Stocks have now recouped all their post-Liberation Day losses. The recovery started as soon as Trump backtracked from his reciprocal tariffs within 48 hours of announcing them. Subsequent steps, including an outline of a trade deal with Great Britain, and a suspension of the lion’s share of Chinese tariffs for at least 90 days, set the stage to achieve a more moderate end point. But Trump has not backed away from his base case of 10% levies against almost all nations, a tariff rate that would still be triple what existed before he took office. Nonetheless, with tariffs moving in the right direction and data to date supporting the idea that the odds of recession are receding, investors saw signs of blue skies ahead.
In Washington, the focus shifted to the “big beautiful” reconciliation bill. Early drafts included goodies for everyone, an extension of the 2017 tax cuts, plus less tax on tips, Social Security and overtime pay for those earning below certain thresholds, expensing of property, plant and equipment costs (again with certain restrictions), increased deductions for state and local taxes, and interest-free car loans. The pay-for was to be tariffs and DOGE savings. However, it seems both of those will likely be a lot less than earlier promised while the largesse of tax reductions is greater than it was in 2017. In two words, the original draft that came out of the House Ways and Means Committee is a budget buster.
The reactions have been swift and predictable. A handful of deficit hawks in the House prevented approval of the package as presented. Trump, of course, was infuriated. Moody’s downgraded U.S. debt ratings, in part due to the potential impact of the House’s first draft. The Moody’s downgrade simply brought it into alignment with S&P and Fitch, so, it’s direct impact should be minimal. The handful of Republican holdouts will eventually be placated by some moves to deepen spending cuts. The CBO will score the package unfavorably at first suggesting annual deficits far above $2 Trillion. Notably, while stocks have risen more than 20% from their April lows, longer term bond yields have been drifting back up to the 4.5% area suggesting some combination of tariff-driven inflation, and/or a supply/demand imbalance for longer dated Treasury debt. The Biden administration tried to dampen long-term rates by shifting the issuance of new debt to shorter term maturities. Scott Bessent, before becoming Treasury Secretary, spoke against such a move citing the future volatility of debt service costs. But, since becoming Secretary, he has had little choice but to stay with that program. Selling more 10–30-year bonds when rates are rising and confidence in the U.S. dollar is fading risks a spike in longer term yields. That would put a dagger in the heart of the housing industry, already suffering from the lowest demand in over a decade. We’ll get more news on that front this week as both new and existing home sales for April are reported.
As for inflation, tariffs already imposed have not affected inflation to date. But as Wal-Mart management stated when it reported earnings last week, the impact of tariffs on its costs will begin to be felt in the weeks and months ahead. While it will try to hold the line on prices as best it can, there will be some need for price increases to offset the tariff costs. Trump predictably railed against that notion suggesting Wal-Mart should “eat” the cost of tariffs. Bessent was a bit more moderate suggesting the company should eat some of the tariff costs. Bessent and management may have differing views of what “some” means.
Through Q1 companies have noted that consumer demand has held up. That includes April, as retailers are starting to report their April quarters. No doubt some Q1 strength came as companies and consumers sought to front run the tariff costs. The key months to watch are May and June. If there was front running, the boost of earlier months will give way to a subsequent lull. But with that said, employment remains solid. And if people have good paying jobs, they are going to continue to spend. Investors have been underestimating the power of the consumer for several years. Unless there is a notable increase in layoffs, they may be making the same mistake again.
But in April, when tariff announcements sent the dollar into a tailspin, the risk was that the Trump administration wouldn’t back away at all and trade patterns around the world would be instantly altered, almost certainly in a very disruptive manner. But if Trump 2025 was similar to Trump 2017 some relief was inevitable. The only question was how much. Clearly, especially with hindsight, investors overreacted to the original pronouncements. As pressure was released, the economic picture became less harsh quickly and stocks rebounded.
