By now, most are aware that tariffs can create inflationary shocks and slow economic growth — a stagflationary setup — by increasing the cost of imported goods. However, despite the potential for such pressures, inflation data has so far remained relatively benign.
May's Consumer Price Index (CPI) came in at 2.4% year-over-year, right in line with expectations, while Core CPI was 2.8%, below the forecast of 2.9%, marking its lowest level since March 2021.
Data suggests that U.S. companies have been absorbing much of the inflationary impact through margin compression since Q3 2024. This can be seen in the differential between CPI and PPI Final Demand (which captures the change in prices as goods leave their place of production). Exhibit 1 highlights that as CPI has been trending downwards PPI has been trending upwards. This spread suggests that businesses are shielding consumers from rising input costs (See Exhibit 2).
If this dynamic continues unchecked (which is unlikely), it could lead to a significant squeeze on corporate profit margins, potentially resulting in cost-cutting measures such as layoffs, and eventually an economic slowdown.
Inventory Front-Running: A Temporary Buffer
Ahead of the April 2nd "Liberation Day" tariff implementation, many companies front-loaded inventory, creating a buffer that could last 6 to 9 months. During this period, firms may continue absorbing higher input costs rather than passing them on to consumers.
In our view, possibly by late 2025 when the restocking cycle begins, the magnitude of the tariffs may make it less feasible for businesses to continue this practice. Instead, they may be forced to pass on higher costs to consumers, pushing inflation higher.
Q1 2025 GDP, according to the second estimate, contracted by -0.5%. This figure was significantly influenced by the import front-running activity ahead of the tariff deadline. A better reflection of the underlying economy in this case is GDP Domestic Final Sales, which strips out the impact of net exports and inventory changes. By that measure, the U.S. economy grew by 1.52% during the quarter (See Exhibit 3).
Soft vs. Hard Data Divergence
A noteworthy shift is underway in the data landscape. Soft data (such as consumer confidence, PMI surveys, and business sentiment) is improving, while hard data (like GDP, industrial production, retail sales, and employment) is weakening. This is a sharp reversal from previous months (Exhibit 4).
This type of divergence normally signals uncertainty, wherein the Fed will most assuredly continue to adopt a cautious stance, balancing weak hard data (prompting potential easing) against improving sentiment (suggesting less urgency for aggressive cuts).
Labor Market: Stable But Softening
Unemployment remains steady at 4.2%, and the job openings-to-unemployed ratio sits around 1 (Exhibit 5), suggesting a labor market that is neither overheating nor in distress.
However, early signs of weakness are emerging. Continuing jobless claims are trending higher, pointing to some softening in labor demand. While not alarming yet, it is a development worth watching closely.
Corporate Fundamentals: Still Resilient
Despite the macro uncertainties, corporate fundamentals have held up well. As of June 19, 2025, trailing 12-month earnings have grown by 11.46%, reflecting solid operational performance (Exhibit 6).
As the market continues its ascent from post Liberation Day, the bottom-up earnings estimates (rolling 12 months) have exhibited a recovery and have been slowly trending upward (Exhibit 7).
As at 6/20/25, the forward estimates increased by 1.13% and 1.27% on a 4-week and 8-week basis respectively (Exhibit 8).
Earnings revisions have also demonstrated improvement from 2025 Q1 to 2025 Q2, with the percentage of companies revising upwards from 17 to 22 (Exhibit 9).
In summation, to date, there is no clear evidence that the U.S. economy or corporate fundamentals are broken. The economy remains resilient, and companies continue to post solid earnings.
Market Outlook: Equities
On a total return basis, all major U.S. indices have now recovered the losses incurred following the April 2 tariff shock (Exhibit 10). As of June 18, the S&P 500 was just 3% below its all-time high. While the major index continues to show strength, the underlying market breadth tells a more cautious story.
An examination of the Mag 7 stocks, which hold substantial weight in the index, shows they have returned 13.53% since Liberation Day, compared to a much smaller 1.02% gain for the S&P 500 Equal Weight Index (SPW) over the same period. This disparity underscores the concentrated nature of the rally, largely driven by AI enthusiasm and the exceptional profitability of mega-cap tech.
Indeed, when comparing operating profit margin (OPM), the Mag 7 average OPM is at 26.87% compared to the SPX at 14.52% (Exhibit 11). This significant margin advantage explains much of their performance leadership and sustained investor interest.
Another key breadth measure — the percentage of stocks trading above their 50-day moving average (See Exhibit 12) — has been trending lower, and currently sits at 65.54%, which is just 6% above its 10-year median.
More notably, longer-term breadth appears even weaker. The percentage of stocks trading above their 200-day moving average (See Exhibit 13) remains well below historical norms, currently at -26% below the 10-year median. This lack of broad participation raises concerns about the sustainability of the current uptrend, as it increasingly relies on a narrower group of leading stocks.
Investors should remain mindful of this divergence. Strong index performance without wide participation could be a sign of market fragility rather than a foundation for long-term gains.
