Markets cheered on May 12th when the Trump Administration agreed to suspend most of the 145% tariff that it imposed on Chinese goods back on April 2nd, substituting a new 10% global base-line tariff plus a separate 20% levy tied to China’s role in the fentanyl trade, a total rate of 30%. In exchange, China will reduce its retaliatory tariff to 10% from 125%. The deal is good for 90 days as negotiations continue. The S&P 500 gained 3.3% on the news and turned positive for the year.

Even before the China tariff reprieve, investors were bidding up the market as companies were generally reporting strong first quarter results. According to FactSet, with 90% of S&P 500 companies reporting, first quarter earnings are on pace to grow 13.4%, the second-straight quarter of double-digit earnings growth. 78% have reported actual EPS above the mean EPS estimate, above the five-year average of 77% and 10-year average of 75%. For the remaining three quarters of 2025 analysts expect earnings to grow 5.2%, 7.4%, and 6.7%, respectively, with a full year prediction of 9.3%. This is a reduction from previous full year estimates that had contemplated double-digit earnings growth.

After a very weak April that saw the market fall from its peak in February to almost bear market territory, valuations look stretched again. The forward 12-month P/E ratio for the S&P 500 is now 21.3, 7% above the five-year average of 19.9 and 16% above the ten-year average of 18.3. Elevated valuation tells us the market believes the aggressive tariffs from Liberation Day and the ramped-up tariffs against China aren’t going to stick.

Through the first part of the year economic performance looks solid but tariffs, government policy, and geopolitics have created uncertainty.

First quarter GDP most clearly demonstrated the impact of tariff policy. GDP fell 0.3%, the first contraction since 2022, as imports surged from businesses’ desire to stock up on goods ahead of additional tariffs. The 41.3% surge in imports contributed to a net export reduction of 4.8% of GDP (imports subtract from the calculation of GDP since they represent spending on foreign-made goods and services, not domestic production). However, other measures of GDP point to continued, steady growth. Final sales to private domestic purchasers, which tracks demand from businesses and consumers without the volatile government, inventory and trade data, increased 3%, up from 2.9% in the prior quarter. Consumer spending rose at a 1.8% pace, the smallest increase since mid-2023, but still healthy.

The labor market has yet to show any significant cracks. The U.S. added 177,000 jobs in April and the unemployment rate held steady at 4.2%. However, this was down from the 185,000 jobs added in March and gains for February and March were revised down by 58,000 jobs. The April data might not tell us much about continuing growth trends as it likely reflected staffing decisions made in February and March. Further, there was an unusually large increase in the transportation and warehousing sectors that added 29,000 jobs for the month. The bump in employment seems linked to the additional import of goods as job-search site Indeed reports that a surge in job openings for loading and stocking workers earlier in the year reversed in April. Even so, jobless claims in early May fell to 228,000, down from 241,000 a week earlier, and continuing claims decreased to 1.88 million.

Other economic signals look mixed. Consumer confidence has fallen substantially, but we put more faith in still positive trends in real wage growth as that provides the cash flow for consumers to spend. Automakers report double-digit increases in new vehicle deliveries, perhaps a reflection of consumers buying ahead of tariff-induced price increases. The housing sector has had a disappointing spring selling season as high mortgage rates continue to weigh on activity. Oil prices have been softer as OPEC announced a 411,000 barrel per day boost in production set to take effect in June, while traders assess the negative growth impact of higher tariffs.

Even with the Liberation Day and China reprieves, remaining tariffs are still meaningfully higher. It appears Mr. Trump is heading toward a global tariff of 10% and higher tariffs for autos, steel, aluminum, and goods from countries out of political favor, such as Venezuelan oil. Higher tariff levels and continued tariff policy uncertainty will weigh on businesses and consumers until there is greater visibility.

Government policy contributes to uncertainty. The Republican party is working on their “One Big Beautiful Bill” that could significantly reset tax and spend policies for the next few years. The amount of fiscal stimulus and/or restraint isn’t yet known and the Republican majorities in the House and Senate are so slim that defectors have great power to twist the outcome. The goal of passing a bill by mid-July is laudable but the odds that one gets done by then aren’t clear.

There are several geopolitical risks. The two biggest current conflicts, Ukraine and Gaza, continue. Taiwan’s independence remains under threat from China as the country ramps up aggressive activities in the Pacific. New trade deals could either alleviate or exacerbate these threats.

After falling for much of the year through early April, the 10-year Treasury rate has increased to about 4.5%, around where it started 2025. The two-year rate has followed a similar trend but the spread between the rates has widened as inflation trends toward the Federal Reserve’s 2% target. This represents a normalization of the yield curve and, along with a balanced labor market, could signal to the Fed that it can cut the Federal Funds rate target of 4.25%-4.50%.

Unfortunately tariffs greatly complicate the Fed’s actions. Tariffs are a tax borne by consumers and producers, acting as a price increase that stokes inflation. Taxes reduce economic growth that eventually spills over to the employment market. After being late to get ahead of inflation in 2022, the Fed’s current stance of wait and see seems appropriate, particularly with unsettled tariff policy. Markets are now pricing in two rate cuts in the fall, down from three before the China reprieve.

Stock and bond markets will likely continue to be volatile in 2025. The resolution of tariffs and the “One Big Beautiful Bill” would go a long way toward giving businesses and consumers what they need to plan. As always, we continue to look for well-managed companies at fair prices that can grow in any environment.

The commentary is excerpted from the issue of the Investor Advisory Service newsletter published at the end of May. 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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