News & Insights

The U.S. government shut down for the first time in seven years on October 1st. Politicians hope voters will blame the other party. Voters may barely notice at all. Outside the federal government, the shutdown has little practical impact on most people’s day-to-day lives. The last shutdown, which occurred during President Trump’s first term, was the longest in history at 35 days yet barely registers today as a storyline from that era.

Official economic data is not being released during the shutdown. ADP’s private employment report showed a small reduction in jobs in September, with annual pay per job up a robust 4.5%. ADP chief economist Nela Richardson underscored a disconnect between declining private payrolls and ostensibly strong second quarter real GDP growth of 3.8%, as reported on September 25th.

Markets have staged a strong recovery from the April lows, with the S&P 500 up more than 30% and hovering around all-time highs. Though there has been a recent broadening out in anticipation of interest rate cuts at the Fed’s September meeting, the market has been largely driven by narrow leadership tied to the AI theme. Oracle’s most recent quarterly earnings announcement simply underscored this, as the company highlighted key contract wins related to its role as a provider of AI computing capacity that are projected to send revenue in its cloud-computing business up 700% over the next three years. Shares surged more than 35% and Oracle added approximately $250 billion to its market capitalization. AI remains very much at the forefront of investors’ minds.

AI may be the dominant theme, but markets have also responded to increased expectations for rate cuts following soft labor reports in July and August. Smaller capitalization companies, which generally are more indebted and therefore stand to benefit from lower rates, have begun to perk up. Since the beginning of August, the Russell 2000 has outpaced the S&P 500, but the small cap benchmark remains well behind the traditional benchmark for the year.

The S&P 500 reached an intraday high of 6,457 on July 28th, nearly triple its lowest point of 2020. The NASDAQ continued setting new highs into August and has now nearly quadrupled from its relatively recent lows. The One Big Beautiful Bill Act has been a tailwind, extending 2017’s tax cuts and providing visibility for income tax rates, state and local tax deductions, and estate taxes.

Another tailwind is earnings growth. With Q2 earnings season about complete, FactSet’s John Butters reports that 81% of companies have reported positive earnings and revenue surprises, with average earnings growing nearly 12%. Q3 estimates call for 7% earnings growth on average. Strong performance has helped justify high valuations. The S&P’s forward P/E ratio based on analyst estimates has reached 22.1, 10% above both its 5-year and 10-year average.

The first half of 2025 has presented investors with a paradox. Equity markets have demonstrated remarkable resilience, staging a powerful recovery from the lows of early spring, while the fundamental economic and policy backdrop has become increasingly clouded by uncertainty. This divergence between market sentiment and economic reality has created a complex and challenging environment. Follow­ing a sharp, tariff-induced correction in the spring that saw the S&P 500 fall 20%, markets executed a rapid rebound, surging 30% to all-time highs. This rally has been fueled by a persistent risk-on sentiment, with speculative appetite visible in the strong performance of recent Initial Public Offerings (IPOs) and the climb of Bitcoin back to all-time highs.

Market strength has pushed equity valuations into elevated territory. The forward 12-month P/E ratio for the S&P 500 now stands at 22.2, well above its 5-year average of 19.9 and 10-year average of 18.4. Such a premium implies a highly optimistic outlook, one that assumes corporate earnings growth will re-accelerate and policy risks will be resolved without major economic damage. This optimism, however, stands in direct conflict with a deteriorating fundamental picture, as analysts have been actively cutting their earnings forecasts. According to FactSet, while earnings growth was strong in Q1, the outlook for Q2 has deteriorated significantly. The estimated earnings growth rate for the quarter has been slashed from 9.4% to just 5.0%.

On the back of easing trade tensions, markets have staged an unusually rapid recovery from a tariff-induced near bear market about two months ago. The S&P 500 rebounded more than 20% from its April low and is hovering near all-time highs. The leadership of the Magnificent Seven faltered earlier in the year, as the group entered a bear market, but the recent rally has seen the celebrated collection of companies reassert its leadership.

Despite a host of uncertainties, market participants have remained in a risk-on mode with a buy-the-dip impulse prevailing. In a sign of the current bullish market sentiment, recent IPOs have performed particularly well out of the gate. Bloomberg reports stocks of companies going public are jumping the most in their first day of trading in three and a half years. Some examples include stablecoin issuer Circle, which leaped more than 165% on the day of its $1.2 billion IPO, Chime Financial, which closed up nearly 40%, and space and defense firm Voyager Technologies, which surged more than 80%. Positioning reports suggest large money managers remain underweight equities, which could prompt a chase later in the year to close the performance gap if the current trend persists. Bitcoin, often viewed as a proxy for investor risk appetite, is also around all-time highs at more than $105,000, up about 40% from the April lows.

Markets cheered on May 12th when the Trump Administration agreed to suspend most of the 145% tariff that it imposed on Chinese goods back on April 2nd, substituting a new 10% global base-line tariff plus a separate 20% levy tied to China’s role in the fentanyl trade, a total rate of 30%. In exchange, China will reduce its retaliatory tariff to 10% from 125%. The deal is good for 90 days as negotiations continue. The S&P 500 gained 3.3% on the news and turned positive for the year. 

