What could go right

With markets settling down after the wild ride of the past several months, a very natural behavioral response has been gripping many investors and, especially, market strategists. Having shifted from bullish to bearish during the big sell-off in April and having missed the subsequent rally that has returned us to where we started just three months ago, most are sticking with their new bearish positioning. Indeed, most of the commentary these days is about what is likely to go wrong: "The tax bill might not pass," "the tax bill will explode the deficit," "the trade deals won't happen" and "stagflation ahead." These are some of the common reasons to justify, consciously or subconsciously, the embarrassing whipsaw. Fortunately, our macro team at Federated Hermes managed to sail through the Straits of the Sirens relatively unscathed and actually emerged with an even larger equity overweight than when we entered. OK, the captain had to strap himself to the mast to do it, but the plan worked. So, let me offer the bears our short list of what could go right.

• The tax bill could pass before July 4. As it grinds through the Senate, it's difficult to separate sausage-making and negotiating from actual progress. Every senator trying to make a point will naturally insist until the last second that their request is unmovable. Our advice: ignore them. Most of this is politics and is allowing various politicians to be “on the record” supporting a particular policy option that matters in their home state/district. In the end of the day, they will succumb to the realities of what is accomplishable with a very narrow House majority. And remember, the Republicans have a second reconciliation bill coming later this year, with more cost-cutting likely. President Trump wants his Big Beautiful Bill on his desk on July 4. Our guess is he will get it. If so, this will be the first big thing that will go right. Growth and market supportive.
• Tariff headlines could recede. I was struck this weekend by noted trade hawk and US Secretary of Commerce Howard Lutnick's talking points on Fox. His emphasis was on the forthcoming deals—even with China—and on the desired outcome of fairer, growth-enhancing trade deals. Talk of all-out withdrawal of the US from the global trading system has all but disappeared. As more trade frameworks are announced in the weeks ahead, hysteria around tariffs crashing the global economy should fade. Growth and market supportive.
• Inflation numbers could come in light, not hot. We have maintained for some time that Trump's complete policy agenda would result in lower, not higher, inflation: a limited revenue-raising 10% tariff partially paid by foreign exporters, fair trade/lower tariffs elsewhere, tax cuts (i.e., cost cuts) for consumers (especially small businesses that file as individuals), rolling back of the regulations Biden’s administration imposed (amounting to around $1 trillion in additional economic costs), the DOGE spending cuts and AI-enabled productivity growth. Last week's surprisingly low core PCE was more evidence that our call here could be right. We continue to expect the Fed to begin a quarterly series of six 25-basis point cuts in the fed funds rate, starting with its September meeting. Note: we've been ignoring what policymakers at the Fed are saying about inflation; their prognostications on inflation are notoriously backward-looking and more often wrong, not right. With core inflation likely to settle in near their target of 2-2.5%, they will cut because they can. Growth and market supportive.
• Deficits could shrink, not expand. Here's another disturbing newsflash for the bears: what if the tax bill is deficit-shrinking, not deficit-expanding? Here's a few reasons why that outcome, at least by 2026, is likely. First, the Congressional Budget Office’s (CBO) 1.8% growth forecast is myopic, and driven by ill-conceived, demand-side economic notions, which will prove as wrong as when they were prognosticated on the outcome of the original Trump tax cuts. The CBO’s 2017 dire warning about the potential forward tax revenue those cuts could achieve was low by nearly $500 billion in 2024 alone, because then, as is the case now, the CBO refused to concede that tax cuts for the private sector might actually expand the GDP pie—thereby increasing federal revenues, even with a lower tax rate. Beyond the forecasted $500 billion per year more in revenue from the coming Big Beautiful Bill, we'd add two other deficit-reducing provisions in the Trump agenda but not in the CBO's forecast because they are not technically in the tax bill: the 10% baseline tariffs likely to endure beyond the forthcoming trade deals and the DOGE cost cuts. Together, the DOGE cuts and the 10% tariff could generate about another $500 billion in un-accounted for deficit reduction. So all in, we believe the actual outcome of the President’s policy package is likely to be the precise opposite of what the accountants at the CBO are estimating: a $500 billion deficit reduction, not a $500 billion deficit increase. Growth and market supportive.
• Economic growth could reaccelerate. If the tax bill is signed and key trade deals confirmed, we expect the resultant clearing of the backlog of investment projects and consumer durable expenditures could lift GDP substantially in the back half of the year. Another factor could be the reversal of the growth-draining impact of the pre-tariff import surge in the first quarter. Our macro team is forecasting GDP growth to end this year at 3%, with more of the same in 2026. Growth and market supportive.
• Earnings growth could continue. Given the above, back half and 2026 earnings look to us to have several accelerators on the way: higher-than-expected GDP growth, cost-reducing deregulations and AI efficiency gains. These should cause corporate earnings growth to reaccelerate. We are holding to our long term $340 earnings estimate for 2027, which will begin to come into focus next year. And we are sticking with our $300 forecast for 2026, which markets will be focusing on as we enter this year's second half (a month from now!). Growth and market supportive.
• The market could rise toward our 6,500 year-end target. When you add it all up, it is increasingly likely that our unchanged 6,500 target for 2025 and 7,000 for 2026 is not only realistic, it may be too conservative. With the Wall of Worry crumbling, investors who realize they missed their chance to buy lower will likely jump into any and all dips ahead that materialize. This is the kind of set-up that can make bull markets strong, and bears shudder. And that energy then feeds on itself. Growth and market supportive.

We acknowledge as always that all of the above could be wrong, and the bears may yet prove right. But with so many leaning the wrong way, we see the balance of risks favoring the bulls. There are just too many things that could go right from here. Welcome to the long, sunny days of summer.