Summary

Back to Opening: Our Monthly Survey of the Economy, Interest Rates, and Stocks The S&P 500 rose 6.2% in May 2005 and had its best month since November 2023. May was an eventful month on the trade front and contained the bulk of a strong earnings season and reassuring employment data. The previous four months of 2025 were tumultuous. The S&P 500 rose 2.7% in January on anticipation of a more business-friendly administration. The index fell 1.4% in February and plunged 5.8% in March as investors realized President Trump intended to make good on his tariff promises. April was hugely volatile, as stocks plunged in the first half of the month and flirted with a bear market after 'Liberation Day,' and then roared back in the second half of the month on promises of more-benign trade deals and a softer tone regarding Fed independence. The May rally has brought stocks back approximately to year-opening levels. Still, few investors anticipate a smooth ride higher from here, given the uncertainty across the economy, the interest-rate environment, the earnings outlook, and the jobs economy. The Economy, Interest Rates and Earnings In the first quarter of 2025, gross domestic product was shaped by corporate actions taken in response to early tariffs and in advance of anticipated steeper tariffs. In the second quarter to date, trade policy from the administration shows signs of coalescing, as the White House works on deals with a multitude of nations and with some announced tariffs being paused or pushed out. We expect this uncertainty to impact GDP growth in the next few quarters. The second (preliminary) report of first-quarter 2025 GDP showed a decline of 0.2%, slightly better than the 0.3% decline posted in the advance report but down from growth of 2.4% in 4Q24. First-quarter 2025 GDP was distorted by a massive spike in imports, which are a subtraction to the calculation of GDP. Government spending also decreased, though less than initially reported; this mainly reflected a pause in defense spending. These subtractions to GDP were partly offset by increases in private inventories, business spending, consumer spending, and exports. Pressure on 1Q25 GDP from the government's still-formulating tariff policy was well anticipated but still had a larger-than-expected impact. Imports in the preliminary GDP report increased 42.6% in 1Q25, actually higher than in the advance report. Exports increased 2.4%, up from 1.8% in the advance report but still overwhelmed by imports. The value of imported goods in 1Q25 increased $342 billion from 4Q25 for an annualized and seasonally adjusted $4.03 billion in the first quarter versus about $3.65 billion in 4Q24. The vast majority of these imports were goods. Imports represented a 4.98 percentage-point reduction to 1Q25 GDP growth. The surge in imports was reflected in the change in private inventories, which added 2.64 percentage points to 1Q25 GDP. This volatile category increased 0.06 basis points in 2024 after subtracting 41 basis points in 2023 during the supply chain crisis. Argus Economics expects GDP to grow in the remaining quarters of 2025 for two reasons. The export-import balance is likely to normalize and in the near term will favor exports (additive to growth) as first-quarter imports are worked down. And the key growth categories of personal consumption expenditures (PCE) and business spending were positive in the first quarter. PCE for 1Q25 rose 1.2% and contributed 0.80 percentage points to GDP in the period. Durable goods spending declined while nondurable spending rose. The large category of services spending increased 1.7%, less than the 2.4% growth reported in the advance report. We expect PCE within GDP to continue to send conflicting signals in 2025, while remaining in the 1%-3% range as the eventual tariff regime becomes settled. Nonresidential fixed investment, the proxy for corporate capital spending, rose by 10.3% in 1Q25. This category, which grew in the 6%-7% range over 2023-2024, got a boost in 1Q25 as companies sought to invest in their infrastructure before stiffer tariffs were put in place. Nonresidential fixed investment added 1.36 percentage points to 1Q25 GDP. Overall government spending was down 0.7% in 1Q25, after being down 1.4% in the advance report; this category subtracted 12 basis points from first-quarter GDP growth. Defense spending declined 7.1%, leading to a 4.6% decline in total federal spending. State and local government spending moved higher by 1.7%. The price index for gross domestic purchases increased 3.4% for 1Q25, after rising 2.4% in 2024. And the PCE price index advanced 3.6%, up from 2.5% in 2024. The Fed needs both GDP growth and lower price increases to cut rates. Elsewhere, the economy has flashed positive signs based on jobs growth and corporate earnings. The U.S. economy generated 177,000 new jobs in April, better than the consensus call of 130,000. The three-month average for jobs growth was a healthy 155,000, in line with the full-year 2024 average of 166,000. The unemployment rate held at 4.2% for April, and average hourly earnings grew 3.8% annually. New claims for unemployment insurance remain relatively low, and expectations for May jobs growth are in the 130,000-140,000 range. Industrial production was little changed in April following a 0.3% decline in March, as growth in utilities output canceled out declines in manufacturing and mining output. Manufacturing decreased 0.4% in April following 0.4% growth in March. Mining fell 0.3%. Capacity utilization