After an impressive mid-year rally propelled equities to fresh peaks in July, tariff announcements and a weak jobs report in early August led investors to reassess the strength of the economic outlook. As we move through the year, the focus will move to the actual impact of tariffs as they kick in and start to affect the corporate sector, inflation and monetary policy.
Markets hit new highs in July
Throughout July, equity markets displayed remarkable resilience and breadth. The US S&P 500 not only made new all-time highs multiple times throughout the month, but economically sensitive small-cap stocks also outperformed sharply in the first three weeks of July (with the Russell 2000 advancing 5% over this period).
Investors took encouragement from solid US GDP figures, a rebound in consumer confidence, and corporate earnings that beat market expectations. Cyclical industries like building products, materials and banks were key beneficiaries of the upswing, underscoring broad-based conviction that underlying economic momentum has remained intact.
Plot twist after month end
In early August, two unanticipated developments converged to unsettle markets. First, the US administration provided more details on the final tariff levels that will apply to key trading partners. Some of these tariffs were higher than expected – causing concern about their economic impact. Notably, tariff rates were higher than expected for Switzerland (39%), Canada, Malaysia, and Thailand (35%). Closer to home, New Zealand also came away with a steeper tariff than expected – at 15% versus the initial 10% proposed. As a result of these announcements, share prices in trade-exposed industries experienced heightened volatility, and risk premiums widened as analysts debated the likely impact of these measures.
No sooner had markets begun to absorb the tariff shock than the August 1 employment report landed well below expectations: nonfarm payrolls increased by just 73,000 in July, markedly short of the consensus forecast of approximately 110,000, and the unemployment rate ticked up modestly. The unexpected softness in hiring – especially within the manufacturing segment – served as a stark reminder of how policy uncertainty can transmit through the labour market, prompting a reassessment of the strength of the economy.
The road ahead: Policy, earnings, and innovation
In the wake of this early-August plot twist, market expectations for Federal Reserve interest rate cuts increased materially. What began in July with only a moderate chance of a September rate cut has now evolved to roughly a 90% likelihood. There is increasing consensus that the Fed needs to cut rates to support a weakening economy.
Looking forward, a positive trajectory for equities over the coming months will hinge on three interrelated dynamics. First, signs that the newly imposed tariffs are having only a moderate impact on the underlying economy and corporate sector. Second, moderation in inflation readings, particularly core measures, has strengthened the case for interest rate cuts by central banks, which would provide more accommodative financial conditions. Finally, the corporate sector must continue to deliver on earnings momentum. While second-quarter results were stronger than expected, particularly within technology firms advancing AI and cloud-computing initiatives, maintaining that growth into the third quarter will be essential to justify current valuation multiples.
Should these elements align – a resilient economy, disinflationary trends, and continued earnings outperformance – equities may well extend their rally. However, after many months of speculation about the impact of tariffs, the rest of the year will be about assessing the real economic and corporate effects. With markets back near all-time highs, any sign of economic weakness, as we saw with the recent jobs data, or inflation, is likely to see a pick-up in market volatility. In either scenario, maintaining discipline in portfolio construction and staying alert to the potential impact of tariffs on portfolio companies will be essential for navigating the uncertainties ahead.
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