Market Perspectives- May 2025

Easing Fears or Buyers Beware

Market and Economic Backdrop

Markets staged an impressive rebound over the past month, driven largely by easing geopolitical tensions and stronger-than-expected corporate earnings, though lingering fiscal and economic concerns remain a source of caution. As of Friday, May 16, the S&P 500 had surged 5.27% for the week, lifting year-to-date performance to +1.3% after previously falling as much as -15.2%.

This dramatic recovery was fueled by a temporary pause in trade tensions, as Treasury Secretary Bessent and a high-level Chinese delegation signaled a willingness to de-escalate, agreeing to a 90-day truce and slashing tariffs to preserve the bulk of trade flows. Optimism extended further with administration officials hinting at additional deals under negotiation with India, other Asian partners, and even select European allies—including a finalized trade agreement with the United Kingdom.

Despite these positive developments, sentiment was tested late Friday when Moody’s Ratings downgraded U.S. sovereign debt from Aaa to Aa1, ending the country’s century-long run of top-tier credit standing. While Moody’s followed the lead of S&P (2011) and Fitch (2023), the move was symbolically significant, citing persistently rising government debt and growing interest expenses as a percentage of GDP. The agency did upgrade its outlook from “Negative” to “Stable,” but investors reacted swiftly in futures trading, pushing long-term Treasury yields higher and causing equities to open lower the following Monday.

Although the downgrade garnered widespread media attention, markets quickly regained composure. The rationale behind Moody’s decision—chronic fiscal deficits and rising interest burdens—was not new and has long been priced in. With neither political party showing a credible willingness to address long-term entitlement spending, most observers dismissed the downgrade’s impact beyond the short term. In fact, the 10-year Treasury yield remains stubbornly above 4.00%, a signal that bond markets had already anticipated much of this risk.

In contrast to the fiscal headlines, the market rally has been grounded in tangible positives. Earnings season delivered meaningful upside surprises—especially in the Technology sector—and enthusiasm around AI investments was bolstered by fresh capital commitments from Gulf nations during President Trump’s visit to the region. The ongoing AI boom has helped pull equity indexes to within a 4 to 7% range of all-time highs.

On the policy front, the sharp reduction in tariffs—from proposed levels of 145% to less than a quarter of that—marked a significant reversal, alleviating some of April’s downside risk. However, that relief came with a caveat: President Trump later noted that negotiation bandwidth was limited and that other regions, particularly Japan and the EU, might still face the return of “reciprocal” tariffs if talks falter. Indeed, reports from both blocs last week suggested a lack of urgency in advancing trade discussions.

• The macroeconomic picture remains complex. Hard data offered a mixed view:
  Inflation cooled significantly in April, with headline CPI falling to 2.3%, the lowest level over four years and approaching the Fed’s 2% target.
• Retail sales painted a murkier picture. While strong earlier in the year, April data showed signs of demand having been pulled forward, with the critical “control group” declining more than expected.
• On growth, the Atlanta Fed’s latest GDPNow estimate pointed to a 2.4% annualized growth rate for Q2, a notable improvement over the initial Q1 estimate of just 0.3%, though the latter is subject to revision on May 29.

Meanwhile, in Washington, fiscal policy remains a potential flashpoint. While the House Budget Committee just cleared a procedural hurdle related to President Trump’s budget, the drawn-out process highlighted the challenges of advancing major legislation amid a fractured and narrow congressional majority. This development reminded investors that while markets may appear to be under cruise control, the road ahead includes plenty of twists.

Bottom line: Markets may have priced out the worst of recent risks, but the durability of the rally will depend on a delicate balancing of tariff policy, economic momentum, and Federal Reserve action. Fiscal concerns, while not immediately disruptive, will continue to cast a long shadow.

Tariff Policy: Relief and Residual Risks

In mid-May 2025, the U.S. and China agreed to a 90-day mutual tariff reduction, significantly easing trade tensions. This agreement reduced U.S. tariffs on Chinese imports from 145% to 30%, while China lowered its tariffs on U.S. goods to 10%. The rollback, which also included the removal of tariffs on specific sectors such as airplane parts, steel, aluminum, and automobiles in a separate U.S.-UK trade deal, has been viewed positively by markets and contributed to a momentary rebound in investor confidence.

Despite these reductions, average U.S. tariffs remain elevated at approximately 17.8%, well above pre-2020 levels. While the current 10% global tariff regime is less severe than earlier proposals, it still imposes additional costs on businesses and consumers. For instance, the music industry has reported increased prices for instruments due to tariffs, affecting both retailers and end users. This is also the case with toys, autos and appliances.

