Monthly Macro with Richard de Chazal—December 2024

William Blair macro analyst Richard de Chazal looks back at the economic highlights of 2024 and shares his insights and predictions for the U.S. economy in 2025, emphasizing resilience, consumer strength, and potential risks ahead.

Podcast Transcript

00:21
Chris Thonis
Hello everybody. Welcome back. Today is December 17th. We are closing out the year with a special Monthly Macro, this time to walk through William Blair macro analyst Richard de Chazal’s 2025 Economic Outlook, which takes a look back at the year that was and then also provides some predictions on the year ahead.

Richard, thanks for joining. To kick things off, let’s first take a look at how the economy fared in 2024. In your report, which is appropriately titled “US Exceptionalism Continues Through 2025,” you state that it's fair to say the economy passed a number of tests in 2024, and that a recession was skirted with unemployment remaining low, inflation continuing to fall and the stock market jumping 28%. What in particular led to this “happy” outcome?

01:13
Richard de Chazal
Happy outcome indeed. So, I guess, great, great to be back. So, I mean, good question. I mean, I think if I go back to this time last year, my thinking was that the odds, of at least slipping into what could be a pretty mild recession were probably higher than even. And I think if we think about what the economic data was saying at the time, you still had pretty much all of the economies sort of best or historically best leading economic indicators pointing to recession.

So, you know, the PMIs were all sub-50. The yield curve would be inverted for a while. You know, continuing jobless claims that the rate of change there was giving you some strong signals. And company rhetoric was also pretty cautious. And the unemployment rate was starting to tick up. And if you remember, you know, sort of around the middle of this year that that Sahm Rule was actually triggered, and we've talked about that in the past and, you know, and previously there'd never been kind of a missed signal on that. And then on top of that, we were still coming off of, you know, this fed tightening cycle, which had been pretty much the fastest tightening cycle in history. So, I think the odds of, you know, having at least a mild slowdown were, were pretty high.

That didn't happen, I think maybe why the consumer is in pretty good shape. They still had some pent-up savings that they were getting rid of. I think at least through the first part of the year, we didn't have any major excesses in the system, say like private sector debt. So, there wasn't something that was sort of desperately needed to be corrected on that front, which is why I thought if there was actually going to be recession, it was always going to be a fairly mild one.

And then, you know, on the manufacturing side, I think what we saw is that even though the manufacturing sector was in a recession and what typically happens is that sort of leads the economy down, and then services start to slow down as well. That didn't happen this year because you had this still this post-Covid cycle where manufacturing sector being very strong.

Then it got very weak. And then you had the service sector take off following that. So it didn't fall through. And then we could see how the manufacturing sector by itself wasn't really strong enough to pull down the economy on its own. So, I think there was that. Also, we saw consumers have these, locked in low rates.

So that provided a nice cushion. So they were somewhat protected from, the Fed's tightening cycle, just like the corporate sector was. And maybe two other factors I think were important is one, we're still in this midst of this innovation wave where companies are really investing in AI and starting to invest more in other areas. On top of the fact that we still had a huge amount of immigration coming through.

So, remember, in the last three years, we've had almost 10 million net immigrants coming into the US, which is just fractionally more than what you had in the ten years to 2019. So that's really significant. It adds to consumption. These people come, they buy more, they eat more. They need housing. So, I think that's been a pretty important factor as well.

And then I think more generally, the US has in itself been incredibly resistant, which has kind of bled to this label of, of exceptionalism because you haven't seen that, that that growth elsewhere. I mean, Europe still seems to be structurally broken. Looking for a new way to grow. UK isn't faring all that much better. Japan still kind of struggling, and China is still in this kind of debt deflation scenario.

So, I think yeah, I mean, it has been incredibly resilient. And it does seem like that's likely to continue through, through into this this coming year, 2025.

05:30
Chris
All right. So, we skirted a recession in 2024. And you say in the report that the probability of doing the same in 2025 is very good. So how so exactly, what’s your takeaway there?

05:43
Richard
Mostly because of the same reasons. So, its good consumer balance sheets. Good corporate balance sheets, you know, are sort of holding up the unemployment rate may be ticking up a little, but we're in this kind of structurally tighter labor market environment. It's not to say that there aren't any risks out there. You know, there are there are a few.

