BY: Jim McElroy

Summer Clouds

“…And we are here as on a darkling plain
Swept with confused alarms of struggle and flight,
Where ignorant armies clash by night.” — Matthew Arnold, Dover Beach

Pardon the poetry, but lately we find current economic and market information even murkier than usual and consequently more difficult to employ in making projections.  Uncertainty is always a given when handicapping the market, but it seems to us that the uncertainties of the current season are of a higher order of magnitude than what we have witnessed over the last few years.

A large part of this is due to Donald Trump’s relentless assault on the status quo.  Trump’s aggressive agenda and limited time to accomplish it — 1 ½ years or 3 ½ years, depending on the mid-terms — and the rapid-fire nature of his executive actions and policy shifts are giving economists and market pundits whiplash.  Tariffs alone are enough to drive forecasters to seek psychological support: since the beginning of 2025, tariffs and the threats of tariffs have ranged from as low as 2.5% to as high as 145% and currently stand at 10%, pending a 90 day truce (now about 40 days) and a federal court ruling.  In addition to the tariff chaos, there’s also the questionable reliability of economic statistics (i.e. statistics on inflation, GDP, employment, etc.) provided by DOGE ravaged government offices.  And, as if that weren’t enough, we now find ourselves in a possible shooting war in the Middle East, which would normally create additional concern about energy prices and inflation during the summer travel season.  Darkling indeed!

The statistics, such as they are, lack clarity.  While they don’t paint a picture of an economy on the threshold of accelerating growth, they show little evidence of an economy on the brink of a recession.  The latest reading for GDP in the first quarter of 2025 showed a slightly negative number (-.2%), possibly the result of heavier than normal imports by manufacturers and consumers hoping to escape anticipated tariffs.  GDPNow, an estimate of real GDP growth based on available economic data for the quarter just ended, does suggest a positive .8% (3.4% annualized) growth rate for the second quarter.  The unemployment rate is holding steady at an acceptable level: a low of 4.2% for May against an average of 4.1% for the prior four months.  Inflation, as measured by Core Personal Consumption Expenditures (the Federal Reserve’s preferred inflation measure), was up 2.5% year-over-year in April, down from March’s reading of 2.7%, though still above the Fed’s 2% target.

The Fed, reflecting the chaotic uncertainty of tariffs, inflation, war in the Middle East, and the still-evolving nature of the Trump administration, has for now resisted any further cuts in the Fed Funds rate, currently in a range between 4.25% and 4.5%. The best prediction/guess by markets and Fed officials is for a .50% reduction sometime before the end of the year; that phrasing, however, suggests more an absence of conviction than an official reticence or obfuscation.  The Fed wants to wait for better information before deciding whether to raise or lower rates.  Trump wants the Fed to lower rates immediately to spur faster economic growth and further reduce unemployment.  The disagreement has of course turned ugly — Trump called Chairman Powell a “moron” and demanded that he resign — adding a new level of uncertainty: Powell’s term as Chairman expires in May of 2026 — he cannot be fired between now and then — but that won’t prevent Trump from naming possible successors and calling for Powell’s “impeachment”.  This will certainly not diminish volatility in investment markets.

Over the last twelve months, the yield curve on U.S. Treasuries has shifted dramatically, particularly in the one-to-ten-year range: all instruments shorter than eight years have declined in yield and all instruments over eight years have increased in yield.  What was once an inverted yield curve is now mostly positive (there is still inversion in the one-to-three-year range, primarily due to Fed actions and/or inactions on short term rates).  We should note that the all- important yield on 10-year Treasuries — the rate which traditionally paces 30-year mortgage rates — is trading at an elevated range of between 4% and 4.5%.  This has been keeping mortgage rates between 6% and 7% for the last year and a half, the highest rates in over 25 years.  Since home construction provides between 3% and 5% of GDP and about 2% of civilian employment, currently elevated mortgage rates, or even higher rates, represent a serious threat to GDP and employment.

Markets are based on uncertainty: without it, there would be no risk and no room for profit or loss.  During these past six months, we have witnessed both profit and loss on a notable scale.  After losing 4.6% in the first quarter of 2025 and an additional 12.1% in the wake of Trump’s April 2nd “Liberation Day” tariff message, the S&P 500 reversed course when Trump announced that his tariffs were negotiable.  The net result is that the S&P 500 year to date (six months) is positive by 5.5%, a meager return, but certainly preferable to the -15.3% return we faced immediately following “Liberation Day”.  At quarter end, the broad index stands slightly above its previous historic high, which was set only this past January.  The index currently sports a 23.1 multiple on forecasted earnings, well above the thirty-five-year average of 16.  A well-known valuation rule of thumb suggests that the inverse of this multiple — the earnings yield — should be compared with the yield on a 10-year U.S. Treasury bond and that the difference can be interpreted as an indication of how much more return one expects from stocks than from a much more predictable and less risky bond.  Currently, this difference is negligible and would suggest that investors should reduce their stock holdings, particularly if their equity exposure is above their long-term asset allocation goal.  We are not predicting an imminent collapse in stocks.  Valuation alone is not a timely indicator of stock direction — as John Maynard Keynes once remarked to a friend, “Markets can remain irrational longer than you can remain solvent” — but   it’s probably a good indicator that investors should avoid overloading their equity portfolios.

“Summertime, and the living is easy” as the lullaby from Gershwin’s Porgy and Bess would have it.  Most people take vacations to the beach, the lake, the mountains, or anyplace that’s cool and refreshing.  Unfortunately, so far this season, cool and refreshing has been in very short supply.  There’s an old saying that one should “sell in May and go away”, probably indicating that most of the positive action in stocks occurs from November to April and that one would be better off in cash or short-term bills from May through October.  There have been years when this has been the case, but many more when it has not.  As we’ve argued before, the best investment strategy is to stick with the asset allocation that best suits your goals and tolerance of risk and, for the most part, to ignore the uncertainties.

“Summer Clouds” Bullets section:

• Heightened uncertainty is the order of the day.
• Concerns about tariffs, the accuracy of statistics from staff depleted government agencies and the fog of war in the Middle East have increased market nervousness.
• The statistics that we have on inflation and employment are inconclusive.
• Public insults about the Fed Chairman from the president are roiling the financial markets.
• The yield curve is now positive, but high mortgage rates are discouraging new home ownership and construction, putting pressure on employment and GDP.
• Equity valuations are extended.
• Client appropriate asset allocation is a best practice among successful investors.

Not Investment Advice or an Offer
This information is intended to assist investors. The information does not constitute investment advice or an offer to invest or to provide management services. It is not our intention to state, indicate, or imply in any manner that current or past results are indicative of future results or expectations. As with all investments, there are associated risks and you could lose money investing.