It’s the economy

“It is the economy, stupid!” This quote from Bill Clinton’s 1992 U.S. Presidential campaign still rings in the minds of many. There were periods when this mattered less for markets, for example, during the times when monetary policy was extremely easy, such as the times when the Fed was conducting so-called ‘Quantitative Easing’. Back then, investors were buying U.S. equities on the back of bad economic data, knowing that the Fed would backstop equity markets and come to the rescue in the event of a downturn.
Not in the current environment.

Fed not easing yet

Despite all the pressure that President Trump has put on Fed Chair Powell, the latter has repeatedly refrained from promising to cut rates, citing the uncertainties brought on by U.S. tariffs implemented by Trump in April. From a central banker’s perspective, Powell’s primary goal is to make sure inflation remains under control – growth and the performance of equity markets have only become prominent factors after the 2008 Global Financial Crisis.

We believe the Fed is being extra cautious this time around because memories of the 2021-2022 period – when it prematurely declared that the post-pandemic inflation then raging was transitory – must still be in their minds. The Fed’s credibility is at stake, should it ease rates too fast and allow inflation to flare up again.

Fiscal stimulus comes into play

This is where the latest fiscal stimulus becomes more important. The “One Big Beautiful Bill Act” is estimated to provide a USD3.4 tn fiscal boost to the USD30 tn economy over the next 10 years. It includes USD4.5 tn of tax cuts (including extension of Trump’s 2017 tax cuts) and new tax breaks for businesses and on tips, overtime pay, auto loans among others. There is also USD1.1 tn of spending cuts, including cuts to healthcare, food and clean energy incentives. The net positive fiscal impact should more than offset the negative impact of tariffs on growth.

However, the market has already been pricing this in. For example, investor positioning in U.S. equities has already recovered from extremely under-owned levels in April back to Neutral. The sharp rebound in U.S. equities from April’s “Liberation Day” sell-off took the S&P 500 index above its previous all-time high this year. We need to see strong U.S. economic data to propel U.S. equities higher from these elevated levels.

Economic data needs to beat expectations to sustain U.S. equities rally

From this perspective, the latest U.S. non-farm payroll numbers did surprise on the upside, with 3-month average monthly payrolls running at a solid 150,000. The unemployment rate also fell to 4.1%. However, the devil is, as always, hiding in the details. Government, education, and healthcare dominated the job gains, but private sector dynamics were softer. A weakening job market is slowing consumption, the main driver of the economy. U.S. real personal spending fell by 0.3% m/m in May.

Meanwhile, U.S. equities is not cheap – the 12-month forward P/E ratio for the MSCI U.S. equity index is at 22.5x – almost two standard deviations above its historical average. We need sustained earnings growth to justify this valuation premium, but markets are currently projecting earnings growth of 5.8% y/y for the second quarter, after growth estimate was revised lower from 12% at the start of 2025. This downward revision reflects geopolitical and tariff uncertainty, and its potential negative impact on supply chains and corporate profit margins.

Trimming excessive U.S. equities into strength

Against this backdrop, investors should take advantage of the current strength in equity markets to trim excessive long exposure in U.S. equities and add to other regional markets which have strong domestic policy support and earnings growth projections, such as China and Korea.

Within the U.S., we expect investor rotation into the major U.S. banks. The sector is riding on the banks passing the Fed’s annual stress tests and expectations of a relaxation in the capital requirements for banks by the Fed. We expect further deregulation to help support U.S. banking sector equities.

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