Open seas ahead!

Back on January 21, we first warned readers of potentially rougher-than-normal waters ahead as we entered a period of unusually high uncertainty from watching the “sausage making” of President Trump’s agenda on trade, taxes and deregulation. To avoid whipsawing ourselves and our clients, we recommended Odysseus’ approach to navigating the Straits of the Sirens, which was to strap himself to the mast, ignore the calls of the sirens to crash into the rocks and sail forward. Little did we realize then just how prescient this forecast would be. Within a few short weeks, markets nosedived in the midst of the trade negotiations. With water crashing across the bow, we bravely inched deeper into stocks, executing a further buy in our balanced models that put us and our clients at 50% max overweight stocks. Importantly, that buy was an add to US growth stocks, where we’d been underweight and which had experienced a -12% correction at that point. Now as we come out of the Straits, we’ve emerged with a larger overweight than we had going in, which is pretty comforting given how easy it would have been to have gotten badly whipsawed over the last four months.

Said differently, we’ve successfully navigated through the Straits and have even emerged stronger, with an extra sail set to windward as we look out on the wide expanse of open ocean ahead.

So, where now? Our short answer: new highs. Our longer answer, for those interested, is outlined below.

Our milestones for progress now become the Wall of Worry that bull markets thrive on.

In the midst of the storm last April, we published a note highlighting seven milestones that we expected would be forthcoming, all of which would be good news for markets. We’ve already made remarkable progress against these and expect more progress, albeit halting, to come. Let’s review each:

