A five-year bull market is running out of “manias”. There is a cycle – even if that seems like a crazy idea to bulls in thrall to market mania. The S&P 500 index has risen 167% from the low in March 2020. Nasdaq 100 is up 202%. This is a bull market that has run almost five years. It has been propelled by three different manias: 1) The Fed’s “big bazooka” of zero rates and 138% growth in its balance sheet in three years; 2) Artificial intelligence mania; 3) Trump mania.
US equities have been underperforming most of the world since the Inauguration of President Trump. That final mania – let’s call it “Trumphoria” – may turn out to be the shortest lived of the three. US equities rallied ahead of the Presidential Election, and after the assassination attempt on Donald Trump, when opinion polls swung in favour of Candidate Trump. Yet since the Presidential Inauguration, the S&P 500 has been underperforming the Hang Seng Index, the HSCEI, and, to a lesser extent, the CSI 300. Meanwhile, Nasdaq 100 has underperformed the SSE Science and Technology Innovation Index. The S&P 500 has also underperformed the Eurostoxx 50 and indeed, the FTSE All-World Ex-US Index.
What’s behind that underperformance. This is counterintuitive. Markets had expected Trump’s tariffs to drive underperformance of Chinese equities vis-à-vis US stocks. What’s going on here?
Yes, it is early days yet. But it seems to us that the US cycle was aged anyway, valuations were too high for market comfort, and the idea of Trump might have been more appealing than the reality. With his relentless and often contradictory barrage of policy signals and signoffs – mostly highly controversial moves spanning domestic politics, trade and geopolitics – Trumphoria might be turning into Trump fatigue.
A tired, old bull market was expecting the President to perform economic miracles. However, what it got were policies that are likely to hasten down the economic cycle and hasten up inflation.
The US stock market cycle – 22x forward PE versus 15x, take your pick. That is the difference between the forward PE valuation of the S&P 500 (22x) versus the CSI 300 (15x). At some point in valuation, the market runs out of stories (“narratives”) to excuse high prices, particularly if the economy starts slowing and earnings expectations weaken. And there is a similar comparison against the MSCI Europe, which is trading at 15x forward PE.
The economic cycle is turning ugly – stagflation is the wildcard. Month-on-month US CPI inflation and core CPI inflation have been turning up from their lows in June 2024. Month-on-month PCE inflation has been turning up from its low in May 2024. Core PCE inflation has been trending sideways since May of last year but picking up from its November low. While it could have been dismissed as “transitory” a few months ago, the persistence of that inflation uptick against a backdrop of huge tariff hikes is bad news. US inflation expectations – as measured by the University of Michigan’s consumer surveys – have surged.
Meanwhile, consumer confidence – as measured by both the University of Michigan and the Conference Board – has slumped. Consumers have been buying ahead of the new tariffs – frontloading spending on consumer durables for the year. Adding to downward pressures on consumer sentiment is the Trump Administration’s massive layoffs of government employees and its intention to cut trillions of dollars off public welfare programmes.
With the slump in consumer confidence, a sharp decline in US retail spending is now a real prospect by middle of this year when “sticker shock” hits – meaning a possible recession in 3Q25 or 4Q25. The US equities market will not wait for a recession to be announced – it typically sells ahead of it.
Policy “bazookas” are not free lunches. Traditional Keynesian economics were “countercyclical”. Governments were to spend on deficits during economic “winters” and then repair the budgets during the “summers”. They were never intended to finance “forever summer” – that is more MMT or Modern Monetary Theory than Keynesian economics. Some sections of the market might want the Chinese government to fire policy “bazookas” as well. But they might want to think whether that is good economic management.
The cost of the policy “bazookas” in the US. The Federal Reserve expanded its balance sheet from US$3.8 trillion just before the Pandemic to a peak of almost US$9 trillion in 2022. The bigger picture is even more alarming, and it speaks to the lack of “repair” during better economic times. The US$9 trillion balance sheet compares to under US$0.9 trillion at the start of the Global Financial Crisis (GFC). Instead of reducing its balance sheet after the crisis, the Fed let it drift, until the next crisis (Covid-19) forced it to take the balance sheet to new highs.
That is mirrored by the surges in US public debt to GDP. It was 63% before the GFC. It surged to over 100% by 2013. Instead of bringing that ratio down, the US government allowed it to drift sideways, until the next crisis (Covid-19) hit, taking that debt to GDP ratio to 133% by 2020. It tried to reduce it for a couple of years, but that figure is rising again. It is now around 122% of GDP.
Debt crisis “heart attack”? Hedge fund manager and author Ray Dalio just warned that the US faces the risk of a debt crisis “heart attack” within “three years”. We recognise that unsustainable positions can continue longer than people might think possible. Still, one has to wonder how much longer this government debt pile can continue to grow. Ray Dalio reckons when that debt crisis moment comes, it will be a sudden response to accumulated excesses – hence his “heart attack” analogy.
As we wrote recently 2025 Market Outlook Part 1 - US Outlook: Cyclical peak valuations amidst heightened secular risks, we estimate the US Federal Government will have to finance around US$2.75 trillion in additional debt each year over the next ten years. That is before refinancing maturing, existing debt. For example, the US Treasury has to find investors to refinance maturing government debt, estimated at around US$9 trillion in 2025.
Former US Treasury Secretary Robert Rubin has also chimed in on the pessimism, telling Bloomberg that the current environment represented the “greatest uncertainty” he has seen in the US in 60 years. He warned that the Trump Administration’s policies will undermine confidence, worsen the US fiscal trajectory, and “create a very serious risk of inflation.”
Calls for diversification out of the US are getting louder. There has been a noticeable shift in the market and media narratives over recent months. Suddenly, the US market is no longer “exceptional”, and the market in China is investible again. The sudden, unexpected, emergence of Chinese AI models such as DeepSeek’s R1 and Alibaba’s Qwen 2.5 Max have contributed to the shift in sentiment. Yet in the end, it may just come down to the swings of market and economic cycles. Nothing lasts forever – neither euphoria nor pessimism.
