Hello, everyone. And welcome to the May Market Compass. You wouldn't know it just by looking at the S&P 500. But a lot has unfolded over the past five months. As of mid-May, US stocks have returned to where they started the year, coming full circle after nearly entering a bear market just six weeks ago. In today's video, we'll explore the drivers behind the recent rally and share our thoughts on what may lie ahead now that we've likely passed the peak of uncertainty.
Let's dive right in. Changes in US trade policy continue to be the main driver of this year's performance. The April 2nd tariff announcement shook investors' confidence and pushed the S&P 500 down 20% from its February peak. But since then, the US administration has softened its stance on trade, fueling an 18% relief rally.
The 90-day pause on the new tariffs was a significant first step. And the latest key development is that the US and China are lowering tariffs on each other for 90 days. This is a meaningful de-escalation, which, at the very least, buys time for countries to negotiate a longer term deal and also for companies to prepare for various scenarios.
The average tariff rate on imported goods is still expected to rise meaningfully from last year's 2 and 1/2 percent rate. But the 15% anticipated rate is much more manageable for the US economy compared to the 20% plus that was projected after liberation day. As we've seen before, trade uncertainty and stock market volatility move hand in hand. So developments on trade will remain important. We expect a mix of positive and negative news as the US negotiates with different countries. But we believe that peak uncertainty is behind us.
In addition to better news on trade, economic data continues to trend positive, showcasing that the US economy has remained firm as it faces headwinds. The pace of job gains is healthy. Initial jobless claims are low compared to history. And consumers continue to spend.
On the corporate front, the first quarter earnings season is nearing its end. And the S&P 500 profits are on track to grow 12%. With profit margins strong, companies have the ability to absorb part of the tariff cost.
The one downside of a still solid economy is that the Federal Reserve is comfortable staying on pause for a while longer. And it is not inclined to preemptively cut interest rates without having enough clarity on the impact of tariffs.
As trade tensions have eased, the market has adjusted its expectations for rate cuts this year, down to 2 from 4 in early April. We think that rate cuts are still on the way in the back half of the year. But the Fed will be cautious. However, the key point is that we remain in a rate-cutting cycle.
Looking ahead, the impact of tariffs will likely become more visible in the months ahead, as several major retailers plan to raise prices. However, a slowdown in services inflation may help offset some of these increases. This was reflected in the April CPI, the Consumer Price Index, where prices for hotels and airfare fell even as furniture and appliance prices climbed.
Economic growth could moderate if consumers begin to pull back. But we believe the broader theme of resilience will remain intact. The policy agenda is also shifting towards market-friendly measures. Republicans are advancing a tax bill expected to be stimulative, extending current tax cuts and introducing new ones. Deregulation efforts may also help support growth.
Because many tariffs are paused rather than removed, we're not out of the woods yet. The 90-day pause on the initial tariffs is set to expire in July, while the tariff pause on China expires in August. We think that if negotiations are taking longer than expected, these pauses will be extended.
It's worth noting that these deadlines coincide with the US debt ceiling standoff, which could add to market volatility. While we expect a resolution, it may not come until the last minute. From a market performance standpoint, near-term gains may be harder to achieve as uncertainties linger. However, history offers some encouraging perspective.
Strong rallies like those seen over the past month are often followed by continued positive returns. In fact, the recent monthly gain ranks as the fifth strongest in the past 40 years. While follow through over the next month can be mixed, historical trends suggest that 12 month returns following rallies of this magnitude have been solid.
Ongoing earnings growth and greater clarity on tariffs could help reverse some of the recent underperformance of US stocks even as international equities continue, in our view, to offer diversification benefits. From a sector perspective, a pivot to market-friendly policies may benefit financials and cyclicals. Meanwhile, reduced recession odds may reduce the need for more defensive positions in sectors like consumer staples and utilities.
In fixed income, the recent rise in the 10-year Treasury yield presents an opportunity to consider intermediate and long term bonds. For more tailored advice, please contact your financial advisor. With that, thank you for joining us. We look forward to seeing you next month for another Market Compass update.