The Good News is in the Price
A photographer recently asked while taking pictures for our new website, “How is the economy doing, and why is the stock market so high when everyone says the economy is slowing?”
Here’s one common answer: The U.S. economy is massive—like an ocean liner, it doesn’t turn on a dime. When it does begin to slow, inflation tends to ease, which gives the Federal Reserve room to cut interest rates. That typically benefits both bonds and stocks. Meanwhile, legislation like the “Big Beautiful Bill” is expected to further stimulate the economy, increasing corporate earnings while new tariffs are projected to help offset the cost of tax deductions.
We agree in part—and disagree in part. Yes, the U.S. economy is the largest in the world and difficult to slow quickly. And yes, a slowdown is widely expected. But there's also a temporary boost to Gross National Product (GNP) from a sharp decline in imports—since imports subtract from GNP, this reduction acts as a short-term tailwind.
Ahead of the April tariff deadline, businesses rushed to import goods, ballooning the trade deficit to $130 billion per month. After tariffs were delayed, the deficit dropped sharply to $60 billion in April, only to rebound to $71 billion in May. This back-and-forth shows how sensitive trade flows are to tariff policy.
Markets appear to be pricing in an average tariff rate of around 16.5%—a significant jump from 2.5% earlier this year. We believe tariffs may go even higher or be reintroduced strategically to pressure trading partners. However, their inflationary impact may be delayed if implementation continues to get pushed back.
Our view is that investors are too optimistic. We think the eventual impact of higher tariffs will likely be more inflationary than the market expects. And since inflation is influenced by many complex variables, the Fed is rightfully cautious about cutting rates too soon. In fact, when it lowered rates last year, long-term yields actually rose—something they’ll want to avoid repeating.
On the fiscal side, Congress is moving to extend tax cuts set to expire at year-end—good news for growth, but also a primary driver of the expanding federal debt. The bill could add $2.5 to $5 trillion to the national debt over the next decade. In anticipation, long-term bond yields have already begun to rise. Meanwhile, immigration policy changes may continue to exert upward pressure on wages in certain sectors, adding to inflation concerns.
What to Do?
The S&P 500 is once again near record highs, with much of the gain concentrated in a handful of large-cap tech names. The equal-weighted S&P 500 is up only 5.3% in Q2, compared to 10.9% for the cap-weighted index—suggesting that broader market participation remains limited.
In light of this, we’ve maintained a larger-than-usual allocation to short-term cash and money markets to reduce portfolio volatility. These allocations currently range from 15% to 45%, depending on your risk tolerance. We expect to hold this position unless we see a significant market pullback that offers an attractive buying opportunity—assuming we don’t also foresee a recession.
Tariff negotiations tend to drag on, and we expect elevated tariff levels—and interest rates—to persist longer than many investors assume. That leads us to believe the stock market is fully valued for now. That said, selective opportunities still exist, and we’re actively looking for them.
As always, we welcome your questions. We want you to understand what we’re doing and why—it makes you a better-informed investor, and us a better advisor.
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