Stocks Surge Amid Tariff Fears: Is the Rally Sustainable?

Market defies expectations as investors bet on a familiar pattern of presidential negotiation.

Despite widespread apprehension regarding impending massive tariffs, the stock market is experiencing a significant upswing, with major indices like the S&P 500 and Nasdaq hitting record highs. This surge defies concerns that President Trump’s trade policies might cripple the economy.

The “It’s the Economy, Stupid” Factor

The resilience of the U.S. economy appears to be the primary driver behind investor optimism. Inflation, while ticking up to 2.7% in June, has not escalated to the dire levels some had predicted. Furthermore, the labor market remains robust, with employers continuing to hire and unemployment holding steady at a historically low 4.1%.

“The economy has proven to be more resilient than many feared in the face of tariff threats,” observes Brad Peterson, national portfolio adviser at Northern Trust. This persistent economic strength is a key factor in the market’s current upward trajectory.

Corporate Earnings Offer Support

Corporate earnings reports are also contributing to the positive market sentiment. Companies such as Alphabet, Netflix, AT&T, and Hasbro have exceeded Wall Street’s expectations, with many expressing optimism about their future outlooks. Delta Air Lines, for instance, noted that travelers are showing increased confidence despite the ongoing tariff uncertainty.

This performance highlights a curious dichotomy: while consumer sentiment may be tinged with concern, actual spending remains strong, bolstering corporate profitability. “We may feel bad. We may feel concerned, but the hard data would suggest our behavior is something else entirely,” stated Amanda Agati, chief investment officer for PNC Asset Management Group.

However, certain sectors are experiencing more significant headwinds. General Motors reported a $1.1 billion impact on its profits due to higher tariffs, though the company remained profitable overall. Small businesses, lacking the financial flexibility of larger corporations, are expected to bear the brunt of these increased costs.

The “TACO Trade” Narrative

The market’s reaction to President Trump’s tariff announcements has also been shaped by a perceived pattern of negotiation. After initial sharp downturns following aggressive tariff proposals, stock markets have rebounded as Trump has subsequently announced trade deals with negotiated, often lower, tariff rates. This has led to the informal “TACO trade” moniker, standing for “Trump Always Chickens Out,” reflecting a belief that his actions may not be as severe as initially threatened.

This phenomenon was recently evident with a trade deal with Japan, where a 15% tariff was announced. While significant, this was lower than the 25% previously suggested, prompting investor relief and contributing to another S&P 500 record high. This dynamic suggests investors are adjusting their expectations, finding relative comfort in outcomes that fall short of the most extreme scenarios.

“We live in a new normal where 10% is the new zero and so 15% and 20% doesn’t seem so bad if everyone else got it.”

—Trinh Nguyen, Senior Economist for Emerging Asia at Natixis

A recent analysis by the U.S. Bureau of Labor Statistics indicates that while import prices have risen due to tariffs, the full impact on consumer inflation is still unfolding, with the Consumer Price Index (CPI) currently showing a moderate annual increase. However, the overall average tariff rate remains at its highest point since the 1930s.

Lingering Doubts and Future Uncertainties

Despite the current market buoyancy, underlying fears persist. Key trading partners like Mexico, Canada, China, and the European Union still face significant tariff negotiations, the outcomes of which remain uncertain. The cumulative effect of these tariffs, even at negotiated rates, could still exert downward pressure on economic growth and contribute to inflation.

Adding to market volatility are ongoing uncertainties surrounding President Trump’s comments and actions regarding Federal Reserve Chair Jerome Powell. While Trump has indicated no immediate plans to remove Powell, his continued criticism of the Federal Reserve and its monetary policies introduces an element of unpredictability.

The current high valuations of stocks also raise concerns. “Everybody’s assuming everything’s going to be perfect,” commented Sandy Villere, partner and portfolio manager at Villere & Co. “That’s usually where you get the pullback. When things are priced for perfection, we get nervous.” This sentiment suggests that the market’s current optimism might be vulnerable to unforeseen economic shifts or policy changes.