Even as the U.S. economy experiences significant adjustments, with a softening job market and President Donald Trump shifting his focus between various economic concerns, the stock market has surprisingly maintained its upward trajectory.
Despite these economic challenges, the S&P 500 Index has gained almost 8% so far this year. The sustainability of this ascent hinges on whether the foundational resilience of the U.S. economy can endure the profound reshaping of the global trading system initiated by President Trump.
Economic theory posits that stock prices inherently reflect a company’s anticipated future profit streams at any given time. However, despite the significant intellectual effort dedicated to these forecasts, they remain largely approximate projections for the coming twelve months and highly speculative assumptions for anything beyond that period.
In recent weeks, companies have reported second-quarter results that surpassed market expectations, leading analysts to even modestly increase their estimates for the upcoming three months. Market valuations currently exceed historical averages (at approximately 22 times forward earnings). Nevertheless, bullish investors contend that this valuation incorporates groundbreaking technology firms anticipated to garner significant benefits from the artificial intelligence revolution.
This robust performance seems plausible for an economy that has sustained growth over the past five years, rebounding strongly from COVID-19-induced lockdowns, navigating the most significant interest rate hikes in four decades, and continuing to demonstrate resilience as the president undertakes a fundamental restructuring of the global trading system. Substantial financial aid and exceptionally low interest rates in the wake of the pandemic could account for at least a portion of this exceptional economic showing.
Nevertheless, equity markets are fundamentally driven by future expectations, and this historical context offers limited insight into the repercussions of the Trump Administration’s significant policy shifts.
The “One Big Beautiful Bill” secured reduced corporate tax rates and provided a substantial increase to defense expenditures, projected to add an estimated amount to the deficit over the next decade, according to the Congressional Budget Office. The administration, however, asserts that this, combined with widespread deregulation, will result in growth rates exceeding 1% over the next four years.
While that would be a remarkable achievement, most independent economists anticipate that tariffs will present greater challenges than tax cuts and deregulation will provide benefits. The International Monetary Fund recently upgraded its global growth forecast to 3.1% for this year—but projects U.S. growth to remain below 2% in 2025 or 2026.
The issue lies in the fact that tariffs effectively act as a significant hidden tax increase, with average rates potentially rising from 2.5% to almost 20%, contingent on the final scope of goods included. Not all prices will escalate proportionally, given that imports constitute just over 10% of the economy, and numerous companies will absorb a portion of these increased expenses. Nevertheless, the estimated $300 billion in tariff revenues that Treasury Secretary Scott Bessent anticipates this year will ultimately be borne by American consumers and businesses.
More concerning than this immediate financial impact, however, is the persistent ambiguity for investors and corporate strategists. Even as Trump’s tariffs are poised to take effect on Aug. 7, essential specifics of the agreements he has publicized remain undisclosed.
Meanwhile, Trump has vowed to impose additional tariffs on certain goods and sectors. And even if ongoing legal challenges compel him to withdraw some tariffs, his threats made via “Truth Social” regarding tariffs to exert pressure on prosecutors or impede purchases of Russian oil will maintain a state of apprehension among stakeholders.
A significant question also surrounds Chinese imports, many of which could see tariffs revert to their previous levels should the current trade truce not be prolonged past Aug. 12. Negotiators had indicated a potential extension of the deadline, aiming for an agreement that President Trump and China’s President Xi Jinping might endorse at a forthcoming fall summit. Subsequently, the White House rejected this suggestion. Indeed, it takes very little, perhaps even just a minor incident like a weather balloon, to disrupt this delicate relationship.
Markets reacted with a significant downturn to Trump’s initial “Liberation Day” tariff announcements in early April, marked by a concurrent liquidation of U.S. stocks, treasury bonds, and the dollar. If that news was a shock, today’s surging stock prices suggest investors are confident the economy can absorb increased costs and ongoing uncertainty. Alternatively, they may anticipate imminent interest rate reductions by the Federal Reserve.
However, the true test will emerge in the fall when products bearing their new post-tariff price tags begin to appear in retail outlets. Will this lead to another inflationary surge that the Fed must counteract with delayed interest rate reductions? Might they dampen the holiday consumer confidence of American shoppers and heighten recessionary risks?
Even more concerning, could both scenarios materialize? If a potential U.S. action targeting Iranian nuclear facilities, ongoing conflict in Ukraine, and the president’s persistent pressure on the Fed are not enough to destabilize this market, it could be a resurgence of 1970s-style stagflation that ultimately succeeds.
