Whether you agree or disagree with the policies and methods of the Trump administration, this past quarter has reconfirmed that when Trump is in the picture, everything gets amplified. With strong opinions on both sides, headline risk has reemerged in the past few months, with media and markets reacting (and overreacting) with seemingly every new headline or report, regardless of underlying details.
During the previous quarter the biggest of these reactions came from the announcement of “Liberation Day” tariffs. Predictions of imminent recession quickly followed, and the stock market pulled back into correction (and in some instances bear market) territory. Fast forward to the end of the quarter, and many have started to get used to the uncertainty around tariff policies while the stock market has rebounded to where it was pre-tariff announcements.
This is not to say that we believe tariffs are good for the economy. Rather, it is simply to illustrate that the details matter. The Trump administration did back off and de-escalate to some degree on the tariff front as negotiations kicked off with a host of other countries.
As investors, it is crucially important that we sift through all of this noise to evaluate where opportunities lie and navigate a choppy and uncertain landscape. We have to take off any partisan lenses and understand the hard data and trends in the marketplace to find good long-term investment ideas.
While the tariff discussion has taken up much of the oxygen in the room, there is a lot more in the mix. Overall, growth and economic activity have held up through the first half of the year. While we saw a small contraction in Q1 (related to tariff front-running), we will likely see a large rebound in Q2 as that activity reverses. Job growth and consumer spending have also continued this year, albeit at slower paces than the past couple of years. Inflation has continued to moderate, and while year-over-year numbers will likely take a pause over the next few months due to lower readings this time last year, we are still seeing a good trend in the monthly data suggesting inflation progress continues. Housing activity continues to struggle with high interest rates, but is showing signs of a thaw, at least at the higher end of the market. Outside of the tariffs, companies are also excited about deregulatory efforts and the renewal and potential expansion of the 2017 tax cuts package.
As referenced in last quarter’s communication, there are pros and cons in the current policy mix along with a large degree of uncertainty. That increases the potential range of outcomes and also makes it more difficult to predict the success or failure of the overall program. Most companies are likely looking at most of these policies favorably, except for the tariffs.
This quarter also brought new activity when it comes to the decades long issue of Iran and their nuclear ambitions. Iran and the U.S. were having discussions to attempt to come to a diplomatic solution to Iran’s nuclear program. However, the 60-day deadline passed, and the IAEA also confirmed that Iran was not meeting its obligations under the Nuclear Nonproliferation Treaty. After this, Israel attacked Iran’s military and nuclear program, followed by the U.S. striking Iran’s nuclear facilities. Many predicted this was the start of WWIII. However, after a few weeks, there are reports of significant damage to Iran’s nuclear program, a ceasefire is currently in place between Iran and Israel, and discussions continue to find a long-term solution to the nuclear issue.
Initial market jitters settled down as it became clearer that there would not be broader geopolitical fallout. It also appears that Iran has been so thoroughly weakened over the past couple of years (between direct strikes on their air defenses to the significant damage done to their proxy network in the region) that they may not be able to mount a significant response in the short-term.
In this age of heightened uncertainty and knee-jerk reactions, let’s stay focused on the fundamentals and block out the noise!
Federal Reserve Policy. The Fed maintained its key interest rate benchmark at 4.25-4.50%. The Fed is in wait and see mode, while still signaling its intention to lower rates twice later this year.
Economic Growth – GDP. Growth came in at -0.5% for Q1. Q2 growth is currently projected to be +2.9% (according to Atlanta Fed GDPNow), showing a reversal after the trade induced contraction in Q1.
Labor Markets. Job growth continued in Q2, albeit at a slower pace than 2024. The unemployment rate ticked up slightly to 4.2%. U6 unemployment ticked down, currently at 7.8%. The Labor Force Participation Rate still sits at 62.40% after a brief increase.
Inflation. Inflation progress picked back up with year-over-year data improving from 3.0% in January to 2.4% in May for the headline CPI. Monthly data has been relatively subdued. Expect a pause in year-over-year progress this summer, with downward trend picking back up later this year. The most recent PCE reading was 2.3%, which is still above the Fed’s 2.0% target.
Consumer Sentiment & Spending. Retail sales are still increasing year-over-year, but have started to show signs of softness. The recent retail sales report for May showed a month-over-month contraction of -0.9%, while still growing 3.3% year-over-year. More concerning are large drops in the consumer confidence indexes during Q1 and Q2. Eyes will be on these measures to see if this is a short-term tariff related blip, or a broader trend. The consumer is extremely important to the overall US economy, and the trendlines in consumer spending have implications for companies across the spectrum.
Housing & Real Estate. The real estate sector was hoping for a shot in the arm with the advent of lower interest rates. However, the Fed has paused their rate movements for the past six months. This has continued to hold back certain real estate activity, and while there was a short burst of activity in the mortgage refi market, that has relaxed as rates increased. The higher end of the market is showing some signs of activity, but the lower end of the market continues to struggle, potentially signaling that buyers are priced out of the market with high interest rates and prices.
Business Investment & Manufacturing. The end of a long period of contraction in the manufacturing sector was short-lived. After a couple of positive readings, the ISM manufacturing index slipped back into contraction territory, and has remained there since its last expansion reading in February. The latest reading in May was 48.5. The service side of the economy has largely remained in expansion territory, although May did bring the first contractionary reading of 49.9.
Regulatory Environment. Treasury and Fed announce regulatory rollbacks for banking industry including relaxing SLR. Tariffs were paused until July 9th, and a mini deal with China was made to de-escalate trade war. Multiple agencies are conducting a rule review to get rid of costly and inefficient rules. Collections restarted on student loans after 5+ year pause. CRA used to kill CA’s EPA waiver for auto emissions rules. EPA moves to rescind Biden Administration climate rules on power plant CO2 emissions and mercury.
Global Economy. Talks continue between the US, Ukraine, and Russia to bring an end to the war. NATO agrees to increase defense spending target for its members to 5% from current 2%. Israel still at war in Gaza. Iran-Israel dust up results in Iran’s nuclear program being significantly degraded, with hopes of more stability for the region. Central banks have largely stopped increasing interest rates. Many have started lowering them. China feeling effects of trade war and continues to hold back rare earth exports.