Tariffs, recession? The US stock market "doesn't care"!

The best forecasters on Wall Street have been warning that tariffs could trigger an economic recession. However, the stock market seems to be "turning a blind eye" to this.

On one hand, Goldman Sachs estimates a 45% chance of a recession occurring within the next 12 months, while the chief economist at Apollo Global Management recently pegged it at 90%.

On the other hand, the S&P 500 index has just completed its longest nine-day winning streak since 2004—rising about 10%, erasing the sharp decline following President Trump's announcement of tariffs last month. The index is down only 3.1% year-to-date. Bond yields and the dollar have stabilized, indicating limited investor concern about the future.

Tom Porcelli, chief U.S. economist at PGIM Fixed Income, stated:

"Given the amount of uncertainty still present, the stock market's rebound feels like they're whistling past the graveyard."

Consumer confidence has not changed, but potential risks remain

According to many economists, even at lower tariff levels, sustained tariffs could have a ripple effect through the U.S. economy, impacting consumer spending, business investment, and employment.

Investors will receive the latest view on the economic situation from Jerome Powell next week, as he will speak at the conclusion of the Federal Reserve's May meeting on Wednesday. One of the main concerns among economists is: Trump's tariffs on imported goods could potentially drive up consumer prices and slow economic growth, creating a bad combination of "stagflation."

This concern is reflected in closely watched surveys, which have recently shown a decline in consumer confidence and small business optimism. However, there is little evidence that American consumers have begun to change their behavior.

A recent report showed that inflation-adjusted household spending surged 0.7% in March, exceeding expectations, possibly spurred by a desire to purchase goods before the tariffs took effect. Investors have dismissed data showing a contraction in the economy in the first quarter, claiming it was distorted by businesses rushing to import goods before the tariffs were implemented. Visa stated that as of April 21, its credit card spending has not shown signs of overall weakness.

Larry Adam, chief investment officer at Raymond James, remarked:

"I am closely watching credit card data, as it will be one of the warning signals. I believe we have passed the peak of uncertainty regarding tariffs, but we are now at the peak of uncertainty regarding the economy."

Goldman Sachs economists noted in a recent report that the impact of tariffs may take two to three months to show up in inflation data, and consumer spending should slow down shortly thereafter.

Vanguard, which manages $10 trillion in assets, recently lowered its forecast for U.S. economic growth for the year to below 1%, citing tariffs and related policy uncertainty. It expects inflation to reach 4% by the end of this year, up from a previous forecast of 2.7%. Senior international economist Kevin Khang stated:

"The idea that we are merely returning to a previous state without causing any disruption to the economy is, of course, optimistic."

Excess Returns Hovering at Low Levels: Insufficient Risk Compensation in the Stock Market

Although overall stock returns are strong, there are also signs of concern beneath the surface.

A few ultra-large tech companies that reported strong earnings are the main drivers of the rebound. Meanwhile, consumer staples and utility stocks—typically seen as safe havens during economic downturns—have performed well, while economically sensitive sectors like energy and discretionary consumer goods have lagged.

Traders in other markets are clearly preparing for at least a slowdown in economic growth. Interest rate futures traders are now convinced that the Federal Reserve will cut interest rates at least three times this year. Betters in the prediction market Kalshi believe there is a 63% chance of a recession this year, up from about 40% in March.

The yield on the 10-year Treasury has fallen from the peak during the sell-off in April. However, it has changed little compared to mid-March, supported by anxiety over inflation and restrained by concerns over growth.

Combined with the rebound in the stock market, this means that investors holding stocks rather than Treasuries are still receiving lower compensation for risk than historical standards.

A commonly used measure of this compensation is the "excess CAPE yield," which shows the gap between the cyclically adjusted earnings yield of the S&P 500 index (the inverse of its price-to-earnings ratio) and the yield on 10-year Treasuries, both adjusted for inflation.

At the end of April, this additional yield was only 1.8%. This is about half of its 50-year average, slightly above March's 1.7%, and below the level in September