News & Insights

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.

The Year In Review: A Reflection on Markets and the Economy

Equity investors have much to celebrate this year as indices continue to rise to all-time highs. The Federal Reserve cut interest rates in September for the first time since 2020, boosting investor optimism and supporting the strong rally in stock prices. In a reversal of recent trends, small-cap companies represented by the Russell 2000 index surged post-election, outperforming large-cap companies. Optimism for policies favorable to U.S. companies may have contributed to some of the outperformance as smaller companies tend to have more exposure to domestic markets.

Stocks were already trading near all-time highs prior to the election, after which markets took another leg higher. Overall, equities have been supported this year as the economy has held up better than many expected following the Federal Reserve’s interest rate increases to combat inflation. A combination of inflation tracking back towards the Fed’s 2% target and concerns about a softer labor market set the table for the Fed to kick off an easing cycle in September with a larger 0.5% cut, its first rate reduction in four years. Beginning the path toward less restrictive policy while consensus expectations reflect projected earnings growth of nearly 10% in 2024 and approximately 15% in 2025 make a relatively attractive backdrop for equities, helping to explain some of the bullish sentiment exhibited by investors.

The Fed continued down the path toward easier policy with a 0.25% cut in November with expectations for another 0.25% reduction in December. Market expectations are for an additional 0.50% of easing in 2025, which should help support equities. Additional rate cuts meaningfully beyond that over the coming year would likely be in response to unwelcome economic or geopolitical developments.

Judging solely by the U.S. stock market, economic conditions could hardly be any better. Year to date, the S&P 500 is up more than 22%. Investors may be taking their cues from economic data suggesting a desirable “Goldilocks economy,” one that is neither too cold nor too hot. Economists forecast U.S. Gross Domestic Product to be up about 2.5% for 2024. Inflation has been gradually ebbing.

Underlying statistics paint a murkier picture. Manufacturing has been in a recession for most of the past two years, and new factory orders continued to decline in August. The Institute for Supply Management’s Purchasing Managers Index showed continued contraction into September. The weakness is largely due to high interest rates that reduce demand for big-ticket consumer and industrial goods like cars, appliances, and factory machinery. The Federal Reserve’s goal in hiking interest rates in recent years was to slow down the economy by making large items more expensive to finance. Demand for services, about 80 percent of the economy, continues to rise steadily.

While the S&P 500 remains near all-time highs, markets have been choppy as sentiment has vacillated between belief in the Federal Reserve’s ability to achieve a soft landing versus concerns regarding a more significant slowdown. Progress on inflation set the table for the Fed’s half-point rate cut at its September meeting, as Chair Powell had noted that the balance of risks to the Fed’s two mandates, price stability and stable employment, have changed. Inflation has come down, trending toward the Fed’s 2% target, while the labor market has slowed. Given the increase in downside risks to employment, at the Jackson Hole gathering Powell stated the Fed “does not seek or welcome further cooling in labor market conditions,” clearly articulating the Fed has shifted its focus, opening the door to a rate cutting cycle.

The September rate cut was the first reduction since 2020, marking the end of the policy tightening the Fed embarked upon beginning in March 2022 to combat inflation. Rate hikes resulted in the target range for the federal-funds rate hitting 5.25%-5.5%, a two-decade high, and remaining there for 14 months prior to the recent cut. This hiking cycle had the desired impact as the Fed’s preferred measure of inflation, the core personal-consumption expenditures index (PCE) came down to 2.6% in July, the most recently available data, compared with a peak of more than 5.5% in 2022. Based on consumer and producer price data already released for August, economists expect the headline PCE for August will be approximately 2.3% with the Fed’s own preferred inflation measure, the core PCE, advancing 2.7%. While we are not yet at 2% inflation, the general trend has been in line with what the Fed would like to see, and policy remains restrictive, albeit less so than before the recent cut.

For much of 2023 and into 2024, markets experienced a low level of volatility in the face of the fastest interest rate tightening cycle in U.S. history. However, since reaching a peak on July 16 the S&P 500 recorded both its best and worst days since 2022 during the week of August 5-9. The reasons for higher volatility are a softer economy, Artificial Intelligence (AI) skepticism, global uncertainty, and a contentious election cycle.

Since 2022, the Federal Reserve has been able to focus on inflation as the employment market has enjoyed a strong recovery from the pandemic. The news here recently has been good. After inflation slightly increased during the first quarter, the CPI has now slowed for four straight months. July’s reading of 2.9% year over year marks the first time since March 2021 that the index has been below 3%. Progress on the core CPI, a measure that excludes the often-volatile food and energy components, is also encouraging, coming in at 3.2%. Other indicators confirm inflation’s downward path. The Fed’s preferred inflation index—the Personal Consumption Expendi­tures, or PCE—has fallen from a high of 7.1% two years ago to 2.5% in June. The Producer Price Increase, or PPI, rose 2.2% year over year in July and has cycled around 2% since early 2023.

