S&P 500 at record high: Is the worst of the trade war behind us?

THE S&P 500 surpassed its February peak last week, reaching multiple new all-time highs amid optimism over trade negotiations and confidence that the economy and corporate earnings can withstand the impact of tariffs.

On Jul 2, the United States reached a trade agreement with Vietnam, lowering tariffs on Vietnamese exports to 20 per cent from the 46 per cent announced on “Liberation Day”, while goods shipped through Vietnam will be taxed at 40 per cent.

Meanwhile, US non-farm payrolls rose by 147,000 in June, exceeding expectations of 110,000. The unemployment rate also unexpectedly fell from 4.2 per cent to 4.1 per cent.

But with growth and inflation risks still lingering, is the rally of the US stock market getting ahead of reality?

Inflation set to rise

US inflation has remained relatively subdued despite the Trump administration’s tariff hikes since the start of the year. In May, the consumer price index (CPI) rose 2.4 per cent year on year, in line with expectations, while core CPI increased 2.8 per cent, below the forecast of 2.9 per cent.

Although the US Federal Reserve’s preferred inflation gauge – the core personal consumption expenditures (PCE) price index – came in slightly above expectations at 2.7 per cent versus 2.6 per cent, it remained in line with levels seen in the second half of 2024, prior to the introduction of tariffs.

The soft inflation numbers can be attributed to several factors, including businesses stockpiling inventories ahead of the tariff implementation and absorbing part of the tariff-related cost increase. At the same time, core services inflation has been moderating, with shelter inflation – a major contributor to sticky inflation in the services sector – trending downward.

As pre-tariff inventories begin to run out and rising costs begin to weigh on profit margins, more and more companies may have no choice but to pass on higher costs to consumers.

In its latest earnings call, Nike announced plans to raise prices to offset an expected US$1 billion of additional tariff costs in its 2026 fiscal year, while other companies, such as Walmart and Macy’s, have also flagged similar intentions.

Importantly, we expect the US effective tariff rates to remain elevated in the 10 to 20 per cent range, as President Donald Trump has yet to agree to rates below 10 per cent for any trading partner.

Although the tariffs imposed under the International Emergency Economic Powers Act of 1977 (fentanyl and “Liberation Day” reciprocal tariffs) have been deemed illegal by the US Court of International Trade and could eventually be struck down if appeals fail, we believe Trump will still find alternative ways to implement his desired tariff regime.

This includes the use of Section 232 of the Trade Expansion Act of 1962, which allows a US president to restrict imports that are deemed to threaten national security. This is already being used to impose tariffs on steel, aluminium and autos, and could be extended to other sectors.

Additionally, tariff revenue has taken on renewed importance, with the One Big Beautiful Bill (OBBB) projected to widen the US fiscal deficit by approximately US$3.4 trillion over the next decade. Without tariffs, that shortfall would be even greater. Therefore, we see little chance of US effective tariff rates reverting to the 2 to 3 per cent range.

Slowing consumption to weigh on growth

Naturally, higher prices tend to dampen consumption, and signs of a slowdown are beginning to emerge.

Final real gross domestic product figures released on Jun 26 showed that the US economy contracted by 0.5 per cent quarter on quarter in the first three months of 2025 – worse than the estimate of minus 0.2 per cent and a sharp reversal from the 2.4 per cent expansion in the previous quarter.

While much of the decline was driven by a surge in imports, as households and businesses rushed to front-load purchases ahead of new tariffs, a slowdown in consumer spending was also a key contributor. Consumer spending rose just 0.5 per cent, down significantly from 4 per cent in the prior quarter, as tariff disruptions weighed on sentiment. Monthly indicators told a similar story, with PCE and retail sales falling 0.1 and 0.9 per cent month on month, respectively.

With consumption making up nearly 70 per cent of GDP, a slowdown in household spending is likely to be a drag on economic growth in the coming quarters. Even so, a sharp rebound in second-quarter GDP is possible as the surge in imports seen earlier this year begins to fade.

On a positive note, the labour market remains resilient, with the unemployment rate remaining low at 4.1 per cent. While wage growth has moderated in recent months, it is still relatively solid. Together with the extension of the existing tax breaks and the roll-out of new personal tax cuts under the OBBB, these factors should continue to support consumer spending and help cushion against a severe economic downturn.

Downward earnings revisions likely

With the US economy likely to enter a period of mild stagflation, current consensus estimates for 2025 earnings growth of around 11 per cent appear overly optimistic. In the coming months, we expect tariffs to weigh more heavily on profit margins, bringing earnings growth closer to the range of 4.5 to 6 per cent. At current prices, this suggests limited upside for the S&P 500.

Nonetheless, there are still bright spots in the US stock market. The tech sector continues to stand out, with earnings growth expected to outpace other sectors. This is supported by rising artificial intelligence adoption and relatively limited exposure to tariffs.

In today’s uncertain environment, we believe it is more important than ever to be selective and to focus on companies with strong balance sheets and structural growth drivers.

The writer is a research analyst with the research and portfolio management team of FSMOne Singapore, the B2C division of iFast Financial