Mid Year Outlook

August 1, 2025

Economy Remains On Pause

A Wall Street Journal headline from early June declared this: "Tariffs Are Projected to Slow U.S. Growth, Raise Inflation." In July, I chimed in with this: "An Economy On Pause." As of this writing, some of my prognosticating looks right, and some looks wrong

Because you know the rest of that story, let’s instead focus on the merits of each side’s argument for cutting rates versus the Fed’s current policy "pause." Let’s also talk about earnings and valuations, which may wind up mattering more to investors in the second half than Washington’s conflicting monetary and fiscal policies.

But at least I’m in good company: The Fed also seems unsure about what’s happening!

Central to all this uncertainty are the comparative trade concessions President Trump has achieved. Far less punitive than he initially trumpeted, share prices have been drifting further into record territory with most every concession. It’s been enough to wonder where stocks would be trading if he simply had said "Never mind!"

Granted, there are holdouts, namely Canada, China and Mexico. But even if all sides blink, the Organization for Economic Cooperation and Development (OECD) forecasts tariffs to shrink U.S. GDP growth to an annualized rate of 1.6% this year, down from 2.8% in 2024. For its part, Goldman Sachs pegs 2025’s growth at just 1.7%, which happens to match the Fed’s projection.

Perhaps because of this, and much c-suite pushback from the very companies the president hopes will benefit from "re-shoring" (think automakers), his tariff concessions are not the sole reason for investors’ new-found enthusiasm for stocks.

While the Consumer Confidence Index rose only slightly in July, it and other economic measures are several steps behind America’s cooling trade war. (To be fair, so were economists’ GDP projections.)

But with only a few U.S. tariffs fully implemented, complicated global supply chains mean that it may take a year or more to accurately gauge the effects of tariffs on inflation. It’s also unknown if they will be absorbed by U.S. consumers, exporters, importers, or some combination thereof. (While my money is on the latter, high-value-added goods will most assuredly be treated differently versus commodities, for example.)

As baseline tariffs of around 15% (the highest in modern U.S. history) become fully implemented on most of our largest trading partners (Japan and the 27-member E.U.), strategic partners (10% for the U.K.) and military allies alike (10% on Australia, but up to 60% on steel and aluminum), it may be decades before its full effects (meaning economic and geopolitical) are made obvious.

For the time being, stock investors are looking past trade and deficit spending to other issues: inflation, interest rates, GDP growth and corporate earnings.

On Wednesday July 30, the Fed’s decision to leave interest rates in the range of 4.25% to 4.5% surprised few, as consumer prices (through June) rose 2.7% — above the Central bank’s well-telegraphed 2.0% target. (Inflation has now topped that level for nearly five years running.)

With two of its 12 members now dissenting, the odds of a September cut nonetheless fell. As has been the case, with Chairman Powell shrugging off President Trump’s insistence that rates be cut, he cautioned of the risks instigated by cutting too soon, while also acknowledging the potential impact of moving too late. (What went unmentioned was the president’s desire to replace Powell, which neither the bond nor stock markets seem to want.)

Catching the Fed’s attention is weakening private employment data (though state and local governments continue to hire), a decline in disposable income, slowing housing starts, and especially the 0.5% contraction in first-quarter GDP growth. On the other hand, preliminary estimates for second-quarter growth popped to a seasonally and inflation-adjusted rate of 3.0%. To some degree, that suggests the economy is faring fine without a rate cut.

Of the most immediate concern to equity investors is earnings. As is typically the case, the outlook for sectors differs greatly.

Among the very first to report were banks. Considered a bellwether for the overall economy, so far they’re beating expectations: Select Banking rose a modest 1.8% last month. But given the market’s volatility in the first half, Brokerage and Investment jumped over 5% in July and almost 22% in the past 90 days.

On the other hand, with oil prices falling nearly 10% this year, the energy sector is expected to have the largest year-over-year earnings decline relative to all 10 other sectors.

With a third of S&P 500 companies having now reported, FactSet reports that across all sectors, 80% indicate both positive earnings and revenue surprises. That’s 2 percentage points above the 5-year average.

That’s the good news. But drill deeper and FactSet’s news gets concerning: not only is the magnitude of earnings surprises down, those already reporting suggest that year-over-year earnings growth rates are at their lowest level since Q1 2024 (up 5.8%).

Further, more companies have so far reported year-over-year declines in earnings versus growth.

If these downward trends persist, they come at a time of record-setting highs for the S&P 500 index and accompanying high valuations. With the forward 12-month price-earnings ratio for the market at 22.4, that’s significantly ahead of its 5- and 10-year averages of just 18.4.

But not to worry — at least not yet. If preannouncements and analysts’ projections come through, the next four quarters should see an acceleration in earnings growth from today’s level. And, with some of the tariff cloud lifting, the chances of providing more accurate forecasts has gotten easier.

Against the backdrop of stocks trading at a premium, minor concerns include modestly higher inflation, a mixed jobs report, an earnings miss for a bellwether stock, or even an unexpected geopolitical shock. Each have the potential to trigger a selloff when prices are this elevated. As the p. 12 chart reminds, market volatility is often present but shouldn’t chase us to the sidelines. That’s all-the-more true when earnings are poised to accelerate.

— John Bonnanzio