Jim Paulsen: Why 1 % Growth, No Recession, and a Broadening Rally Are on the Horizon
Jim Paulsen, Chief Investment Strategist at Leuthold Group, argues that the U.S. economy is stuck in a low-growth rut—yet recession remains unlikely. More importantly for investors, he believes the long-awaited broadening of equity leadership is finally within reach once the Federal Reserve begins an aggressive easing cycle. Below are the key take-aways for Australian investors and traders.
- Real GDP is crawling at ~1 % annualised through H1-2025—close to stall speed but not yet recessionary.
- Inflation is already “mission accomplished”: CPI at 2.7 % is identical to January 2020 levels; no secular inflationary impulse is evident.
- S&P 500 trades ~50 % above its 80-year trend line, rivalling only the dot-com peak; yet most of the market is not extended.
- Russell 2000 EPS has flat-lined since 2022 while S&P 500 EPS surged—creating historic divergence and latent catch-up opportunity.
- Policy stance is still restrictive: real fed-funds rate ~1 % above neutral, inverted yield curve, strong USD, and flat fiscal impulse.
- Recession buffers are unusually high: record fiscal deficit, ultra-low confidence (contrarian bullish), de-levered balance-sheets, and massive liquidity buffers.
- Fed pivot is the catalyst: Jackson Hole guidance for September cuts should unlock lower yields, weaker USD, and rising money supply—historically powerful supports for small-caps and value.
- Portfolio positioning is lopsided: widespread overweight in mega-cap growth leaves “dry powder” for rotation into mid- and small-caps once easing begins.
Growth: Sub-par but Stable
Paulsen calculates that after smoothing tariff-related import distortions, underlying real GDP growth is running just 1 % annualised—well below potential but not negative. Employment growth has slowed to ~0.7 %, consistent with a soft landing rather than contraction.
Inflation: The Fear is Overdone
With CPI steady at 2.7 %, PPI at 3.3 %, and wage growth flat at ~4 %, Paulsen sees no evidence of an inflationary spiral. Commodity prices are down 35 % from 2022 peaks, and forward breakevens are anchored at current levels. He argues the Fed’s obsession with a 2 % target is arbitrary; 3 % inflation would still be consistent with healthy nominal GDP growth.
Valuation: Two-Speed Market
While the S&P 500 is stretched, only seven of twelve major U.S. sectors trade above their long-term trend lines. Small-caps, value, and cyclicals screen as cheap—echoing 2000 rather than 2021. Paulsen’s work shows that when the Fed eases with such dispersion, laggards typically outperform by double digits over the next 12–18 months.
Policy Outlook
Paulsen expects the Fed to cut 75–100 bp by year-end, pushing 10-year yields below 4 % and the DXY lower. That combination historically triggers:
- Money-supply growth > nominal GDP (liquidity tail-wind).
- Outperformance by equal-weight indices vs cap-weight.
- Rising consumer and CEO confidence—currently at multi-decade lows.
Actionable Insights for Australian Portfolios
- Consider lifting exposure to U.S. small- and mid-caps via ETFs such as IJR or IWM on any post-cut strength.
- Watch AUD/USD and ASX 200 industrials—a weaker USD typically benefits commodity-linked names and offshore earners.
- Rebalance away from mega-cap growth if weightings have drifted above target; value and cyclicals offer better risk-reward.
- Monitor domestic small-caps (ASX: EX20, ASX: VSO)—global liquidity inflections often spill over to Australian mid-tiers first.
Bottom line: Paulsen sees a rare setup where macro risk is limited, valuations are bifurcated, and policy is on the cusp of turning supportive. For investors willing to look beyond the headline index, the next 12 months could deliver outsized returns in the forgotten corners of the equity market.