August 14th, 2025
We are now four months past liberation day which ushered in a new era of global trade. The market has completely recovered from the 26% sell-off that coincided with the announcement of higher tariffs. Some of this recovery is a result of the administration reducing the size of the announced tariffs and carving out exceptions for products like semi-conductors and for trading partners like Canada and Mexico.
The history of trade wars is not very encouraging. In the past, when one country erected tariff barriers, their trading partners responded in kind. This led to a cycle of tariff increases that ended up costing the consumers and producers of both countries.
There is a possibility that it is different this time. So far, U.S. trading partners seem reluctant to counter with their own tariff increases. Only time will tell whether this is a temporary reprieve, while they attempt to negotiate trade deals with the Trump administration, or whether they are so dependent on the U.S. market that they are willing to accept Trump’s new, hardline approach to global trade.
Today, there are more confusing crosscurrents than usual. The media does not effectively discuss all of the variables. They create narratives that maintain the interest of their audience. These narratives tend to dwell on the extreme rather than the most likely outcomes.
The extreme scenarios are, by definition, less likely than the more mundane outcomes. Overreacting to short-term events has generally been counterproductive to the long-term success of investment portfolios. Deliberation and underreaction reduces the likelihood of unforced errors.
It’s too early to know the impact of higher tariffs. The Federal Reserve employs 785 economists, over 400 of which have PhDs. They’ve said that they have no idea how the economy will respond to trade policy. I won’t even hazard a guess at this point. We’ll know a year from now when we can review the impact on imports and exports.
The market is expressing its opinion that the impact will be fairly benign. Currently, the S&P 500 is at an all-time high. Valuations are expressing confidence that earnings should stay solid, and the economy should continue to grow.
The pace of economic growth is the most significant question. The labor market integrates both micro and macro aspects of the U.S. economy. Payroll data is a crucial economic indicator. Monthly non-farm payroll figures provide valuable insights into prevailing labor market conditions. This data acts as a primary indicator for assessing economic growth, inflation, and unemployment and is influential in shaping U.S. monetary policy.
The July employment report showed that U.S. payrolls grew by an anemic 73,000. The government also revised the prior two months payroll numbers—reducing the total by 258,000 jobs. This means that the last three months’ employment data was worse than any other three-month period since June of 2020, during the Covid slowdown. The positive aspect of weak jobs reports is that they persuade the Federal Reserve to cut interest rates to support economic growth.
At the beginning of the year, the two-year Treasury bill was in line with 3-month Fed funds rate which is set by the Federal Reserve. The bond market sets the two-year rate. When the two-year matches the Fed funds rate, it suggests that the market agrees with current Federal Reserve policy. Since the disappointing labor report, the two-year rate has dropped by almost ¼ of 1%. Now, the two-year rate is ½ of 1% lower than the Fed funds rate, strongly implying that the Federal Reserve will lower rates twice within the next six months or so.
A half-point cut in short-term rates is very helpful for stocks. Falling interest rates tend to cause the value of the dollar to depreciate, which leads to higher earnings for large multi-national companies. Data from Apollo Global suggests companies within the S&P 500 generate around 41% of their total revenue from outside the U.S., and a weaker dollar increases their value when it comes to financial reporting.
In terms of reported revenue, an item sold by a U.S. company in Europe in June 2024 for 100 euros would translate to around $107. The same item sold last month would generate $118. The increased value of foreign profits could more than offset the tax increase from increasing tariff rates.
The combination of lower interest rates and rising earnings estimates is a powerful driver of stock market gains. As long as the economy isn’t headed for a recession, the stock market should prove resilient. Lower interest rates also support fixed income returns. The benchmark for bond returns is up almost 5% year to date. 2025 is shaping up to be a very productive year for portfolios that own both stocks and bonds.
My original year-end target of 7,000 on the S&P 500 still seems possible, although it may be a little optimistic. Year-to-date, our stocks are up around 7-8%. Bonds are producing solid returns as well, up almost 5% year-to-date. After two years of very strong performance, expectations should be a little lower for this year. As long as the economy continues to grow, valuations hold up. With valuations stable to increasing, the modest earnings growth for 2025 should lead to modestly positive returns for stocks.
The stock market discounts future earnings growth. As of this writing, the S&P 500 is trading at an all-time high of 6,445. This is 22.45x expected earnings twelve months from now. S&P 500 earnings a year from now should be around $287. To try and project returns for the next 12 months, we need to project earnings estimates two years from now. There aren’t many estimates this far out, and the farther we project, the less reliable the estimates will be. We have to start somewhere.
Services like Bloomberg and Factset compile the estimates of the economists and analysts who have the job of modeling what the economy will look like in the future. The current consensus of these analysts for S&P 500 earnings two years from now is $321. Assuming that we don’t go into a recession within the next twelve months, this estimate seems reasonable. If we don’t have a recession, the valuation of stocks should stay around where it is today.
The most likely level for the S&P 500 this time next year is 7,200–an increase of about 12% from today. Add in a roughly 2% dividend and we can project a next twelve-month return of about 14%. Not too shabby!
Eric Barden, CFA