So, stock market valuations are pretty high. So that does open up some, vulnerabilities. And I think some of the policies being proposed by the new Trump administration, if implemented as fully as they're kind of being written on the tin, that could be a bit of a shock to the system. So, there's definitely a lot of uncertainty out there and the error bands around.

Any forecast I think going into this year are pretty high. But on the whole, I think, you know, we're entering the year with a fair amount of momentum and, you know, touch wood, that continues through, through the year.

06:45
Chris
And over the past year, the US consumer has been what you deem a strong contributor to US economic growth. I know we talked a bit a bit about that, rising by an average annualized rate of 2.6% over the last three quarters. Are you expecting much of the same next year, or are there vulnerabilities we should be looking out for?

07:04
Richard
I think we do get some deceleration in growth, so consumer spending is likely to moderate. Again, I think we sort of move from this surge in durable goods spending to then a surge in services. And now we're going to continue to sort of normalize that. And the labor market, strong. Again, it's structurally tight, meaning that companies are still struggling to find workers.

We've got the aging baby boomers kind of moving out. We've got lower population, more birth rates for the population and potentially that that squeeze on immigration. I mean, Biden actually closed the border back in June. So, immigration growth is already slowing. Trump is kind of likely to tighten things up a little bit further there. So, but I think, you know, generally real income growth is pretty strong.

You know, in terms of vulnerabilities. I mentioned earlier, the stock market, I think, potentially opens up from some vulnerabilities. I think what we have seen recently is, the wealth effect has been kicking in a little bit more than in past years. So maybe consumers sort of feel like the stock market is, is doing a little bit of or more of the savings for them than in the past.

So, you know, the more reliant you are on that does create some sensibilities there. Similarly, what happens on the immigration side is pretty significant. So, we discussed it earlier. But if Trump actually does start deporting a lot of these workers, again, these were people who were in the country and consuming. And if you remove them, that takes out a higher level of consumption.

So, we'll have to see what plays out there. And then again, I guess we still haven't finished with the impact where the lag impacts from, from higher rates. So those, could continue to flow through if the fed, say, was to stop cutting rates today. Maybe one sort of upside risk actually is that consumers haven't really during this, this past cycle taking on a lot of credit.

Remember they had good balance sheets. They had a lot of that excess savings during the pandemic. They paid down a lot of debt. They were still deleveraging since the global financial crisis. And, you know, in the last few years, they haven't really been ramping up consumption through credit. So what we've seen is, is the spending has been really income based spending rather than credit based spending.

So maybe they start to take on a little bit more credit if they get really positive about the economic environment. Maybe you get some deregulation coming through on the banking side, and maybe banks start to loosen a little bit their lending standards. So probably not something that might be so good in the in the longer term. But certainly in the shorter term that that could help to provide some support for growth.

10:15
Chris
And what about business investment, what should we be watching out for in 2025 there?

10:21
Richard
That's something, you know, I've been banging on for a while now. I think the consumer is maybe not the sort of massive marginal mover of GDP growth that it has been in the last, say, sort of 50 years. I mean, I think what we saw from the 1960s to about, you know, the global financial crisis was the sort of consumer spending was growing faster than GDP pretty much every year.

So GDP went from sort of 55% of GDP to kind of 70% of GDP. And now it's kind of peaked and sort of falling back. And I think what's replacing that is business investment. I think businesses are going to necessarily need to invest more. Now, why is that? I think one is you had this kind of supply glut of, of labor where companies found that labor was very cheap and plentiful and not hard to find, and they kind of killed the labor unions. So it was easy to manipulate. And that helped to boost margins higher. And then you didn't really need strong productivity. But I think if the labor market is now structurally very tight, companies who are going to want to defend their high margins are going to want more productivity. And I think to get that, they're going to have to shift from spending more on labor to spending more on capital.

And I think we're sort of moving into that environment. So, more business investment there. I think they haven't invested for a while. So, they need to upgrade their capital stock. And once again, we're also in the midst of this AI innovation boom, digitization, whatever you want to call it. But there's certainly a huge incentive to invest to, to, to take advantage of that.