On the economic front, the impact of tariffs on inflation has been less pronounced than initially feared. The Consumer Price Index (CPI) rose by 2.3% over the past year, aligning closely with the Federal Reserve’s target. However, consumer sentiment has declined, with the University of Michigan’s Index of Consumer Sentiment edging down in May for a fifth straight month as Americans increasingly worried that President Trump’s trade war will worsen inflation. The preliminary reading of the University of Michigan’s closely watched consumer sentiment index declined 2.7% on a monthly basis to 50.8, the lowest reading since July 2022.

In summary, the recent tariff reductions have alleviated some economic pressures and improved market sentiment. Nevertheless, the persistence of higher-than-normal tariffs and the potential for policy reversals continue to pose risks to the economic outlook as the trade environment remains fluid and susceptible to political developments.

Market Performance & Economic Backdrop

The S&P 500 experienced a significant recovery over the past month. After a peak-to-trough decline of over 15%, the index rebounded to near its all-time high in just 25 trading days. This marks the fastest turnaround for such a recovery in over 40 years, according to Bespoke Investment Group.

Historically, when the S&P 500 closed within 3% of a prior high after a 15%+ drop, forward returns have been strong. Again, according to Bespoke Research, the median gain six months later is 9.1%, while one-year returns have posted a median gain of 15.6%, with positive outcomes nearly 90% of the time.

For the week ending May 16, 2025, the major U.S. indices posted strong gains:

• S&P 500: Up 5.3%, closing at 5,958.38.
• Nasdaq Composite: Gained 7.2%, closing at 19,211.10.
• Dow Jones Industrial Average: Increased by 3.4%, closing at 42,654.74.
• Russell 2000: Rose 4.5%, closing at 2,113.35.

The Dow Jones Transportation Average also showed strong performance, closing at 15,159.32 on May 16, 2025.

Market breadth improved significantly leading up to May 16:

• 77% of S&P 500 constituents were above their 50-day moving average
• 66% were above their 100-day moving average
• 54% were above their 200-day moving average

These readings mark the highest levels since early March, indicating a more inclusive rally. The NYSE Advance-Decline Line also hit new highs, reinforcing the strength in market breadth.

Despite positive market indicators, macroeconomic and geopolitical uncertainties persist. In Q1 2025, the term “uncertainty” was cited on 84% of earnings calls by S&P 500 companies, the second-highest percentage in the past decade. This reflects ongoing concerns about trade policies and economic conditions.

The Cboe Volatility Index (VIX) declined from above 50 to below 20 between April 10 and May 16, marking the fastest rate on record. In tandem with the declining volatility index, investors recovered lost ground, driving the S&P 500 recovery from an April 8 low of 496 to a May 16 Index close of 594, a gain of approximately 19%.

International equities have outperformed U.S. stocks in 2025. As of late May 16, the year-to-date (MSCI) emerging markets and European (EAFE) markets have led the U.S. markets (S&P) by considerable margins.

European equities, particularly Germany, have surged due to robust defense and infrastructure spending. Germany’s parliament approved a significant multi-billion euro spending plan, including up to €1 trillion allocated for infrastructure and defense.

Emerging markets such as Poland and Brazil have posted strong ETF gains, while the iShares China Large-Cap ETF (FXI) is up 17.08% over the same time frame. Mexico’s market is likewise up 27.10%.

Trade tensions are resurfacing as a potential source of volatility. While markets have largely shrugged off renewed tariff rhetoric, the economic risks are non-trivial. International equities may benefit from lower direct exposure to U.S. tariffs, but for U.S. firms—particularly those in the industrial, technology, and consumer sectors—ongoing trade disputes pose real margin and supply chain risks.

The lack of market reaction to tariffs may also reflect misplaced complacency, especially when considering the broader macro setup. With the yield curve having only recently uninverted and 10-year Treasury yields remaining sticky near 4.5%, equity valuations appear increasingly stretched. As such, further escalation in trade frictions could act as a volatility catalyst and potentially reset earnings expectations or valuations.

Consumer Behavior, Economic Underpinnings, & Tariff Impact

April’s economic data painted a picture of a consumer still active but increasingly fickle, with spending patterns marked by sharp month-to-month variability—likely driven in part by persistent tariff uncertainty and shifting expectations on inflation and interest rates.

Retail sales data was positive but fundamentally messy. Sales rose just 0.1% in April, slightly above expectations, but that modest gain followed an upwardly revised +1.7% surge in March (initially reported at +1.4%). That March strength likely reflected a one-time catch-up following winter weather disruptions and a severe flu season—and potentially a temporary tariff-driven demand spike. While some early reports suggested that consumers were buying vehicles in March to front-run auto tariffs, the 0.1% decline in vehicle sales in April calls that narrative into question.

