On the back of easing trade tensions, markets have staged an unusually rapid recovery from a tariff-induced near bear market about two months ago. The S&P 500 rebounded more than 20% from its April low and is hovering near all-time highs. The leadership of the Magnificent Seven faltered earlier in the year, as the group entered a bear market, but the recent rally has seen the celebrated collection of companies reassert its leadership. 

Despite a host of uncertainties, market participants have remained in a risk-on mode with a buy-the-dip impulse prevailing. In a sign of the current bullish market sentiment, recent IPOs have performed particularly well out of the gate. Bloomberg reports stocks of companies going public are jumping the most in their first day of trading in three-and-a-half years. Some examples include stablecoin issuer Circle, which leaped more than 165% on the day of its $1.2 billion IPO, Chime Financial, which closed up nearly 40%, and space and defense firm Voyager Technologies, which surged more than 80%. Positioning reports suggest large money managers remain underweight equities, which could prompt a chase later in the year to close the performance gap if the current trend persists. Bitcoin, often viewed as a proxy for investor risk appetite, is also around all-time highs at more than $105,000, up about 40% from the April lows. 

Uncertainties spanning the Israel-Iran conflict, trade policy, and an uneven economy combined with the recent market runup have led to increased scrutiny on multiples. According to FactSet, the current forward multiple for the S&P 500 is over 21.5x, ahead of both the 5- and 10-year averages. While estimates for earnings have come down since the beginning of the year, consensus expectations reflect approximately 9% growth for 2025 with low double-digit growth in 2026. If this proves accurate, a reasonable case can be made in support of the current multiple. Expected earnings growth for 2025 has been cut by about 4% since the start of the year, even as first quarter results comfortably exceeded expectations and management commentary on second quarter trends generally suggests those results are likely to be solid.

The consumer has been resilient, and the economy has largely held up, helping support markets. However, there are indications the economy is slowing, including lower job growth and a cooling housing market. The May jobs report showed the U.S. economy added 139,000 jobs, slightly ahead of expectations, though job gains for the prior two months were revised lower by a combined 95,000. Job gains in May came from the health care and leisure and hospitality sectors, helping offset a decline of 22,000 federal government jobs. Continuing unemployment claims are running at recent highs, an indication that it is taking longer to find new work. Given evidence of a slow-to-hire, slow-to-fire environment where employers are hesitant to cut workers they scrambled to find just a few years ago, some have expressed concerns that a continuation of softening demand could reach a tipping point, triggering a wave of job losses. While there have been notable recent announcements of layoffs from companies like Disney and Microsoft, the trend has not yet been strong enough to signal widespread concern. 

The unemployment rate in May was steady at 4.2%, remaining in the 4.0%-4.2% range it has resided within over the past year. However, the participation rate fell to a three-month low of 62.4%. Wage growth picked up with average hourly earnings up 3.9% over the past year, helping to support consumer spending. However, retail sales in May fell for a second consecutive month, down 0.9% versus the prior month following a downwardly revised 0.1% decline in April. In better news, “control group” sales, which exclude food services, auto dealers, building materials stores, and gasoline stations, and which feeds into the calculation of goods spending in GDP, was better than expected, up 0.4%.

On the inflation front, recent data has been encouraging but inflation remains above the Fed’s 2% target. Consumer prices rose 2.4% in May versus a year ago, in line with expectations and near a four-year low. The core measure, excluding changes in food and energy prices, remained flat at 2.8% versus expectations of a slight increase. Thus far, consumer prices have defied expectations that tariff-related price increases would flow through to the inflation readings. Some have suggested businesses stocked up on inventories ahead of tariff increases, allowing them to delay price increases until later in the year. Others have suggested that demand isn’t strong enough to increase prices, which would ultimately pressure margins. Inflation data over the next several months will be closely scrutinized for any sign tariffs are putting meaningful upward pressure on prices. The conflict in the Middle East has also complicated the inflation picture as it has sent oil prices up by about 10%. 

The most recent reading of the Federal Reserve’s preferred measure of inflation, the personal consumption expenditures index, fell to 2.1% in April, while the core measure that excludes food and energy showed prices increased 2.5% over the past year. Importantly, long-term inflation expectations remain “well anchored,” with both the 5-year and 10-year breakeven inflation rate at 2.3%, down a touch from the start of the year and only slightly ahead of the Fed’s target. The Fed is particularly sensitive to changes in inflation expectations, and provided these remain around the 2% target, it could open the door to rate cuts later in the year. 

Setting aside the longer-term aims of the administration, tariffs are complicating the Fed’s job. Despite encouragement from the President to cut interest rates in conjunction with the implementation of tariffs, the Fed left rates unchanged for the fourth consecutive time at its June meeting. That meeting underscored that the Fed remains in wait-and-see mode until it achieves further clarity on the impact of the administration’s policies on the economy. Tariffs pressure both sides of the Fed’s dual mandate of price stability and full employment, as they are generally expected to contribute to inflation and also lead to slowing economic growth. Ideally, inflation continues to track towards target and the economy remains resilient, likely allowing for rate cuts later this year. However, a pickup in inflation would take potential cuts off the table, while a meaningful slowdown in growth would argue for quicker cuts. A scenario where growth slows and inflation picks up would put both sides of the dual mandate in conflict and force the Fed to prioritize one or the other in the near term. Such tension is likely to result in the prioritization of price stability.

At the June meeting, Chair Powell continued to highlight a slower, but still solid, growth outlook while also underscoring the uncertain environment with elevated risks to both higher unemployment and higher inflation. Consensus expectations reflect 0.50% worth of rate cuts this year, with the first reduction occurring in September. This closely mirrors the Fed’s own median expectation, though several members of the committee expect no rate cut this year. Despite some volatility earlier this year, the yield on the 10-year Treasury has remained rangebound over the past month between 4.25%-4.50%. 

The mix of policy uncertainty that investors have digested well following the initial “Liberation Day” selloff has now been joined by incremental geopolitical uncertainty. An expected slowdown in growth in the back half of the year combined with multiples that are elevated relative to history makes for a particularly tricky market environment. Maintaining focus on the long term with a bias toward owning quality companies that are both growing and trading at reasonable valuations remains a sensible approach for investors.

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The commentary is excerpted from the issue of the Investor Advisory Service newsletter published at the end of June. To receive commentary like this in a more timely matter and receive actionable stock ideas each and every month, subscribe today. The Investor Advisory Service stock newsletter was named to the Hulbert Investment Newsletter Honor Roll for the 15th consecutive year for outperforming every up and down market cycle since 2007.

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