Feeling less lonely than I like ... yet still bullish

It’s been a full month since my last memo, The Other Side of the Rainbow. Since then, more investors have been seeing what we’re seeing, and the Rainbow is coming into focus. The trade war uncertainty though still present has become less bad; inflation data has continued to soften; the probability of the Fed starting a new rate cut cycle is rising; the job market is holding up and the economy with it; and earnings have been coming in better, so far. Markets have continued to rally, with the S&P up another 6% on the month, led by growth stocks and small caps. The US dollar has stabilized, as have the bond markets. All pretty good.

So, what next?

Well, it would be sensible for sure for markets to take a breather here. With so much good news priced in, why not? We’d note for example that Netflix, one of the leaders of the present rally, fell Friday on a terrific “beat and raise” earnings announcement. It was a beat, but not enough for the traders that were hoping for even more. This said, Federated Hermes’ macro team is sticking with our present overweight position in equities and hanging tight. We are in a solid bull market here, and in our experience, in bull markets, you don’t sell rallies; you buy dips. We see a rotation into some of the market laggards as more likely than a full-blown market correction.

This memo will assess where we are now, what we like ahead, and where this present bull market could go from here.

Where We Are Now

Despite the enormous move off the lows, which everyone focuses on, YTD we’re only up 7% and still below our long-standing 6,500 year-end forecast. Small caps have lagged, while the Nasdaq has led.

This said, most sentiment indicators are far from overbought despite the move, and sell-side strategists on average have year-end targets below present S&P 500 levels. In some ways, this has been a hated rally, with a wall of cash stuck on the sidelines following the scary 12% market plunge in April where many investors sold out.

While key uncertainties remain, on nearly all fronts of the major worries that gripped the market in February, we are better off today than we were then:

Tariffs and the trade war are fading as existential risks to the Bull. Most "deals" are still in process, but increasingly we seem to be centering on a 10-20% tariff level.  Although substantial, given that imports only represent 12% or so of US GDP, this one-time inflation impact is relatively small, likely less than 1% (roughly, a 15% average tariff x 12% of GDP imported x 50% of tariff paid by foreign exporter = a 90 bps one-time hit, spread over many months). No wonder that tariff headlines no longer have the ability to move markets.
Geopolitical risks are also receding. While both Ukraine and the Mideast conflict remain unresolved, they seem to be moving in the right direction. The China "Cold War" is similarly unresolved but markets have taken comfort from President Trump's pragmatic approach towards maintaining this important trading relationship rather than sundering it. (See for example last week's announcement that Nvidia will be allowed to ship H20 chips to China.)
The tax bill has been passed and exceeds expectations. Somewhat surprisingly, the "One Big Beautiful Deal" passed on time, with better-than-expected economic boosts, such as accelerated depreciation on capital expenditures and tax cuts on tips. With this, the economy has overcome a major area of uncertainty which had been holding back big and small businesses from making substantial forward-looking investments. This alone should goose growth numbers in the back half of this year and especially 2026.
Inflation data has stabilized. For much of the year, traditional Keynesian economists have been forecasting a big pickup in inflation. Like waiting for Godot, the pickup has never arrived. Worse for the bears, the housing component of the inflation gauges — a key driver of the price index and far more important than tariffs — continues to grind lower. Consensus is now forming around our long-standing 2.5% core inflation forecast by year-end 2025.
The Fed rate cut debate has shifted from "if" to "when." While the Fed remains on hold despite its fed funds rate running 200 bps above the core inflation rate, even it has acknowledged that rates now will be heading lower. Its latest dot plot calls for two cuts this year and one cut in 2026. While traders get excited about which week this new cycle begins, for long-term investors, whether cuts begin in September or October or December really doesn't matter; the terminal rate for fed funds is clearly now closer to 3% than 4.5%, meaning equity valuations are far less stretched than assumed.  
The economy, buoyed by a resilient jobs market, has been holding up through thick and thin. US GDP for quarters 1 and 2 of this year, supposedly most negatively impacted by the uncertainties listed above, has stunned the bears with its resilience. Although the two quarters were bumpy as orders were shifted around to adjust to the uncertain outlook, the two quarters together averaged 0.8% growth, far from the recession some had expected. Federated Hermes' macro team is forecasting a solid rebound in the back half of this year and an acceleration in 2026. With labor still in relatively tight supply, employers have been more inclined to reallocate resources rather than lay employees off, even as AI implementation is raising productivity numbers. And when American consumers have jobs and their wages are rising, they spend. Even the fiercest bears have now surrendered; recession calls have grown quieter today than they have been in years.
Earnings, the fuel of the stock market, continue to grow. So far, this earnings season has been solid, with beats running even higher than normal. Growth this quarter seems poised for a 13% rate, with more likely to come as the economy re-accelerates in the back half and in 2026. Importantly, as the 2025 calendar begins to tick down, forecasts for 2026, and increasingly 2027, will begin to play into stock valuations. Our 2027 forecast of $340 in S&P earnings implies a 30% earnings updraft from here by then, which makes our two-year S&P return target of 20% seem conservative. 
What we like ahead

While we always get nervous when consensus moves our way and the market rallies, the underlying bearishness of most investors and sell-side strategists gives us some comfort. With a wall of cash still on the sidelines and fundamentals better, not worse, than six months ago, pullbacks are likely to be bought quickly, making them shallow not deep.   

A more likely outcome from here is the market finally begins to shift out of the relative security of the "Magnificent Seven" towards other areas of the market whose earnings are more cyclical but where valuations are substantially cheaper: emerging markets, small caps, industrials, financials, and "value tech." Even select large-cap pharma names, beaten to death now by a variety of forces, are more likely to bounce from here than to decline further. We are overweight most of these areas and will remain so. 

Despite the 26% run off the lows, as we enter the final five months of 2025, we anticipate the market continuing to grind higher towards our long-standing 6,500 year-end target. Market rotation seems more likely than a sharp decline. It is getting less lonely than we like up here, but not enough to scare us off the hill.