continues to edge lower, coming in at 77.7% and about two percentage points below the long-run average. The NFIB's Small Business Optimism Index, which reached a six-year high of 105.1 in December 2024, has been declining amid on-again, off-again tariff policy. The index came in at 95.8% in April, down from 97.4 in March and marking a second consecutive month below the 51-year average of 98.0. NFIB Chief Economist Bill Dunkelberg stated that 'uncertainty continues to be a major impediment for small business owners,' affecting everything from hiring plans to investment decisions. The ISM Manufacturing PMI remained below 50 for April, but at 48.7 actually ticked up from 47.9 for March. Purchasing managers are perhaps anticipating that tariffs will incentivize companies to shift from overseas manufacturing to higher levels of onshore production. The ISM Services PMI registered 51.6%, indicating expansion for the fifty-sixth time in 59 months (since the pandemic) and rising from 50.8% in March. Although consumers are concerned that tariffs could cause higher inflation, the University of Michigan Consumer Sentiment Index finally steadied in May. The index held at 52.2 in May, level with the April reading. Consumer sentiment remains near record-low readings, however. The Conference Board's Consumer Confidence Index for May 2025 rallied to 98.0 in May, up over 12 points from 85.7 in April. The Expectations Index, based on consumers' short-term outlook for income, business, and labor market conditions, surged 17.4 points to 72.8. That lifted it up from 54.4 for April, the lowest level since 2011. But expectations remain below the threshold of 80 that usually signals a recession ahead. The Bureau of Economic Analysis within the Commerce Department reported that personal incomes rose 0.8% in April 2025, following growth of 0.7% in March and 0.8% in February. Personal consumption expenditures (PCE) rose 0.1% for the month after rising 0.7% in March. The Atlanta Fed's GDPNow model, which forecast negative 1Q25 GDP, is currently estimating that second-quarter GDP will grow 3.8%. That represents a meaningful uptick from the 1% range of two weeks ago, reflecting the import-export pendulum swinging to strong net exports. Argus Chief Economist, Chris Graja, CFA, looks for generally low-level but positive GDP growth for the remainder of 2025, with economic momentum increasing as a tariff-impacted global economy stabilizes. We are currently modeling GDP growth of 0.5% for 2025. Argus believes GDP growth is likely to remain positive in 2026, ticking higher potentially to the 2% range. The Federal Open Market Committee (FOMC) of the U.S. Federal Reserve concluded its May 2025 meeting at mid-month and, as expected, maintained its fed funds target at the 4.25%-4.50% level. This marked a third straight meeting in which the Fed stood pat, after 100 basis points (bps) of cuts in fall 2024. Ahead of the mid-June FOMC meeting, investors broadly expect the Fed to stand pat once again. The Trump administration knows that tariff policies risk weakening near-term economic activity and would like the central bank to lower rates as a means of offsetting tariff impacts. The White House first attempted a blunt approach, demanding rate cuts and disparaging the Federal Reserve Chairman. This aggressive language and threats to Fed independence caused the bond market to tank and the dollar to weaken. The administration has since moderated its tone to a more conciliatory stance while maintaining pressure to lower rates. Market interest rates, which moved higher on the administration's tough talk, have not come back down, however. Bond investors have a new set of concerns centered on the administration's 'one big, beautiful bill.' The bill permanently extends the cuts from the Tax Cut & Jobs Act of 2017, eliminates taxes on tips and Social Security for moderate wage earners, and may raise deductibility of state and local taxes. Even with offsets from lower Medicaid spending and other cuts, the bill could add up to $4 trillion to the national deficit over the coming decade. Washington's tariff policies, rising tension with China, and deteriorating relations with former allies are reducing the attractiveness of U.S. Treasury debt as the ultimate safe haven. Recent bond auctions have met with tepid response, particularly from overseas investors. The increased focus on the ballooning national deficit and its upward impact on bond yields has obscured recent progress on inflation. The Consumer Price Index rose 0.2% month over month in April 2025 after dipping 0.1% in March 2025. All-items CPI for April was up 2.3% over the previous 12 months, improved from 2.4% as of March. Core CPI was up 0.2% month over month and up 2.8% from April 2024. The Fed's preferred inflation gauge, the Core PCE Price Index, edged up 0.1% in April after being unchanged in March. This metric was up 2.5% on an annual basis, its lowest reading since March 2021. Bond yields, which hit multi-month lows following the Fed's September 2024 rate cuts, have been volatile ever since. Given the deficit spending envisioned in the huge appropriations bill, maturities at the short end of the curve had tended to move slightly higher in the past month and those at the long end of the curve have moved more meaningfully higher. The 10-year Treasury yield was 4.41% as of the end of May 2025, compared with 4.33% as of the end of April. The long yield reached a low of 3.75% as of September 2024, while the cycle peak for the 10-year yield was around 