap.
The boost to the economy will be short lived as the negative effects of the tax bill are delayed. The tax bill primarily favors the top 10% of income earners and may have a negative effect on lower income groups when all of the negative effects are considered such as the cutbacks in Medicaid, further widening the income disparity and making the economy more vulnerable in the long term. Trump’s last tax cut bill in 2017, which was bigger than this year’s bill, increased GDP for a few quarters before reverting back to average GDP growth in 2019 and 2020 estimates before Covid. Don’t expect anything different this time.
One of the biggest risks is the appointment of Hassett or another crony of Trump as the new Fed chairman. The longer term Treasury yields will rise if the new Fed chairman lowers rates more than the long term bond vigilantes desire. It could backfire and cause chaos in the bond markets. The Fed has already lost credibility with their not very serious goal of 2% core PCE inflation rate. Businesses do actually listen to the Fed’s inflation targets to conduct business, but now the Fed may have lost that influence which is really underrated. If they change their target to 3% inflation, businesses may believe they may move it up to 4% in a few years if targets are not met, so why should they be sacrificial lambs and hold back on price increases.
Full Disclosure: I own several of the securities mentioned positively. None have been purchased within the last month. The opinions merely represent the opinion of the author as CIO of Journey 1 Advisors, LLC and intended to inform the readers about our investment philosophy and strategy. The contents of this report are based on sources believed to be reliable. It is not intended for circulation. It is not intended to offer investment advice, or to recommend the purchase or sale of any securities or investment product. Investment advice is only given after a client has signed an investment advisory agreement with Journey 1 Advisors, LLC and will be subject to the terms and conditions therein. Your decision to buy or sell a security should be based upon your personal investment objectives and should be made only after evaluating the stock’s expected performance and risk.