A Glass Half-Full

Despite tariffs and the angst that goes with them and despite inflation remaining stubbornly close to 3%, the S&P 500 continues to grind higher.  It reached an all-time high on September 11^th and is now up 13% for the year.  Depending upon your frame of reference in these politically charged times, it seems that the current backdrop is either a glass half-full or a glass half-empty.

The tariff-induced selloff earlier in the year from mid-February to early April saw the market fall 18.8%, down sharply in a very short amount of time.  But since April 8^th, the market is up 33% as investors determined that the most disruptive tariffs were modified to some degree and agreements with most of the US’s major trade partners pointed toward a resolution.

The market has largely been rallying on the belief that the Fed is now poised to cut rates in September and possibly one or two more times this year.  This is despite inflation remaining above its preferred target.  This would seem to indicate that the Fed’s mandate to promote full employment has priority, at least for now, over the Fed’s price stability mandate.  The impetus for the Fed to cut rates is the slowing job growth that we’ve seen over the last couple of years now (chart #1 below).  Younger people in particular are experiencing higher levels of unemployment.  16- to 24-year-olds had an unemployment rate of 6.6% in April 2023.  It now stands at 10.5%, while the overall unemployment rate stands at 4.3% (chart #2 below).  Higher minimum wages likely explain part of this issue, but we also hear of recent college graduates finding it increasingly difficult to find a job.

Indeed, McDonald’s CEO recently said that they are seeing middle- to lower-income consumers under pressure right now.  He said that “it’s really kind of a two-tier economy” where upper-income consumers remain healthy and in spending mode, while everybody else is rather cautious.  Despite these comments from the CEO, McDonald’s stock is up 8.2% this year compared to the broader restaurants group being up 2.9%, as restaurants have had to deal with higher food and labor costs.

An example of tariffs directly impacting a company can be seen in Caterpillar’s recent disclosure that the net impact from tariffs in Q3 would be $500 million to $600 million.  And for all of 2025 the impact would be $1.5 billion to $1.8 billion, this is up from the previous range of $1.3 billion to $1.5 billion.  Caterpillar’s stock however, is up a healthy 20.4% year to date on continued strong non-residential construction activity.  This is compared to the industrials sector’s up 16%.

As mentioned above, inflation has been trending sideways and not necessarily, at the moment, showing firm signs of moving closer to the Fed’s preferred target of 2%.  But this hasn’t stopped the entire interest rate curve from shifting lower over the course of the year so far.  Two-year and ten-year treasury yields have fallen by 70 and 55 bps to date, respectively.  The decrease in the 10yr rate has led mortgage rates to fall to 6.27%, down from over 7% in January.  This in turn has caused housing-related stocks to rally.  Since mid-June housing-related stocks have inflected and are outperforming the market, up 32.2% compared to 10.4% for the S&P 500.

Biotech stocks are another group of stocks benefiting from lower rates.  Since mid-May they are up 25.2% compared to the broad market’s 12.3% return.  Small- and mid-cap biotech stocks are highly impacted by their cost of capital and the recent relief in rates has been welcome for this group that has been weak for the last three-plus years.

So, we see the market having a glass half-full outlook as it continues to move higher this year.  The issues of tariffs and their potential implications on inflation and a bifurcated consumer spending backdrop remain areas of concern for the market and the Fed.  And we can see different parts of the market anticipating ahead of time lower interest rates from the Fed.   This has lifted beaten down, interest rate sensitive groups of stocks, demonstrating the impact that lower rates can have in short amount of time.

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