As America hikes tariffs sharply, the jobs market slips, and President Donald Trump turns his ire from Harvard to the Bureau of Labor Statistics the stock market refuses to collapse.
Despite these economic speed bumps, the S&P 500 Index is up nearly 8% so far this year. How long this rise can continue depends on whether the fundamental strength of the U.S. economy can withstand the wrenching transformation to the global trading system that President Trump has forced.
Economics textbooks insist that stock prices reflect the future stream of a company’s profits on any given day. For all the brainpower devoted to these forecasts, however, they are essentially rough estimates of what may happen over the next twelve months and wild guesses about anything after that.
Over the past several weeks, more companies than usual reported second-quarter results that beat market expectations, and analysts have even slightly raised their estimates for the next three months. Market valuations are higher than historical averages (about 22 times forward earnings) But the bulls argue that this includes those transformative tech firms that will reap handsome rewards from the artificial intelligence revolution.
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That’s all pretty reasonable for an economy that has grown on average 2.8% for the last five years, recovering nicely from COVID-19 lockdowns, powering through the sharpest interest rate increases in 40 years, and still going strong as the president fundamentally redesigns the global trading order. Generous checks and rock-bottom interest rates following the pandemic may explain at least some of this remarkable performance.
Still, stocks are all about future expectations, and none of this history reveals much about the impact of the Trump Administration’s dramatic policy departures.
The “One Big Beautiful Bill” locked in lower corporate tax rates and delivered a massive boost to defense spending, adding some $3.4 trillion to the deficit over the next decade, according to the Congressional Budget Office. The administration promises, however, that together with a wave of deregulation, growth rates will be more than 1% higher over the next four years.
That would be quite something, but most independent economists expect more headwinds from tariffs than tailwinds from tax cuts and deregulation. The International Monetary Fund recently raised global growth forecasts to 3.1% this year—but doesn’t expect more than 2% in the U.S. in 2025 or 2026.
The problem is that tariffs represent a large stealth tax increase as average rates rise from 2.5% to nearly 20%, depending on what goods are ultimately covered. Not all prices will rise by this much as imports represent just over 10% of the economy, and many companies will absorb some of the higher costs. Still, the $300 billion in tariff revenues that Treasury Secretary Scott Bessent expects this year will be paid by Americans.
Worse than this one-off blow, however, is the lingering uncertainty for investors and corporate strategists. Even as Trump’s tariffs went into effect on Aug. 7, crucial details of the deals he has announced remain unknown.
Meanwhile, Trump has promised more tariffs on pharmaceuticals and semiconductors. And even if pending court cases force him to backtrack on some tariffs, his “Truth Social” threats of tariffs to pressure Brazilian prosecutors or block India’s purchases of Russian oil will keep everyone on their backfoot.
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There’s also a big question around Chinese imports, many of which could see tariffs snap back to 145% if the current truce is not extended beyond Aug. 12. Negotiators signaled they might extend the deadline, working towards an agreement that Trump and China’s president Xi Jinping could endorse at a fall summit. Then, the White House walked back this suggestion. Indeed, it doesn’t take much more than a weather balloon to derail this fragile relationship.
Markets delivered a bone-chilling response to Trump’s initial “Liberation Day” tariff announcements in early April with a simultaneous sell-off of U.S. stocks, treasury bonds, and the dollar. If that news came as a jolt, today’s rocketing stock prices suggest investors believe the economy can handle higher costs and persistent uncertainty. Or they believe the Fed will be cutting rates soon.
But the real test will come in the fall when goods with their new post-tariff price tags start arriving in stores. Will they bring another burst of inflation that the Fed has to fight with delayed rate cuts? Could they damage the holiday spirits of American shoppers and raise the risks of recession?
Still worse, might we see both? If a U.S. bombing of Iranian nuclear facilities, escalating fighting in Ukraine, and the president’s persistent attacks on the Fed aren’t enough to derail this market, it could be a burst of 1970s-style “stagflation” that does the trick.