Looking under the hood, just 5 of the 13 sectors surveyed by the U.S. Department of Commerce Department posted gains in April. Pockets of strength included bars and restaurants (+1.2%) and building materials and garden supplies (+0.8%), both likely boosted by warmer weather and seasonal demand. On the flip side, sales at gas stations fell 0.5% due to lower pump prices, and discretionary categories like sporting goods, hobby, and bookstores (-2.5%) and department stores (-1.4%) slumped notably. Meanwhile, online sales ticked up 0.2%, continuing their modest, steady climb.

Perhaps the most telling indicator was the retail sales control group, which strips out the more volatile components like gas, food services, autos, and building materials. It declined -0.2% in April, well below the +0.3% consensus estimate, and marked a sharp reversal from +0.5% in March and +0.3% in February. This pullback highlights a cooling in core consumer spending at the start of Q2 and signals potential downside risk for GDP estimates if the trend persists.

Tariffs have clearly influenced consumer behavior, though their effects are proving uneven. The March sales surge—possibly driven by tariff front-running—appears to have borrowed demand from future months. Adding to the uncertainty, Walmart’s recent earnings call flagged rising input costs and suggested that price increases may be forthcoming due to the “speed and magnitude” of supplier cost pressures, many of which are being exacerbated by trade barriers. If more retailers follow suit, the impact on consumer purchasing power could become more pronounced in the months ahead.

The labor market, by contrast, remains resilient. Initial jobless claims remain subdued at 229,000, consistent with a healthy job market. Nonfarm payrolls rose by 177,000 in April, slightly above the 12-month average of 152,000. The unemployment rate held steady at 4.2%, and while long-term unemployment rose by 179,000, it still accounts for a manageable 23.5% of total unemployed individuals. Sectors such as healthcare (+51,000), transportation and warehousing (+29,000), and financial activities (+14,000) led the way, while federal government employment fell by 9,000. Wage growth remained steady, with average hourly earnings rising 0.2% month over month and 3.8% year-over-year, while the average workweek held at 34.3 hours.

Federal Reserve Chair Jerome Powell reiterated this past week that the central bank remains in a holding pattern, seeking “greater confidence” that inflation is sustainably moving toward the 2% target—particularly in the stubborn categories of core services and shelter. That stance was validated by the Fed’s decision to keep interest rates unchanged at its latest meeting, continuing a “wait-and-see” approach amid a complex mix of improving price data and lingering economic uncertainties.

Recent inflation data provided some welcome news. The April Consumer Price Index (CPI) showed that headline inflation rose just 0.2% month over month and 2.3% year- over-year—the slowest annual pace since February 2021 and slightly below expectations for a 2.4% increase. Core CPI, which excludes volatile food and energy categories, also rose 0.2% in April, in line with forecasts, and was up 2.8% year-over-year. On the surface, these results suggest that inflation pressures are easing, although still above target.

Digging into the components, energy prices edged higher by 0.7%, driven by gains in natural gas (+3.7%) and electricity (+0.8%), while food prices actually declined (-0.1%). Notably, grocery prices were down broadly, with five of the six major food group indexes falling, including a sharp 12.7% drop in egg prices.

Even more encouraging was the Producer Price Index (PPI) report, which delivered a significant downside surprise. Wholesale prices fell -0.5% in April, the largest monthly decline since the pandemic and well below consensus estimates for a 0.3% gain. The core PPI, which excludes food, energy, and trade, declined -0.1% month over month, bringing the year-over-year rate to 2.9%. Wholesale service costs plunged -0.7%, marking the biggest drop since that data series began in 2009. These results counter the narrative that tariffs have triggered a surge in upstream price pressures—if anything, they suggest subdued demand and a front-loading of supply have helped contain inflation.

As of May 16, 2025, market expectations for Federal Reserve interest rate cuts have shifted notably due to recent economic data and evolving policy outlooks. For investors and consumers alike, the road ahead hinges on whether this disinflation trend proves durable or merely temporary noise in a still-uncertain economic environment.

June 2025 Meeting:
The probability of a rate cut at the June Federal Open Market Committee (FOMC) meeting has decreased significantly. According to the CME Group’s FedWatch Tool, there is an 8% chance of a 25 basis point reduction at this meeting. This marks a substantial decline from earlier expectations, reflecting the Fed’s cautious approach amid ongoing economic uncertainties.

July 2025 Meeting:
Expectations for a rate cut in July have also diminished. The likelihood of a 25 basis point cut stands at 28.0%, down from previous estimates. This adjustment aligns with statements from Fed officials emphasizing a “wait-and-see” strategy to assess the economic impact of recent policy changes and trade developments.