So, if you want to ask me where the puck is going on the on the GDP side of things, I think it's more the business investment side rather than the consumer side of things.

12:33
Chris
Got it. You lay out your expectations that there would be further dollar strength in the coming quarter as well. Especially as we settle into this world of relatively, as you call loose fiscal policy and still moderately restrictive monetary policy, which is generally dollar bullish. Again, in your words. Can you break that down a bit for us?

12:55
Richard
Yeah. So, I think I think this is pretty important actually. And it's potentially where we're seeing a huge conflict in some of the proposals, being put forward by the incoming Trump administration. Basically, just about all of the things that Trump is proposing tariffs, tax cuts, deregulation, all this kind of stuff is quite dollar bullish. But then on the flip side, Trump is talking about the fact that he wants to have a weaker dollar.

So, the two don't really work. I mean basically tariffs if you're encouraging more domestic consumption fewer dollars are going abroad. The faster domestic growth is sort of penalizing foreigners. So that interest rate differential kind of shifts towards the domestic economy more, so that attracts more money flows into dollars. But then you have Trump, who's suggesting that maybe he wants to force some foreign economies into some kind of new Plaza Accord, you know, call it the Mar-A-Lago Accord, where he would sort of force these economies to appreciate their currencies upwards and bring the dollar down.

And my guess is that, you know, if you were a foreign economy and had some influence over your currency, and if you kind of saw that coming down the road at you, maybe you'd want to allow your currency to depreciate as much as possible until you get to that Mar-A-Lago meeting. And when you then sign on the dotted line and agree to, appreciate your, your currency, you know, against the dollar and avoid whatever stick Trump is, is threatening you with, it's much easier to then, you know, have your currency appreciate and look like you're living up to that agreement.

So, I think in in certainly up to that point, a lot of countries would be partial to allowing their currencies to depreciate. And of course, it also takes the heat off of tariffs. Remember that, you know, if you're raising 20% tariffs on a foreign economy and your currency depreciates by 15%, you know that that takes absorb a lot of the hit from that.

So, I think with the dollar again and you know, what does it do is if you have these Trump policies that are very sort of Make America Great Again, they're sort of pro domestic growth. It builds up pressures in the system and the currency, what it does is it acts as a kind of a pressure release valve and allows an economy to import more disinflationary forces and export more inflationary ones.

And if you're stamping down or turning off that tap by wanting a weaker dollar, that puts a little bit more pressure on the system. So I think that that would actually be a big mistake if Trump tries to do that, and then in turn, I think what it would do is also potentially put more pressure on the fed to tighten rates, to act as a control on any inflationary pressures building there, which in turn put the fed at odds with the Trump administration and they could butt heads, as well.

So, I think, you know, the dollar is going to be a very key area to watch over this administration, probably didn't pay too much attention to it under the Biden administration. But Trump, with his quite adversarial geopolitical stance, the dollar is a much more important linchpin in that whole kind of, scenario. So, we'll, we'll watch and see, see what happens.

17:07
Chris
You call out a, a new terminal rate of between three to, 3.25% for this easing cycle by 2026 to be more realistic than what was originally expected to be a return of 2.5% or even 2% in the coming years. What changed?

17:25
Richard
What changed is basically Trump one and two. The economy has been much more resilient. And also, inflation has been a little bit slower to, to come down. So, I think if the Harris Biden administration or Harris administration had, taken office, I think we would still be seeing, forecasts for inflation sort of in that two and a half to 2% range.

I think with Trump, there's definitely a risk, if inflation skews to the upside, if his policies. So Trump has, quite inflationary policies and quite disinflationary policies. And the hope or the view of the administration is that those are going to neatly offset each other. And the risk is that they don't. And I think that that skews the risk for inflation to be a little bit higher going forward.

And then I think that in turn has to be reflected in, in those rates, on top of the fact that the economy has been quite resilient in and of itself. So, I don't think that the, so that's the terminal rate, which is the rate the fed easing cycle ends up at, rather than the actual neutral rate, which could be above or below that terminal rates.