1. Emphasis shifts within the administration from Navarro to Bessent. Check. This shift as stated was our shorthand for a needed shift within the trade discussions from a full on path toward total US protectionism and isolation (call it the Peter Navarro camp) to a more balanced approach seeking to slow the pace of rising US trade deficits by leveling the international playing field, lowering trade barriers around the world and expanding US domestic investment (call it the Scott Bessent methodology). The pace and details of all trade discussions since suggest this latter path is very much the one the administration is now firmly on. And while this path is itself not without worries and issues, it certainly appears more realistic in terms of pace and level of adjustment needed by the global economy to gradually address President Trump’s concerns on fair trade while also insuring we don’t spin into a global recession scenario while addressing those very concerns. Market positive.
2. Clarification of tariff war objectives. Partial check. When we highlighted this milestone in our piece on April 14, we felt we’d already reached clarity by the way in which the temporary rollback was announced. That may have been a bit of a cognitive leap forward, but subsequent announcements have only reinforced our interpretation of where we are. The 10% tariff, which remains in place everywhere, is likely permanent. Effectively, it’s a national sales tax on imports, which raises about $320 billion to help pay for the President’s domestic tax cut program. The administration’s hope is that most of this “tax” will be paid by foreign exporters and/or will be absorbed out of corporate profits. Walmart’s recent protests aside, our guess is that this will prove to be the case, and it’s one of the reasons we’ve modestly scaled back our S&P 500 profit forecast for this year and next. The much larger reciprocal tariffs, which were pulled back (for 90 days) for most countries on April 9 and for China more recently, were there to jump start negotiations toward more fair trade around the world. And finally, the additional 20% tariff on China beyond the “reciprocal” tariffs and the already extant 10% tariff is a negotiating tool for achieving their agreement to help shut down the fentanyl trade. Our expectation is that China will do so, and that the current 40% will eventually become a permanent 20%. While our interpretation of the tariff objectives is relatively benign, the reality is that the administration has never fully explained this and is unlikely to, given what that would do to its negotiating position. But with each incremental tariff deal that gets announced, our interpretation should become the consensus. Market positive.
3. The bond market should begin to stabilize. Partial check. What really worried markets in the midst of the Straits was the sudden lurch higher of US government bond yields by 50 basis points in little more than a week following the “Liberation Day” announcement. These kinds of moves are unusual to say the least, and the MOVE index, a measure of bond market volatility, quickly spiked to its highest level in more than two years. While a variety of factors were driving this move, highest on the list were concerns about the trade war. So, the administration’s shift to suspend the massive ex-China reciprocal tariffs on April 9 quickly helped the bond market settle down: the MOVE index is now squarely back at normal levels and, perhaps ironically, has actually dropped further since Moody’s much-covered but belated downgrade of US government bonds to the same rating as S&P’s. Historically, over the long haul, the yield on US government debt should largely reflect the level of US inflation plus around 150-200 basis points, and for that reason, we expect yields to gradually stabilize around the 4.0% level. Our guess is we’ll get there by year-end, once the tax bill is completed and the trade deals are behind us. In the meantime, we expect the normal bumps and bruises as deficit projections rise and fall, inflation expectations shift, etc. We might even approach 5.0% in the short term as the budget deal is finalized. However, in our view, the long-term direction of travel is now clearer. Yields should stabilize lower. Market positive.
4. More trade deals should be announced with our key trade partners. Partial check. So far, we’ve had two “deals” announced, or perhaps better characterized as “frameworks.” The UK’s was a framework for deals with our friendly trade partners, and China’s (last week) for how a more adversarial deal would be structured. While the precise tariff levels and other elements of each deal will be important, barring an unexpected, exorbitant tariff level that effectively becomes a trade embargo, what matters most to markets is to see progress towards outlining the new terms of trade. The expectation is that, once known, our highly flexible US economy will adjust to the new realities and move forward. Each incremental announcement is therefore helpful, and more are clearly coming. Market positive.
5. Congress should reach an agreement on the tax cut extension. Partial check. Even as we speak, the President’s “One Big Beautiful Bill” has passed through the House Budget Committee, marking a major milestone toward its eventual passage. And while there remain a number of hurdles before reaching the President’s desk sometime this summer, we’ve already seen enough to credit this with a “partial check” for now. One remaining Siren Call we’d recommend clients ignore, by the way, is the harping about the bill’s future fiscal deficit impacts. Most of this can be dismissed as poor Congressional accounting methods, not the reality that markets will end up pricing. For example, in its present form, the bill is unlikely to take into account revenue and/or cost-cutting credit for the 10% tariff discussed above, and/or for the DOGE cost cuts currently underway. On our numbers, these two alone would offset much of the incremental revenue losses from the tax bills cuts beyond the extensions of the 2017 cuts. In addition, the economic growth rate used in the deficit calculations, just over 2% per year, is, in our view, too low and gives insufficient credit for the growth-boosting policy measures of the administration. Markets seem to understand this, however. Note that bond yields today have barely budged despite the weekend’s news of the tax bill’s emergence from committee. Ditto stocks. Market positive.
6. Deregulation announcements should begin. Partial check. A major feature of the bull case for the President’s policy agenda is the promise of significant regulatory reform, which should lift a huge cost drag on the US economy. Under the previous administration, according to the report by American Action Forum, 851 new Federal rules were issued across the economy, costing American businesses an estimated $1.37 trillion to comply with. We anticipate the vast majority of these Federal regulations will be pulled back or reformulated over the coming months, sometimes quietly and sometimes loudly. For instance, thus far we’ve seen rollbacks by the Environmental Protection Agency (EPA) and reforms at both the Consumer Financial Protection Bureau (CFPB) and Federal Deposit Insurance Corporation (FDIC). As more regulatory reforms are implemented, the cost of business investment should decline and economic activity should pick up. Our multi-year economic forecast is running about 50 basis points ahead of consensus, largely for this reason. Market positive.
7. The Fed should begin a new rate-cutting cycle. Not yet checked. Although the President from time to time grows frustrated with Federal Reserve Chair Powell’s forecasts of future policy plans, our advice to him would be to stop listening to Powell’s forecasts of what he is going to do next. These forecasts, built on rearview-looking measures, such as trailing inflation and trailing unemployment, have tended to be almost always wrong. We are more focused on where the data is heading and are assuming the Fed will act on that data once it evidences itself. On our numbers, inflation is heading lower, not higher, despite the modest, one-off impact of the new 10% tariff. We expect core inflation readings to stabilize around 2.5% over the next several months (we are already there on certain measures), and once we do so, the Fed will begin cutting rates because it can begin cutting rates. Normally, fed funds should run about 50 basis points above the inflation rate, or 3.0%. That implies 150 basis points of cuts ahead. And if there is any sign of employment weakness thanks to the uncertainty created by the trade wars, the Fed would have another policy objective reason to cut. Sooner or later, they will do so. Market positive.

When you add it all up, most of the news flow ahead looks market positive to us, rather than the reverse. Yes, we still have a Wall of Worry to climb (see the number of “partial check” and “not yet checked” notes above.) And yes, market pundits will wax and wane as news flow comes in that is more or less supportive of a constructive advance. And ditto earnings, which will certainly come under some near-term pressure as companies adjust to the new trade rules still being negotiated and released. Even here, though, there’s a good deal of bad news already accounted for. According to Bloomberg, consensus EPS estimates on the S&P for 2025 have declined from $273 at the start of the year to $261 today.

In addition, as further progress is made against the milestones above, the uncertainty premium on stocks should decline, allowing for a higher market multiple even as the advance of earnings towards our still-$300 forecast for 2027 is temporarily slowed. So, although our 7,000 reiterated market target on the S&P for 2026 seemed wildly optimistic just four weeks ago, it now seems quite reachable.

From our perch, it’s open seas ahead. While the occasional summer thunderstorm can pop up at any time, it appears the big one is behind us. Sails away!