Even before the China tariff reprieve, investors were bidding up the market as companies were generally reporting strong first quarter results. According to FactSet, with 90% of S&P 500 companies reporting, first quarter earnings are on pace to grow 13.4%, the second-straight quarter of double-digit earnings growth. 78% have reported actual EPS above the mean EPS estimate, above the five-year average of 77% and 10-year average of 75%. For the remaining three quarters of 2025 analysts expect earnings to grow 5.2%, 7.4%, and 6.7%, respectively, with a full year prediction of 9.3%. This is a reduction from previous full year estimates that had contemplated double-digit earnings growth.

The Trump administration's sudden imposition of aggressive reciprocal tariffs on April 2nd triggered significant selling pressure, causing the S&P 500 to fall by a staggering 10.5% over two days. This tariff-driven panic has secured its place among Wall Street's most notable events.

Following the initial shockwave, markets have shown signs of stabilization and recovered some losses, partly supported by subsequent announcements, including a 90-day pause on certain tariffs. The exclusion of major electronics from the steep 145% tariff levied on China helped alleviate immediate concerns about drastic price increases, contributing to a relief rally. Nevertheless, persistent trade tensions and the possibility of future escalations continue to foster caution among investors.

We warned about froth in equities last month, and the S&P 500 responded with a sharp correction. The index experienced a steady slide from its peak of 6,163 on February 19th, closing in correction territory down 10.3%, on March 13th. The more volatile NASDAQ 100 slid 13.5% during the same period. A subsequent bounce left both indexes trading in territory they originally reached six to nine months ago. After starting the year up about 4%, 2025’s market now has a foot in the hole.

It is no surprise that the biggest contributors to the market’s multi-year gains, the so-called Magnificent 7, also paced it on the way down. The March 17 cover of Barron’s Magazine illustrated their pullbacks from respective 52-week highs. Six of seven showed declines in a range of 19%-23%. Tesla showed a 50% decline, returning to its pre-election range. The graphic was printed on a solid red background under the heading “Mag 7 on Sale”. Barrons Cover Curse believers might debate whether the red background portends a green bounce or whether the reference to stocks “on sale” foreshadows another leg down. Either is certainly possible. The S&P 500’s trailing P/E ratio remains in the mid-20s, at the high end of its all-time range. A return to the 20-year average of about 16 would equate to nearly a 40% drawdown from here, give or take earnings growth for the constituent companies. On the other hand, while corrections are historically common and occur about once every two years, bear market drawdowns of 20% or more occur only half as frequently. Treating every correction as a budding bear market is equally likely to be right or wrong.

After two great years in the equity market, 2025 got off to another strong start with the S&P 500 making record highs driven by earnings growth and non-Magnificent 7 stocks. Valuations are stretched, and there are other signs of froth in the market, arguing for caution. The economy is on solid footing with moderate employment gains and continued economic growth. However, inflation remains higher than the Federal Reserve’s 2% target and the Fed anticipates only a half percentage-point reduction in the Federal Funds rate this year. Long-term rates remain about where we entered the year. Their direction from here will be a function of inflation and government borrowing requirements as the new administration implements its tariff and fiscal policies.

Year to date the S&P 500 is up 4.2%. But in a change, the Magnificent 7, about a third of the index, has lagged while the other 493 stocks have powered the gain. Excitement for Artificial Intelligence continues to drive the market and its impact was visibly seen on January 27th when DeepSeek, a Chinese AI firm, reported using older Nvidia chips to train AI models at a fraction of the cost of current methods. Nvidia, the leading AI chipmaker and stock powering the AI revolution, dropped 17% on the news. Since the announcement Nvidia has recovered most of this drop as investors were soothed by the increasing capital expenditure plans from other Magnificent 7 members Microsoft, Alphabet, Amazon, and Meta Platforms. However, except for Meta these “Cloud Titans” have seen their shares struggle as investors stomach these massive spending plans while worrying that revenue from AI won’t fully justify them.

Market volatility has picked up in early 2025, a continuation of December’s fluctuations. This shouldn’t come as a surprise as several factors are each promoting increased volatility. The greatest impact results from investor concern over interest rates. The Federal Reserve controls short-term interest rates by setting the Fed Funds rate, the interest banks charge each other when lending or borrowing excess reserves. The Fed has cut this rate three times since September 18, kicking off its easing cycle with an eye-catching 50 basis point reduction prompted by a weak employment market in the late summer and early fall. The market, however, determines interest rates for everything else. While the Fed Funds rate is down a cumulative 100 basis points since the September Fed meeting, yields on the 10-year Treasury Note have risen 80 basis points during that time from 4.00% to a recent high of 4.80%.

Despite the drag from 11 rate hikes from March 2022 to July 2023, the U.S. economy has continued to grow solidly overall with a few pockets of weakness emerging, particularly in manufacturing. Employment growth has remained positive with modest job growth from April through October giving way to stronger numbers in November and December.