Outlook for 2025:
Looking ahead, the market anticipates a total of 50 basis points in rate cuts by the end of 2025, most likely occurring later in the year. The Fed’s current stance reflects a balance between addressing inflation concerns and supporting economic growth, with future decisions contingent on incoming data and global economic conditions.

While no rate hikes are currently being priced in, the path forward for interest rates has clearly shifted to a “higher for longer” regime. The Fed is not expected to ease until closer to November, even as traders fully price in at least one cut by then. This more cautious policy stance reflects the Fed’s desire to see consistent evidence of disinflation, especially in sticky core categories—before acting.

Still, the softer inflation prints have helped push back on the more dire stagflation concerns that emerged earlier in the year. April’s data, coupled with better-than-expected economic growth and solid labor market conditions, contributed to a modest rally in equities last week and strengthened the case for a “soft landing” rather than an imminent recession.

In sum, while inflation data in April was a step in the right direction, the Fed remains cautious. The central bank will need more consistent evidence of moderating inflation—particularly in core services and housing—before it shifts decisively toward easing.

Closing Thoughts and Investment Outlook

Despite ongoing macroeconomic uncertainty, the past month has delivered several encouraging signals for investors. From moderating inflation and improving trade rhetoric to resilient earnings growth beyond the tech sector, green shoots are beginning to break through the noise—and markets have responded in kind.

Inflation: Inflation is calming, but not conquered, as April’s data confirmed a much-needed cooling trend. The Consumer Price Index (CPI) rose just 0.2% month over month, and 2.3% year-over-year—its lowest annual pace since February 2021 and below consensus estimates of 2.4%. Even core CPI, which excludes volatile food and energy prices, posted a 0.2% m/m gain and was up 2.8% y/y, matching expectations.

The message from the data is clear: inflationary pressures are abating, particularly in the face of slower global growth and rising inventories from pre-tariff import surges. Energy and food prices showed mixed results, with food at home down 0.4% and eggs dropping by a striking 12.7%.

The Fed:  On hold, but not off the hook with the Federal Reserve maintaining rates steady last week as expected, signaling it still needs “greater confidence” that inflation is sustainably falling—particularly in sticky segments like shelter and core services. The tone has remained hawkish even as hard data softens.

Earnings: Broadening beyond big tech as corporate earnings strength has broadened, especially beyond the high-flying “Magnificent 7.” With 456 S&P 500 companies having reported as of May 16, earnings are up +12.1% YoY on +4.5% revenue growth. Notably, 71% of companies have beaten earnings estimates, with an average 6.1% surprise. Importantly, S&P 500 earnings growth outside the Magnificent 7 has turned positive and is accelerating—from -5.2% in 2023 to +3.9% in 2024, and a projected +6.2% in 2025. This broadening of growth supports a more durable market rally.

Global Trade: Encouragingly the trade war appears to be entering a phase of de-escalation. U.S. Treasury Secretary Scott Bessent acknowledged the unsustainability of the tariff standoff with China, and President Trump has hinted that final tariffs “won’t be anywhere near” the 145% ceiling, even suggesting unilateral cuts if no deal is reached. Multiple other trade partners, including the EU and U.K., are also at the table, aiming to remove remaining trade barriers.

At home, while Trump’s public criticism of Fed Chair Powell raised market concerns, he clarified in a follow-up conversation that he has “no intention” of firing Powell, easing fears of an abrupt leadership change at the central bank.

While tailwinds are forming, several headwinds remain:

• Fiscal deficits remain structurally large, with gold prices climbing in anticipation of further spending imbalances. The 70%+ correlation between gold and deficits suggests traders are skeptical of deficit reduction under either administration.
• M2 money velocity is still far below pre-COVID norms, implying excess liquidity without strong transmission into real economic activity.
• Interest rates, especially long-dated Treasury yields, are nearing critical levels. If yields fall without spending restraint, risks of debt-driven feedback loop grow.
• Consumer loan delinquencies have returned to levels last seen during the Great Financial Crisis.
• Geopolitical risk has moderated but remains unresolved, especially with volatile hotspots like Ukraine, Gaza, and the India/Pakistan border.
• Labor market transitions, such as Trump’s proposed reduction of federal workers, raise questions about the private sector’s absorptive capacity.
• AI spending remains aggressive—beneficial for productivity but with questionable investment returns if demand fails to meet expectations.
• Tariff policy unpredictability: While de-escalation seems likely, uncertainty persists around whether Trump can negotiate reciprocal reductions or follow through on threats.

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