Looking past tariffs, taxes, geopolitical risks and slower economic growth.
Today is the first day of summer. Like me, you might feel excited to finally see the sun. It changes everything in my mood to walk outside and feel the warmth of her rays and see the blue skies above.
Johnny Nash’s crooning voice says it best, “I can see clearly now, the rain gone/I can see all the obstacles in my way/Gone are the dark clouds that had me blind/It’s gonna be a bright (bright), bright (bright) sun-shiny day.”
As we round into the last days of June and close out the first half of 2025, investors want to see the sun, too. But there are many obstacles to clear on the path ahead for the economy and markets.
Tariffs and trade negotiations remain in limbo. The budget bill is still under negotiation, and concerns about the country’s deficit have grown following Moody’s downgrade of the U.S. government’s AAA credit rating. The Federal Reserve has yet to lower rates, and while its future projections suggest rate cuts may be coming, there was an air of stagflation in their forecast and notes from this week’s policy meeting. Finally, President Trump has given himself two weeks to decide whether the U.S. will join Israel in attacks on Iran.
Equity markets rallied to start the year—and then sold off by 20%, led by the formerly trailblazing Magnificent Seven. Just when concerns reached their peak in early April following the Liberation Day tariff announcement, the markets rallied more than 20% in a round trip. Ten-year Treasury yields began the year at 4.5% and remain at about that level now, having gone on a rollercoaster ride down and then up and then back down again over the last few months.
So, where will the economy and markets go from here?
We need to get real answers on trade deals to remove the clouds of doubt. To feel comfortable making spending decisions, consumers and executives need to see progress on trade agreements that permanently lower or eliminate implemented tariffs. While the worst-case scenario for tariffs has seemingly been mitigated, they remain at an average effective level (15% to 20%) that is higher than we have seen in almost 100 years. Ideally, they would fall even further, as low as 5%, if a court ruling holds that tariffs imposed under the International Emergency Economic Powers Act (IEEPA) are unlawful. A 5% tariff would still be double what was in place in 2024 but could be something consumers and corporations can absorb.
Likewise, we need a tax bill that walks the fine line between competing priorities, including extending tax breaks introduced by the 2017 Tax Cuts and Jobs Act (TCJA), offering relief for lower- and middle-income taxpayers, and forging a path for revenue growth and expense reductions. Congress also has to balance making necessary infrastructure improvements and maintaining safety nets we have in place for Americans.
At press time, among the considerations to pay for the bill are cuts to Medicaid spending and the repeal of so-called green tax credits for electric vehicle purchases and domestic and business energy upgrades that passed in 2022 as part of the Inflation Reduction Act.
For investors to have confidence in valuations, they must believe that corporate America can continue to generate earnings growth. Corporate executives have certainly noticed recent economic headlines: Expected annual earnings growth for the S&P 500 has declined from 15% in the fourth quarter of 2024 to 9% currently. That said, given all the headwinds, if that level of earnings growth is achieved with a better outlook going into 2026, it should provide a reasonably positive backdrop for investors.
There is no doubt that trade policy has tested the resiliency of the U.S. economy so far this year. Still, the economy has shown strength. Excluding the impact of net exports on Q1’s slightly negative GDP report, the underlying economy continued to grow. The momentum that the U.S. economy had coming into the year has persevered through the headwinds.
Barring further unforeseen shocks, like the U.S. entering a war in the Middle East, we anticipate the U.S. economy will continue to grow slowly in the back half of the year, which should support earnings growth. Volatility is likely to continue, but the April equity market lows priced in a fair amount of bad news on trade, economic growth and earnings. The recovery since those lows reflects the delay and resizing of those risks; a return to “worst-case” tariff levels or a tax bill that does not offer stimulus and a path to deficit reduction will set us back. However, we have a sense of the scope of what that risk adjustment could look like and are braced for it. Diversification has been the key to weathering these risks to date, and we continue to believe that is the best way to position portfolios as we enter the second half of the year and look for the sun.
Johnny Nash sang of a day when “all of the bad feelings have disappeared/Here is the rainbow I’ve been prayin’ for/ It’s gonna be a bright (bright), bright (bright), sun-shiny day.” What a lovely thought and dream to hope for in this crazy world and in these crazy times!