After a massive drawdown in the initial reaction to President Trump's April 2 tariff announcement, major stock indexes have roared back, with the S&P 500 (^GSPC) adding $9 trillion in market value in just over a month.
But after six straight days of gains that have brought the S&P 500 within 3% of a new all-time high, some on Wall Street are cautioning the market rally may have extended too far, even if the probability of recession has declined in recent days.
“Equity markets have reacted with unwarranted optimism, overlooking the persistent economic drag posed by elevated tariffs,” EY chief economist Gregory Daco wrote in a research note on Tuesday.
The latest tariff delay, a 90-day pause on duties between the US and China, moved the estimated effective tariff rate from around 25% down to 14%, according to Daco. As we noted in the Yahoo Finance Chart of the Week, this better-than-expected tariff outcome helped drive the latest boost in stocks.
But now, with markets back at levels not seen since late February, Daco fears investors may be ignoring the fact that the effective US tariff rate remains at its highest level since 1939. And while the economic story has improved, forecasts aren't calling for accelerating growth either. Daco projects that US economic growth will approach “stall speed” by the fourth quarter, with GDP rising just 0.6% from the year prior in the final three months of 2025.
Read more: What Trump's tariffs mean for the economy and your wallet
Daco expects tariffs to eventually result in higher prices and weigh on household demand. He sees real consumer spending growing 2.2% in 2025 and that rate slowing further to 1.1% in 2026. In 2024, real consumer spending advanced 2.8%.
“While the near-term outlook is more constructive, risks remain tilted to the downside,” Daco said.
Still, it appears that investors are hoping the effective tariff rate will come down further, limiting impact to the economy. In a research note sent to clients on May 16, Deutsche Bank US equity strategist Parag Thatte noted that discretionary investors have moved back to an overweight position in stocks, which reflects no slowing in earnings growth or GDP on the horizon.
“An increase in tariff rates of this magnitude will weigh on growth, but discretionary investors are likely factoring in additional rollbacks and exemptions once the impacts start to manifest,” Thatte wrote.
On Monday, JPMorgan Chase (JPM) CEO Jamie Dimon warned that he sees an “extraordinary amount of complacency” in markets after investors clawed back their “Liberation Day” losses. Dimon added that the risks of “stagflation,” where economic growth slows and inflation reaccelerates, remain.