Slight difference there. I think the terminal rate hasn't changed dramatically. So, the market seems to be believing that the terminal rate is actually much higher than we thought it was. So, three and a half to 4% people are talking about the fed is we have a FOMC meeting coming up. Probably going to raise its estimate of that neutral rate. I think it's still in the low threes rather than that sort of three and a half to 4%. So, I think what the fed is doing is it sees the economy is doing pretty well. I think it sees that, you know, it says, you know, let's lock in what we see right now. But to lock that in I think it has to continue to lower rates.

Right. If you just stand still and don't lower rates policy continues to tighten. Remember because inflation's coming down. So, the real rate is moving up. And remember those lagged effects don't disappear. So as the corporate sector as the household sector continues to roll off their contracts that they'd locked in on that lock that continues to tighten policy.

So, to actually stand still, I think the fed needs to take rates down much closer to where that neutral rate is. So, you're going from A restrictive to B neutral, but you're not going down all the way down to see, you know, accommodative, as it were.

20:27
Chris
So then everything taken together and I think is a final good point. What are your expectations for the smid-cap market in 2025.

20:36
Richard
This is kind of kind of what I saw the same as last year to be honest. So last year I argued that it was you know, 2024 was going to be a pretty good year for the smid-caps. That turned out to be mostly wrong, although I will admit partially right. In the sense that year to date they have been underperforming the large.

But what's interesting is all of that underperformance really happened in the first half of the year. If we look at how the performance has been during the second half of the year, they've actually been outperforming quite nicely. Those smid-caps. And I think the case is really down to a few things. One is that valuations are still very attractive for this group of stocks.

So, the multiple has risen a bit in the second half of this year. But you're still sort of well below normal on what you would expect that PE multiple to be for these stocks. I think they're also still really under owned. I think you know, many portfolio managers are still quite wary of them. They've had a few head fakes over the years, but they're still…. from that perspective. And because they're so under owned, it wouldn't take much of, the sort of new money flowing into them to get that performance, rolling again. And also, they're still very much some of the biggest beneficiaries of this AI Boom. So, whether that's, you know, smaller tech companies or, you know, some of these defense companies, I think there's some, some really attractive stories that are coming out there, which, you know, my colleagues in research, have been highlighting.

We get Trump in now. He clearly wants to be more domestically focused in his growth agenda, that domestic growth tends to be more associated with, better performance from smaller and mid-cap companies, which is also associated with the stronger dollar. So stronger dollar helps that relative performance for against for the smaller companies relative to the to the larger ones, which, you know, they have a tougher sail with that stronger dollar.

And I think one last thing I would note is what's interesting, and if we're going to make analogies with maybe other points, in time, you know, looking back at history, I think there are a few similarities, with what we see today compared to, say, the late 1990s, when you also had this kind of large cap growth tech boom going on, and the small caps were similarly basically, you know, ignored.

And I think valuations today are very similar. They're back down to those levels that you had back then. And I think what's interesting is that those small caps or smid-caps started to outperform really from late 1998 onwards. So that was kind of three years before that internet bubble finally burst. So, it wasn't as if fund managers were moving away from their large cap tech bias.

It's just that they were being forced to allocate more money away from the larger caps as they kind of blown through their weightings in their portfolios. And they were still, you know, we're still really large cap growth, tech focused. But that small amount of money that was sort of taken out of there and put into, the smaller caps really started that ball going and they continued to outperform those stocks.

And even when the recession happened, in 2001, those smid-caps actually continued to outperform the larger cap. So that's not what typically happens. But this was the exception that proves the rule. So, I think what we're seeing today is investors are looking for diversification. They really want to diversify. I think they're wary of doing so given the great perform events that we've had from the magic seven stocks.

But I think they are happy to slowly try and sort of diversify that money into very attractively, valued other, maybe less correlated parts of the, of the stock market. So, I think that's going to be a very interesting area to look at in this coming year.

25:35
Chris
Well, Richard, that's all the time we have for today. It has been a real pleasure chatting with you every month like this through the year, especially through the last few months, which were fascinating to me, you know, to say the least. More of Richard's 2025 outlook can be found in his “Economic Outlook: U.S exceptionalism Continues Through 2025” report. You can request copy of both by reaching out to us at WilliamBlair.com/Contact-Us. Thank you for taking the time to be with us today.

26:04
Richard
And I just wish you all, very happy, holidays and a very successful and prosperous 2025.