The Looming Adjustment: Why Postponing Economic Reality Could Spell Trouble in Q2 2025

Marko Kolanovic, J.P. Morgan’s chief market strategist, has long warned that markets and policymakers are delaying the inevitable: a reckoning with unsustainable economic conditions. His recent analysis paints a stark picture of Q2 2025 as the crucible where years of postponed adjustments—monetary excess, fiscal inaction, and structural imbalances—will collide. The consequences, he argues, could reshape financial markets and economies for years to come.

Market Overvaluation: A Precarious Tightrope

Kolanovic’s central thesis revolves around the S&P 500’s overvaluation, which he claims has yet to account for mounting recession risks. As of early 2025, the index traded at a forward price-to-earnings (P/E) multiple of 20x, far above historical averages. . Kolanovic argues that a more realistic multiple—factoring in a recession—would drop to 15x, implying a 20% decline from current levels. If earnings also deteriorate due to slowing demand, the fall could be even steeper.

Trade Wars and Geopolitical Volatility

The strategist identifies trade wars as a critical catalyst for 2025’s adjustment. Tariffs imposed on China and other trading partners have already forced banks like Deutsche Bank and Citigroup to slash S&P 500 forecasts. Deutsche Bank revised its year-end 2025 target to $6,150 (from $7,000), while Citigroup lowered its estimate to $5,600, citing tariff-driven declines in earnings per share (EPS). .

Kolanovic also highlights the volatility tied to U.S. policy shifts. A temporary tariff pause by the Trump administration, for instance, caused the SPDR S&P 500 ETF Trust to surge, creating its largest premium to net asset value since the 2008 crisis. This underscores how geopolitical noise is amplifying market instability.

Recession Risk: The Clock Is Ticking

Kolanovic warns that the probability of a recession is “very high”, possibly already underway by early 2025. The yield curve’s inversion—a historical recession signal—has persisted, while inflation lingers due to delayed Fed action. He draws parallels to the 1970s, when post-pandemic fiscal/monetary easing failed to purge speculative excesses.

The strategist points to market crashes and a spiking VIX volatility index as harbingers of trouble. . These metrics mirror past crises, suggesting markets are ill-prepared for the coming storm.

Structural Challenges: Supply Chains and Energy Costs

Underlying the adjustment are structural vulnerabilities Kolanovic has tracked for years. Geopolitical tensions, energy transition bottlenecks, and fragile supply chains are squeezing corporate margins. Energy prices, already volatile, could rise further if production constraints persist. . Meanwhile, resilient labor markets in the U.S. and Europe—while delaying near-term recession risks—risk prolonging wage-driven inflation, forcing sharper corrections later.

Investment Implications: Navigating the Storm

Kolanovic advises investors to exercise extreme caution in Q2 2025. Overvalued sectors like tech and real estate—sensitive to rate hikes and earnings downgrades—are particularly vulnerable. He recommends diversification, focusing on defensive assets and real-time valuation tools to navigate dispersion. Platforms like InvestingPro could help track shifts in real-time.

Conclusion: The Cost of Delayed Realities

Kolanovic’s analysis is a clarion call: the longer policymakers and markets delay addressing inflation, trade imbalances, and structural flaws, the sharper the eventual correction. With the S&P 500 facing a potential 20% drop, recession risks at critical levels, and geopolitical tensions flaring, 2025’s adjustment could rival past crises in severity.

The data is clear:
- Deutsche Bank’s revised S&P 500 target of $6,150 implies a 400-point drop from early 2025’s highs.
- The Fed’s delayed rate hikes left the yield curve inverted for 14 months straight by Q1 2025—a duration not seen since the 2000s.
- Energy prices have surged by 30% since late 2023, amplifying input cost pressures.

Investors ignoring these signals risk being blindsided. As Kolanovic reminds us, markets eventually demand reckoning with economic reality—preferably sooner than later.