4.9% in October 2023. The two-year Treasury yield was 3.83% as of the end of May 2025, versus 33.83% as of the end of April. The two-year yield reached a cycle low of 3.55% in September 2024; the peak level was 5.2% as of October 2023. The giant appropriations and tax bill wending its way through Congress is just the latest factor to exert upward pressure on rates. Over time, Argus expects short-term yields to move lower from current levels. Long yields over time are expected to widen their relative premium to short yields. We likely have seen the end to twos-10s inversion in this cycle, and even the three-month yield was below the long yield as of the end of May 2025. Argus Fixed Income Strategist Kevin Heal continues to model two quarter-point rate cuts in 2025. That would bring the central tendency in fed funds to 3.75%-4.0% by December 2025. He also acknowledges the possibility that the Fed holds rates unchanged in 2025, as it continues to monitor the economy, employment, and inflation. The Fed is cognizant that tariffs historically are associated with higher goods price. Were inflation to rise from current levels, we believe this Fed would not hesitate to return to neutral or even to restrictive monetary policy, i.e., start raising rates again. We have adjusted our estimates of S&P 500 earnings from continuing operations for calendar 2025 and 2026 to reflect potential negative impacts on earnings from higher costs and reduced commerce. For now, our EPS reductions are tweaks rather than big cuts. On the upside, the first-quarter earnings season modestly outperformed our expectations, with annual EPS growth of about 14%. We had been modeling high-single-digit to low-double-digit EPS growth. On the downside, with steep tariffs being scheduled and then paused or pushed out, companies are still struggling to finalize their 2025 capital budgets. Major corporations are considering a range of strategies to deal with tariffs. We believe most will strike a balance: pass along some portion of tariffs to end-customers and absorb some portion. Passing along tariffs to consumers could result in lost revenue as customers (particularly in the lower tiers of the economy) forego planned purchases and make do with less. Absorbing tariffs should do a better job of protecting the revenue stream but inevitably will cut into margins. Both absorbing and passing along tariffs, in other words, will impact earnings. For 2025, we have reduced our forecast for S&P 500 earnings from continuing operations to $270, from $276. Our new 2025 EPS estimate implies full-year EPS growth of 10%, reduced from 12%. For the middle quarters of 2025, we are using more-conservative growth assumptions for most sectors. In particular, we have reduced our 2025 growth assumptions for Consumer Discretionary, Healthcare, Industrial, and Information Technology. Consumer Discretionary faces the triple whammy of already-high goods inflation, the potential for further price hikes due to tariffs, and financing rates that are too high for large-ticket items. We still look for Healthcare EPS to grow in double-digit percentages, but have cut our growth forecast nearly in half due to the potential for White House-mandated lower drug prices and pressure on insurance company earnings from elevated procedure volumes (hips, knees, etc.). Industrial earnings could be impacted by reduced foreign demand for big-ticket equipment (machine tools, commercial aircraft, etc.). Information Technology faces multiple risks including unsettled tariffs on smartphones, PCs, and semiconductors and an ever-shifting web of regulation on what technology can and can't be shipped to China. For 2026, our new estimate is $300, reduced from $307. That estimate assumes EPS growth of 11%. Whereas 2025 EPS is forecast to be strong in the first and last quarters and weak in the middle quarters, our 2026 EPS growth forecast calls for more-stable quarterly performance amid partly subdued growth across 2026. Domestic and Global Markets Stocks hit their 2025 trading year lows in the immediate aftermath of President Trump's 'Liberation Day' tariffs announced on 4/2/25. At a closing low of 4,983 on 4/8/25, at the height of tariff panic, the S&P 500 was down 15.3% year-to-date and 18.9% below its all-time closing high of 6,147 from February 2025. The stock market enjoyed a strong second half of April, and then roared higher in May to close the month approximately in line with year-opening levels. At the end of May 2025 on a total return basis (with dividends), the S&P 500 was up 1.1% year to date after being down 2.9% at the end of April. The Nasdaq was down 0.7% year to date at the end of May after being down 6.7% at the end of April. The Dow Jones Industrial Average was up 0.1% at the end of May 2025 after ending April down 2.4% for the year. Wilshire Large Cap Growth was up 1w.6% as of the end of May, closing the gap with Wilshire Large Cap Value's 2.5% year-to-date gain. The Russell 2000 was down 6.9% year to date, even though these smaller, domestic-facing companies are expected to be less impacted by tariffs. The Barclays Bloomberg U.S. Bond Index, which finished 2024 with a 0.9% gain, was up 2.2% year to date as of the end of the May 2025. Bond returns bounced around all through 2024, and there is no reason to assume they will be stable in 2025. With May now complete, the stock market is showing very different sector leadership in 2Q25 compared with 1Q25. During the first quarter, the best-performing sectors were defensive, rate sensitive,