Weekly Newsletter: May 19, 2025
“We gotta get right back to where we started from.” Since the tariff announcements in early April and the quick, steep selloff that followed, the markets have been working hard to erase those losses. This past week, they have turned positive for the year. Monday’s announcement that tariffs would drop from well north of 100% to “only” 30% was THE event of the week. A moratorium was announced for 90 days, turbocharging the market to a better than 5% gain on the week. It was a pretty good month during those 5 trading days. Raise your hand if you thought the markets could erase all the tariff losses within a few weeks. More importantly, what is next? In what will be a quiet week, economically speaking, there will be plenty of Fed speakers chatting about tariffs, potential inflation, and risks to economic growth. The data last week was benign and indicated that inflation remains somewhere in the foggy future. The weekly jobless data remains stable, indicating the job market remains good. The combination of modest inflation and still good jobs did not translate into strong retail sales. While still good, the modest increase was a big letdown from the very robust March figures. Retail earnings will finish up the earnings season with a mixed bag of results. Chatter about tariff rates will likely drive market moves without the help/hindrance from hard economic reports this week.
Last week had the much-anticipated inflation data, but the driver of market returns was the reduction in tariff rates with China and a 90-day “hold” to negotiate further. The economic data took the back seat as a driver of the markets. Inflation continues to modestly move toward the Fed’s target of 2%, however, Chair Powell is waiting for additional information on the impact of tariffs before pushing the Fed to lower rates. Coming into the year, four rate cuts had been penciled in. Today, there is a discussion between just one or maybe two. Comments from retail earnings last week (more to come this week) centered on consumers moving “down” in pricing, looking for bargains rather than buying with impunity. Anecdotally, consumer debt levels have increased a bit, but more concerning is the increase in delinquency rates on a variety of loans. The markets may be getting caught in an interesting web. The hope is that tariffs return to prior levels and all goes as it has been for years. In that scenario, economic growth in the US would pick up, and earnings would rise. Interest rates might also rise since the economy would not need lower rates to make things go. At some point, higher rates would be a challenge for stocks. Conversely, the tariff dustup carries long-term impacts that could push inflation higher as supply chains are strained. The Fed could lower rates, but corporate earnings decline as sales slump. The starting point for stocks is at a historically high multiple of earnings, which has led to poor returns over the following 5-10 years. The strong rally back from tariff lows indicates all is and will be just fine.
Short-term interest rates are a full percentage point lower than they were a year ago, while long-term rates are higher by roughly one-half of a percent. The modest “reinversion” of the yield curve, where 10year yields are a half percent higher than 2-year yields, may point to better economic strength in the months ahead. The warning sign of a recession, an inverted curve, where long rates are lower than short rates, has been “corrected”. That said, recession fears remain a feature of most analysts’ prognostications for late 2025. Right now, based on the data at hand, that does not seem to be in the cards. So, the reason for the Fed cutting rates may be off the table for quite some time. It may be that rates stay in a range around current levels, which has existed for long periods before the financial crisis.
In keeping with the theme this week, the rally from the tariff lows of early April is back to where they started. That starting point was and is all about technology. Technology stocks are up over 20%, while value and small stocks are up less than 15%. The tech chatter around AI, Chinese technology, and the impact of tech companies doing business in China has focused investors once again on the tech sector. The stretched valuation of the market discussed above is due in large part to the high valuations of technology stocks. Many believe they are the only companies with above-average earnings growth, but looking at the top line (revenue), those growth rates have moderated over the past few years. This is more an indication of financial engineering than true earnings growth.
The Fed and tariffs should dominate the conversation this week. Volatility has not diminished, but no one is complaining when that volatility results in large market gains vs. losses.
The opinions expressed in the Investment Newsletter are those of the author and are based upon information that is believed to be accurate and reliable but are opinions and do not constitute a guarantee of present or future financial market conditions.