AOR Update: US economy and US equities set to lead again

Key takeaways

• A resilient US economy has stood out against other developed nations in recent years with stronger economic growth and healthier corporate profits that have fueled outsize stock market gains.
• We believe that three of the four key components of exceptional relative US economic growth—the consumer, productivity gains and a solid fiscal impulse—should remain intact while the fourth (growing labor supply) is likely to come under pressure but should not derail the expansion in 2025.
• Backed by a green and improving signal for the ClearBridge Recession Risk Dashboard, we are bullish on the US economy in the year ahead and expect GDP growth to deliver an upside surprise relative to current forecasts. Coupled with broadening earnings participation, we expect US equities to maintain their positive momentum.

Trump win, Fed pivot support resilience

The “most anticipated recession ever” failed to materialize this past year, with the US economy achieving a soft landing. The pace of expansion appears likely to stay buoyant in 2025 as the economy rides the tailwinds of both a fiscal impulse, courtesy of Donald Trump’s election win and a Republican sweep of Congress, and a monetary impulse from the Federal Reserve’s pivot to a rate-cutting cycle.

Over the past several years, the resilience of the US economy has stood out against other developed economies. A key question for investors is whether this trend can continue, as stronger economic gains have translated into a healthy corporate profits environment that has fueled outsize stock market gains. Our starting point for such analysis continues to be the ClearBridge Recession Risk Dashboard, which is our north star when thinking about the health of the US economy. Fortunately, the dashboard’s overall signal is currently in green/expansionary territory and it has been consistently improving over the course of 2024. There are no changes to the dashboard this month (Exhibit 1).

We believe there have been four key components of exceptional relative US economic growth over the past few years: the strength of the US consumer, productivity gains, growing labor supply and a solid fiscal impulse. Looking ahead, three of these are likely to remain intact in 2025, while the fourth, growing labor supply, should be less of a benefit, but not so much less that it could derail the US economy.

The US consumer has been a source of strength, initially powered by accumulated savings and generous government transfer payments during the pandemic. As these funds waned, a strong labor market fueled further upside as wage gains and broad job creation helped boost labor income, the largest single source of spending power for most Americans and closely tied to aggregate consumption trends. These trends appear largely intact as the calendar approaches 2025, with average hourly earnings holding up at a healthy growth rate of 4.0% year over year in October versus 4.3% coming into the year, for example.¹

Sticky wage gains have been a source of concern, and some worry that corporate profit margins will be crimped as businesses have to pay their workers more. We take a different view, however, believing that wages relative to a worker’s output (unit labor costs) are actually the key for profit margins. This is an important distinction because productivity gains (a worker’s output) have been robust over the past several quarters, returning to levels consistent with the 1950-2009 average as opposed to the post-global financial crisis experience. Looking ahead, we believe productivity will remain healthy given lower levels of job churn; if workers are changing jobs less frequently, these employees are more experienced, typically more tenured and more productive.