Now, however, the risk/reward picture is different. There are two deadlines out there when 90-day tariff relief expires. The first is July 2 when all those reciprocal tariffs announced on April 2 could go back in place. No one expects that to happen (except maybe Peter Navarro). Nor are 100+ trade agreements going to be finalized by then. So far, there is a grand total of one outline (Britain). There are suggestions that dozens more are coming but most of those won’t be negotiated. Rather they will be U.S. declarations of what we want to see in order not to impose tariffs above 10%. Where such declarations lead is open to debate. But from the point of view of equity investors today, the risks are for more pain, not further relief.
China is a different story. Depending on who is doing the scoring, the present tariff rate during the latest reprieve is 30-54%, still a level that will stifle trade between the two countries. Apple# has suggested it plans to move iPhone assembly to India from China, in part to diversify its supply chain and in part to lessen its tariff burden. Again predictably, Trump yelled foul. He wants the phones to be assembled in the U.S. Logistically, that isn’t going to happen very soon. And if it could happen, the price of an iPhone would have to be increased materially. Blame for a large price increase would land precisely at 1600 Pennsylvania Avenue no matter how many social media rants emanate from the White House.
As noted in past letters, the opportunity to balance the trade scales with China are present now. While Trump wants to move quickly, China won’t move at Trump’s pace. Yes, there could be some agreement about fentanyl that grabs headlines. But fentanyl has never been key to the economic issues that surround fair reciprocal trade. Such negotiations will take months, possibly years.
Thus, here’s the current picture investors face.
1. Where overall tariffs end up over the next several months is likely to be north of 10% but less than the composite 25%+ announced on Liberation Day. They will be a headwind into 2026 if not beyond.
2. The odds are that Trump’s big beautiful reconciliation bill will get across the finish line close to the self-imposed July 2 deadline. From a tax cut point of view, it will be pretty. From a deficit/debt viewpoint, it won’t be pretty at all. Once passed, there will be little the Trump team can do to mitigate a series of large annual deficits short of much greater steps to reduce spending than have taken place to date. Defunding USAID or pushing some of the Education Department’s expenses back down to the states makes headlines but won’t come close to offsetting rising entitlement and debt service costs. If Trump wants to attack spending, he has to take aim at the big elephants in the room, namely entitlements and defense spending. He has shown no inclination to do so.
3. The housing industry is having a poor spring selling season. Unless 10-year Treasury yields come down meaningfully, the outlook is poor. Don’t expect an economic boom with housing in the doldrums.
4. Auto dealers had a good spring as buyers tried to beat tariffs. But late spring/summer sales don’t look strong. Soon new car sales will carry tariff burdens. Not a great outlook.
5. The good news is that AI and related tech spending continues unabated and robust. Capital spending to make our electric grid robust continues to grow as well.
Thus, while a month ago there were signs of relief and improvement, today more clouds are appearing. The tax package will undoubtedly pass with some modification and more spending cuts. The keys will be what happens to the dollar and interest rates. Trump can’t control either, at least not directly. Should the impact of tariffs and any economic lull impact consumer spending, the Fed could institute a rate cut this summer. Still too early to make that call. Inflation apart from tariffs remains fairly stable and long-term inflation expectations are also contained.
Valuation is also a mounting headwind for further near-term upside to stocks. Stocks currently trade at over 22x 2025 estimated earnings. Against a backdrop of 10-year yields close to 4.5%, that is expensive. Momentum could carry stocks higher in the short-run, but a partial retracement of the April/May advance would seem more likely.
I want to end with a mystery question of life that surrounds the recent proposed gift of a lavish 747 from Qatar to be a new Air Force One. There are currently two, both decades old but kept up to date. Two new planes were ordered in 2018. With delays and cost overruns, they are due to enter service in 2029. Supposedly, the Qatar plane can be modified to hardened standards worthy of a Presidential jet within a year or two, maybe even months. Since the old jets, the new jets on order and the Qatar plane are all made by Boeing, how can the Qatar plane be modified in a short period of time while the new planes require more than a decade to build and four more years to finish. Please email me if you have an answer to this riddle.
Today, the Who’s Pete Townshend turns 80.
James M. Meyer, CFA 610-260-2220