After spending much of the year lagging behind the Magnificent 7, a broader array of stocks joined the party and pushed the market to all-time highs. The reason appears to be investors’ growing belief that the Fed will start cutting interest rates in September in response to falling inflation and a softer employment market. Interest rate cuts would improve the prospects of non-technology stocks by spurring economic activity and increasing the appeal of those paying dividends. 

Investors take cues from the Fed’s data dependency when setting interest rates to fulfill its dual mandate:  full employment and stable prices. The Fed started the year expecting three rate cuts in 2024, but inflation’s rise and a solid employment market in the first quarter led the Fed in early June to revise its expectations to just a single quarter-point cut. 

Economic growth has been steady, unemployment is relatively low, and the stock market is flirting with all-time highs. Yet, 68% of Americans rated economic conditions as fair or poor in a recent survey. Meanwhile, 32% said the economy was good or excellent.

The problem isn’t the overall economy, but different perspectives based on one’s position in the economy. An investor with a substantial stock portfolio considers conditions to be pretty good because their personal circumstances are likely favorable. Someone who doesn’t own stocks might not share that rosy point of view.

The S&P 500 has rebounded to all-time highs, up over 10% year-to-date after recovering from a dip of over 5% in April. Earnings season is upon us, with over 90% of companies already reporting results. Using FactSet’s blended formula that combines reported earnings with remaining estimated earnings, analysts expect 5.4% year-over-year earnings growth in the first quarter. The index's top five contributors to earnings growth are Nvidia, Alphabet, Amazon, Meta, and Microsoft. Excluding these five compa­nies, year-over-year earnings growth is estimated to decline 2.4%. Medium-size companies represented by the S&P 400 have advanced 8% this year, broadening the rally. Small companies remain far behind, with the S&P 600 up only 1% year-to-date.  

The Dow Jones Industrial Average looks to pierce through 40,000 for the first time in history. The index of 30 blue chip companies, up nearly 5% in 2024, is price-weighted rather than market-cap-weighted. The Dow has lagged other indexes for many years as market-cap indexes continue to benefit from the outperformance of mega-cap companies. However, the potential of these large companies to spend hundreds of billions of dollars on hardware and software in the next few years to develop artificial intelli­gence and alternate reality environments is a source of great anticipation. It will be interesting to see how this investment will shape their future earnings growth.  

The first quarter of 2024 was largely a continuation of the strength the stock market exhibited in 2023. The S&P 500 advanced nearly 11% in Q1, following a strong 2023 that saw the index rise 26%. Large-capitalization technology companies again led the way, as the Magnificent Seven averaged a 13% gain for the year through March, while the remainder of the S&P 500 was up a more modest 6%. In contrast to the lockstep move amongst the Magnificent Seven last year, the dispersion of returns amongst this celebrated group in the first quarter was notable. Nvidia was the strongest performer, riding investor enthusiasm over artificial intelligence to a greater than 80% gain in Q1. At the other end of the spectrum, Tesla shares fell 29% as demand for electric vehicles cooled.

Overall investor sentiment has been supportive of risk assets, as belief has increased the Federal Reserve will be able to engineer the historically difficult “soft landing” by bringing down inflation without a meaningful economic slowdown. Inflation has come down from the peaks achieved in 2022, the economy has remained resilient, and consensus expectations reflect double digit earnings growth in each of the next two years. Add to this Fed’s indications it has likely reached the end of its hiking cycle along with expectations for multiple rate cuts this year and it makes sense why market participants have been bullish.

Expectations for rate cuts in 2024 have moderated since the beginning of the year. Based on the CME FedWatch Tool, the current expectation is for three 0.25% rate cuts in 2024 with the first cut occurring in June. This is down from expectations at the start of the year for six rate cuts with the first reduction occurring in March. One might expect the revisions since the start of the year would spell trouble for equities, but stronger than expected economic data has helped propel the market while calming fears regarding an imminent recession. 

Real GDP increased 2.5% in 2023 and economists tracked by Bloomberg now expect real GDP to grow more than 2% in 2024, reflecting the view that the risks of a near term recession are remote. Regardless, the Fed appears ready to step in upon signs of a meaningful downturn in the economy while fiscal policy also remains stimulative, helping support risk appetite. 

The S&P 500 closed above 5,000 for the first time in history on February 9. The index has risen more than 50% since the end of 2019. The Russell 2000 index of smaller companies has only slightly underperformed the S&P over the past month. The persistent rally finally broadened out.  

Valuations are stretching, though. According to FactSet Earnings Insight, authored by John Butters, the S&P’s estimated forward P/E ratio has risen to 20.3, above the 5-year average of 18.9. With three quarters of the S&P having reported fourth quarter earnings, the composite Q4 growth rate for earnings stands at 2.9%. That modestly lags consumer price inflation over the same period, meaning the purchasing power of corporate earnings remains in modest decline. Markets look ahead, suggesting improved earnings growth will be necessary to justify the optimism baked into current valuations.