Where are the economy and equity market heading next?

Review the latest Weekly Headings by CIO Larry Adam. 

Key Takeaways

• The full impact of the rapidly changing tariff landscape has not yet hit
• Inflation boost from tariffs likely to be a temporary blip
• We envision further downside to S&P 500 2025 EPS estimates

It’s hard to believe it’s already been three months since President Trump’s so-called 'Liberation Day' on April 2. While the initial wave of tariffs sparked plenty of market volatility, both the economy and financial markets have held up surprisingly well. After a sharp ~20% drop, the S&P 500 has staged a strong V-shaped rebound, climbing to a new all-time high. So far, fears that trade tensions would slow the economy or drive-up inflation haven’t played out. But this calm may not last – especially with the average tariff rate still expected to settle in the mid-to-upper teens. The recent passage of Trump’s 'One Big Beautiful Bill' has brought some clarity to the fiscal picture, but two areas of focus – renewed tariff threats and 2Q25 earnings season – hold the keys to where the economy and the equity market head next. Here’s how we see things shaping up from here.

• Tariffs still set to dent growth | Recent economic data has been somewhat erratic, as consumers and businesses shifted their spending to get ahead of tariffs. While quarterly growth estimates have seen big swings—mostly due to trade-related volatility—the broader economy has stayed surprisingly resilient. Despite some signs of strain in the job market, like rising continuing unemployment claims, downward payroll revisions, and slower hiring, overall job growth remains solid. That said, things may get tougher in the second half of the year as the full impact of sharply higher tariffs—six times higher than at the beginning of the year—kicks in. With job growth slowing, consumers likely to pull back their spending, and businesses trimming inventories, growth could slow or even stall by 4Q. The good news? A few well-timed Fed rate cuts—we expect two the remainder of this year—should help keep the expansion alive. And looking ahead to 2026, the outlook improves as the economy gets a boost from President Trump’s new tax bill.
• Inflation boost from tariffs a temporary blip | Tariffs haven’t fully shown up in the inflation numbers yet either. In fact, recent inflation reports have been surprisingly tame, even though many businesses have warned they’ll need to raise prices. So far, falling energy prices and a gradual easing in shelter costs have helped offset rising prices for goods. However, we still expect tariffs to push inflation higher in the months ahead. The full impact of the rapidly changing tariff landscape is still working its way through the system. Our estimates show the effective tariff rate jumped from ~3% in 1Q to ~15% in 2Q, and it’s expected to settle in the mid-to-upper teens. We anticipate PCE inflation will rise to ~3.5% by the end of 2025 as businesses pass on higher costs. However, this should be a one-time bump rather than a lasting trend—especially if foreign producers absorb some of the cost increases, which could even bring inflation in below our forecast.
• Earnings in focus | Next week, all eyes will turn to earnings as the big banks kick off the 2Q reporting season on Tuesday. In 1Q, companies held up well despite tariffs—S&P 500 earnings grew 13% YoY and beat estimates by a healthy 8%. But with tariffs still climbing into the mid- to-upper teens, as previously noted, we expect those impacts to start showing up in the results. As a result, the combination of looming tariff effects and the market’s recent strength has set the stage for both a low and high bar for this earnings season.

  • Revisions set up low bar—Heading into earnings season, expectations have been dialed back—setting the stage for potential upside surprises. Over the past 12 weeks, 2Q25 earnings estimates have been revised down by about 4%, slightly above the 10-year average of 3.6%. That’s brought projected earnings growth down to just 5%, the slowest pace since 2Q23. While 2025 was expected to bring broader earnings strength, tariffs have caused a clear divide. Sectors most exposed to tariffs—like Consumer Discretionary and Materials—have seen the biggest downward revisions. As a result, only 6 of 11 sectors are expected to post positive earnings growth this quarter, the fewest since 1Q23. On the bright side, AI-related spending continues to power Tech and Communication Services, which are expected to see the strongest earnings growth. Overall, additional tailwinds could come from a weaker dollar—down 8.5% YoY—which could support multinational companies’ earnings—and lower fuel prices.

    Higher bar set up by market rally—Even though earnings estimates have come down, the recent market rally has raised the bar for this earnings season. The S&P 500 has surged 25% over the past 12 weeks—its strongest pre-earnings run since 4Q23—pushing valuations into the 93rd percentile historically. With tariff risks resurfacing and valuations already stretched, earnings will need to do the heavy lifting moving forward. We expect the economic impact of tariffs to start showing up this quarter, and we anticipate consensus full-year 2025 earnings estimates will gradually be revised down toward our $255 forecast. That’s why we’re staying cautious in the near term as these upcoming earnings results may not be enough to justify these premium valuations.

Bottom line | For more insights and our latest views on the economy and financial markets, please join our webinar this Monday, July 14 at 4 PM EDT as we present our 3Q25 Investment Outlook—Back to the Future: Lessons from the Past, Strategies for the Future. Register here!

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