At current levels, markets appear priced for perfection, leaving little room for disappointment. The equity risk premium (defined as the SPX 12-month forward earnings yield less US 10-year treasuries) is essentially zero (-0.06 as at 6/19/25), signifying that investors are not being compensated for holding equities over risk-free assets.
Looking ahead, several near-term risks are coming into sharper focus. The upcoming expiration of the reciprocal tariff rollback on July 9 introduces uncertainty over potential trade disruptions. Geopolitical tensions — particularly between Israel and Iran, and the ongoing Russia-Ukraine conflict — continue to pose significant risks to global stability and market confidence. Additionally, concerns about a widening fiscal deficit and long-term debt sustainability are intensifying. These factors, taken together, could weigh heavily on investor sentiment and economic performance, particularly in an environment where the equity risk premium remains historically low.
While it's still too early to assess the full economic implications, we believe the market has been getting a bit ahead of itself and is due for a near-term pullback.
On a valuation basis (Exhibits 14 & 15), the S&P 500's current forward P/E multiple of 21.42x stands 7.16% above its 5-year average and 15.59% above its 10-year average — a sign that the market is pricing in a relatively optimistic outlook.
With forward earnings per share (EPS) currently projected at $279, a reversion to the 5- or 10-year average P/E multiples would imply a potential fair value range (Exhibit 16) for the index between 5,015 and 5,572 — a broad value zone which investors could find attractive towards adding exposure on any weakness.
However, if we account for a -5% decline in forward EPS — reflecting the potential for a modest growth slowdown (not a recession) stemming from increased inflationary effects from tariffs — this would reduce forward EPS to approximately $265 (see Exhibit 17). Applying the 5-year average multiple to this revised estimate suggests a potential pullback toward 5,293 in that scenario. The 5% peak-to-trough EPS decline is in line with more recent periods of growth slowdowns outside of outright recessions (Exhibit 18).
In short, while the market remains resilient, elevated valuations suggest a narrowing margin for error. Any softness in earnings or macro sentiment could prompt a re-rating closer to historical norms.
Barring an inflationary shock, any pullbacks are expected to be shorter term in nature, as it is our view that the market will start to look beyond short-term headwinds and begin to price in the potential for policy-driven support (i.e. the "Big Beautiful Bill") and a more accommodative monetary backdrop for the second half into next year.
Interest Rates
The US yield curve has been undergoing a bear steepener wherein long-term rates have been rising at a faster rate than shorter-term rates.
Exhibit 19 highlights the 10-year less the 2-year treasury steepened 16.5 bps on a year-to-date basis (as at 6/24/25).
Exhibit 20 highlights the 30-year less the 2-year treasury steepened 49.4 bps on a year-to-date basis (as at 6/24/25).
Exhibit 21 highlights a notable divergence in macro market dynamics: the U.S. 10-year Treasury yield is trending higher as the U.S. dollar weakens. This pattern is indicative of rising term premia, reflecting growing investor concerns over inflation, elevated government debt levels, and broader macroeconomic uncertainty.
Supporting this view, Exhibit 22 presents data from the New York Fed's ACM Term Premia Model, which shows that term premia on the 10-year U.S. Treasury have been steadily rising since 2020. Notably, current term premia levels are now at their highest point since 2014, underscoring recent market debate regarding a potential structural shift in investor risk perceptions and inflation expectations — likely leading to a further steepening of the yield curve. It is worth noting that recent treasury auctions for the 10-year continue to exhibit strong investor demand with bid-to-cover ratios above 2.5.
Investment grade (IG) credit spreads have continued to tighten, with OAS levels now sitting just above one standard deviation below their long-term average — a level typically associated with rich valuations. From a historical perspective, this suggests that IG bonds are starting to look expensive once again (See Exhibit 23).
However, for investors focused on locking in income and holding to maturity, investment grade credit still offers compelling relative value (See Exhibit 24). Breakeven spread analysis remains supportive, especially in lower-rated parts of the IG index. For example, Baa-rated bonds currently offer the highest spread cushion and elevated all-in yields, making them attractive for those prioritizing income over price gains. Risk-adjusted metrics, such as volatility-adjusted breakeven spreads, show A-rated corporates as the best value within IG. On the other end, AAA and AA bonds continue to screen as expensive, offering limited breakeven buffer and relatively low income.
Conclusion
Tariff uncertainty, widening deficits and debt sustainability remain as key risks on the dashboard, as demonstrated by higher term premia. Over the next week the July 9th expiration of reciprocal rollbacks could potentially lead to further trade friction. However, both the economy and corporate fundamentals have proven to be resilient and are suggestive that while the caution lights are on, the engine is still running. In this environment, investors don't need to hit the brakes — but rather just keep both hands on the wheel.
Investment grade credit offers solid yield opportunities for income-focused portfolios (5 to 7-year duration mark), and any pullbacks in equities within the value zone present an opportunity, especially with longer-term policy tailwinds on the horizon. We believe this is a market that rewards selectivity, patience, and a steady hand. PMI
