Tariff threats and a shrinking labor force put downward pressure on stocks and the economy. The S&P 500 is trading at 22x the forward 12-month EPS target, which is predicting an increase of 13% in EPS.
The problem is that the 10-year average PE ratio is just 18x EPS. And that 13% increase in EPS in the next 12 months is extremely optimistic. It assumes that earnings can grow 13% in a world where nominal GDP growth should be only around 4%. It also assumes that Washington D.C. can extend the 2017 tax cut and jobs act, which would otherwise amount to a $4.5 trillion tax hike. Then again, this would only equate to an extension of the existing tax rates.
Thus, it would not be a significant boost to the economy. And it also assumes that the significant tariffs imposed that are needed to pass such a tax-cut extension would not have any adverse effect on GDP growth. Likewise, any retaliatory tariffs would be innocuous as well. However, even if all works out flawlessly, the point is that the current valuation of equities has already priced in perfection in both EPS growth and valuation.
But economic growth is already slowing. However, this is occurring at the same time inflation is proving to be sticky—at least for the time being. The Philly Fed prices paid component showed that February inflation is at the highest rate since October 2022. This is before any of the inflationary effects from tariffs kick in. So far, the US has imposed just a 10% tariff increase on China.
President Trump paused the 25% duties on Mexico and Canada and has only proposed reciprocal tariffs on all countries. Also, there remains the promise of 25% tariffs on autos, pharmaceuticals, computer chips, steel, and aluminum. We believe tariff hikes do not equate to a commensurate increase in prices. But they do increase economic friction, just as they also put some degree of upward pressure on prices. We will know much more about the tariff situation next week, as the 30-day suspension of the 25% imposition on Mexico and Canada duties expires.
The consumer research firm Wallet Hub's Economic Index decreased by around 13% between February 2024 and February 2025. This means consumers are less confident about their financial outlook this month than they were at the same time last year.
Here are some other key findings: The share of consumers who expect to buy a car in the next six months is almost 23% lower in February 2025 compared to last year. Home-buying interest among consumers decreased by over 21% compared to last year. This is not cause for any extreme alarm yet, but it clearly shows that inflation has hampered most consumers' ability to continue their pace of spending, just as their willingness and/or ability to take on more debt is diminishing.
The Atlanta Fed GDP Now forecast for Q1 GDP growth has crashed from its initial estimate of nearly 4% growth to just 2.3%. US flash services PMI fell into contraction in February, falling from 52.8 in January to 49.7.
This is very significant as it shows the services sector of the economy—its largest sector—is now in recession. In other data, the University of Michigan's February consumer confidence fell to 64.7, compared to the estimate of 67.8. February's confidence was down 10% from the January reading. Meanwhile, inflation expectations in the same survey increased by the most since May 2021.
More evidence of my prediction of a faltering real estate market is arriving daily. Inventory is at a 5-year high, and the DOM to sell a home is also at a 5-year high. Existing home sales fell to 4.08 million units vs. the estimated 4.13 million. That is down 4.9% m/m. New home sales for January came in at 657k units at an annual rate. The estimate was 680k. New home sales fell 10.5% m/m while the forecast was for a much smaller 2.6% decline. Pending home sales are down 4.6% m/m and 5.2% y/y. Maybe this is why Home builder Toll Bros stock fell 10% last week. The home-builder ETF (ITB) is down 4% year-to-date and has fallen 23% over the past 3 months.
Weakening GDP growth with slightly higher inflation has been the scenario the IDEC Model predicted. That is the current scenario. But now, the model is signaling a rising possibility of a sharper decline in economic growth with a shift from reflation to disinflation later this year.
DJT's longer-term policies should be very beneficial for the economy and markets. However, in the short term, slashing government spending is a depressant to growth because government spending was the leading impetus for growth under the Biden administration. In fact, according to the new Treasury Secretary Scott Bessent, over 70% of the jobs created under the Biden administration were government-related.
A quick note on debt and deficits: The CBO projects the 2 trillion dollar deficit for fiscal 2025 will grow to $2.5 trillion by 2035, and today's $36 trillion debt will grow to $60 trillion in 10 years. That assumes the business cycle has been cancelled, there is no recession over the next decade, and inflation averages just 2%.
A figure so low that it has been unachievable for the past 4 years. It also assumes the 2017 tax cuts and jobs act expires at the end of this year and taxes increase dramatically. For the CBO to guesstimate--or more accurately stated “hopetimate”--that the benchmark Treasury yield averages just 3.8% over the 10-year horizon, (which is well below the current 4.5% level), is absurd.
The only way the 10-year Note yield averages 3.8% is if the economy falls into a pit in the next decade. That scenario is very likely to occur. That means revenue to the Treasury will be greatly reduced, and debt and deficits will skyrocket yet higher.
Warren Buffet has been aggressively selling stocks and raising cash. Berkshire Hathaway has the highest cash as a percentage of assets in its history. We believe high-yielding short-term Treasury Bills are a prudent and safe way to invest with a significant weighting of your portfolio for the moment. Our Inflation/Deflation Portfolio is just 20% net long equities. The risk/reward ratio skews in favor of cash over equities because the equity risk premium has turned negative.
Wall Street has been preaching the buy-and-hold investment strategy for decades. Hence, the next asset bubble implosion is nigh, and so is the renaissance of active money management.
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Michael Pento is the President and Founder of Pento Portfolio Strategies, produces the weekly podcast called, “The Mid-week Reality Check” and Author of the book “The Coming Bond Market Collapse.”