FROM TURMOIL TO OPTIMISM

Stocks continued their roller coaster ride in the second quarter of 2025. Having reached a high on February 19^th, they declined to a low on April 8^th. This was a 19% decline and slightly exceeded 20% on an intra-day basis. The primary reason for the April decline was the introduction of President Trump’s tariff policy, which at its onset seemed punitive and recessionary. As visibility on U. S. policy improved, however, stocks recovered with the S&P 500 closing at a new high, in part anticipating the passage of the One Big Beautiful Bill, which was signed into law on July 4^th.

Provisions in the bill allowing for full expensing of capital investments in the U.S. coupled with tariffs are a powerful incentive for CEOs to invest in plants and equipment. Mega cap tech companies had already been investing hundreds of billions of dollars in an Artificial Intelligence  arms race. This spending means strong sales for companies across diverse industries from semiconductors to data centers to utilities, their equipment suppliers and beyond. Further clarity on the final level of tariffs should increase capital investment intentions from here.

Stagflation concerns morphed into soft landing optimism. Inflation has not accelerated as feared, as companies have chosen to absorb some tariff impact in their margins rather than increasing prices.

While there is evidence of some softening in the labor market, the unemployment rate remains low at 4.1% and is not signaling recession. Jobs continue to support spending. Some durable goods purchases were likely pulled forward ahead of tariffs. Though that may have altered the basket of goods consumers buy, aggregate retail sales continue to increase, growing 2.8% from year-ago levels in May.

Risks for the second half of the year start with current market valuation. The aforementioned  positive developments are not lost on the market with the S&P 500 trading at a historically expensive 24 times earnings, making the market vulnerable to a corrective pullback. The sluggish housing market is a risk to employment and household balance sheets. High mortgage rates are dampening activity and moderating home sale prices. Potential policy changes reducing the independence of the Federal Reserve could frighten the bond market, sending long-term rates higher if investors fear a future Fed Chair would trade short term monetary largesse for long term discipline on the inflation front.

As we enter the third quarter, generally considered the weakest part of the year, both the corporate and consumer sectors have proven resilient in the challenging evolution of U.S. policies. Corporate earnings are still growing, and this earnings growth supports a continuation of the current bull market, even if the robust recovery from April lows requires a digestive period.

July 2025

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