This was the opening sentence from my letter last week. “Now that the Big Beautiful Bill has passed, attention will turn to the path forward on tariffs and to second quarter earnings that will start to be reported within the next two weeks.” How fast the reconciliation bill fades into memory amid all the tariff noise of the past few days. And, at least for now, I do mean noise. We’ve seen the playbook a lot over the past several months. Announcements of huge tariffs, some moderating responses from the countries impacted and then some retreat. The word some is important. No one, probably including President Trump himself, knows what will be implemented on August 1 and how long the additional tariffs might last.
While the market’s reaction to Liberation Day tariff announcements back in April was severe, this time around, investors are taking more of a wait and see attitude. As I said, we have all seen this playbook before and no one wants to overreact a second time. Of course, that elevates the risk that the actual August tariff levels will be higher than perceived at the moment. Between now and then there will likely be waves of angst, confusion, and moderation. Trying to predict the outcomes is futile. If Trump overreacts, markets will punish him although with stocks at record levels he may well be willing to absorb more pain than in April.
As a rational observer, it’s hard to make sense of some of the actions. Realizing that the Brazilian tariffs are politically motivated as we actually run a trade surplus with Brazil, it is a big supplier of food and agricultural goods that we depend on and can’t produce ourselves. How far will Trump go to defend a political ally if it means a spike in prices for coffee, fruits and vegetables? As for Canada, our largest trading partner, tariffs not covered by treaty are going to be increased to 30%+. Not noting the exceptions (Canadian oil is a crucial feedstock for midwestern refineries, for instance), it is hard to judge the impact. Clearly, the alleged excuse of rampant fentanyl is a trope for raising tariffs.
And with the deficits implicit within the Big Beautiful Bill just passed, the government will need as much tariff revenue as possible if it is going to make a dent in future deficits!
So much for tariffs, at least for now. While more news is undoubtedly forthcoming, the focus will now turn to earnings. They get started Tuesday with several big banks reporting. Financial stocks have been on a tear recently often outperforming the Mag 7 names. Moderate interest rates, good investment activity, record stock prices and a solid economy should result in good earnings. While the strong performance of banks has discounted some good news, I would expect earnings season to give equities a lift. Why not? GDP is growing at a reasonable pace, unemployment is low and jobless claims are modest, the weak dollar will give reported foreign earnings a near 10% boost on a reported basis, and with tax legislation passed, clarity has improved. Moreover, whereas during first quarter conference calls managements voiced a lot of angst, mostly tariff related, I would expect a bit less caution this time around given the persistence of strong consumer spending patterns.
As noted previously, the lynchpin to a continued strong stock market performance is an assumption that 10-year bond yields can be contained within the range of the past nine months, mostly between 4.0% and 5.0%. At the moment they sit in the middle of that range. Near term inflation doesn’t seem to pose an immediate threat to higher rates. June CPI data will be released this week. Over 40% of core CPI (less food and energy) is comprised of rents and owner-implied rents for owned houses. Lately, home prices have shown weakness although, conversely, rentals are firm given so many potential first-time home buyers staying in rental units.
Another risk is the rise of speculation, a hotter IPO market, the reemergence of meme stock popularity, and record bitcoin prices for example. The bubble may be expanding but it shows no signs that it will burst anytime soon. With that said stocks remain expensive but they can stay expensive for a long period of time. It takes a catalyst to burst the bubble and none is yet in sight.
Thus, over the next several weeks we are likely to experience a tailwind of good earnings and an uncertain outlook for tariffs. Assuming that the extremes can be avoided the path of least resistance continues to be up with the caveat that day-to-day fluctuations will be impacted by the tariff news of the day.
Today, actress Jane Lynch turns 66.
James M. Meyer, CFA 610-260-2220