Market Thoughts: De-escalating indigestion

As Liberation Day unfurled I mentioned the importance of anchoring as a negotiating tactic. Tossing out 145% tariffs on Chinese imports as an opening offer spooked markets. It effectively equates to a trade blockade. Slipping in a ‘hard’ 10% floor on all tariffs was tactically clever.

We’ve been modeling the impact of across the board 10-15% tariffs. A de-escalation pause for China begot a huge sigh of relief. If we land on comprehensive +10% tariffs, Washington will have increased existing tariffs fourfold. Everyone quickly walking away, clutching a “win.” De-escalating indigestion.

Recession isn’t our base case over the next year. But that remark is predicated on short, sharp, shocked trade negotiations quickly striking memos of understanding, so tariff headlines can fade into the distance. Just as Congress ramps up discussion about the budget and tax cuts. And the Administration pulls onto center stage deregulation. Deregulating banks seems to be on deck.

A mix of ‘all of the above’ has allowed risk assets to recover. We’re back to about where we were before Liberation Day. Quite the time traveling feat. The import stockpiling ahead of tariffs from the first quarter may repeat. The lowering of tariffs on China for 90-days could incite a second wave of import stockpiling. The second half of this year will prove more complicated.

The next few months should offer support to growth that rhymes with what we saw in the first quarter, at a slower pace. If consumer demand holds, it will lend support to earnings. Black Friday is coming early this year. Any day before August 10th, when Chinese tariffs potentially ramp back up.

By creating ‘shop now’ demand—a rush to the register before tariffs ratchet higher—hard data should be supported over the next quarter. That impetus fueled a bounce in animal spirits. Having been whipsawed about, investors are rightly showing caution. Also, fatigue.

We’re modeling U.S. growth this year at around 1%. For Europe, the starting point is 0.5%. In both instances, risk skews to the downside. Sub-trend growth in the U.S. Europe flirting with recession. The Fed on hold. The ECB and Bank of England easing. The dollar range-bound.

With about 90% of companies having reported, U.S. earnings have increased about 12% in the first quarter. If we continue to see businesses pulling forward imports and consumers spending, the second quarter may repeat some of that strength. That’s allowing analysts to revise up 2025 earnings, as recent worst case scenarios are backed away from. We’re modeling 6-8% earnings growth for the S&P 500 this year, as a starting point.

For Europe, we’re modeling 2-4% earnings growth. The catch-up trade in European equity valuations for the most part seems played out. Valuations have done the heavy lifting. Earnings need to carry the market forward. I’d say the same about the U.S. Our base case today is that U.S. earnings outgrow Europe by, let’s directionally call it, 2-4x. It’s why we’re not overweight Europe.

It’s been quite the rollercoaster ride. Having hit reset from early April, investors are left with high hopes that tax cuts and deregulation fan greed. In the opposite corner? Multiples that appear fully valued. That’s a pragmatic observation about the upside from here; it’s not meant as a negative.

Shorts have covered. Market momentum appears to be fading. The headlines will continue to come fast and furiously. For the portfolios we manage, it leaves us where we’ve been. We’re fully invested, not overweight risk. Not chasing after markets. So far, that discipline has served us well.

When Liberation Day hit, I didn’t rush to start a soundtrack accompaniment to ensuing market madness. I’ve given in. There’s a new tunes4ourtimes playlist on Spotify: Tariff taunts & tantrums. It’s an eclectic reflection on the emotion I’ve heard expressed by investors globally. Happy listening…