Equities Post Strong Gains as Some Investors Look Past Uncertainty

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities posted strong gains last week, with the S&P 500 and NASDAQ each hitting new all-time highs. The move higher came thanks to a ceasefire between Israel and Iran and the late-week announcement that the U.S. and China had reached agreement on the outlines of a trade deal. Administration officials also announced it was close to reaching trade deals with some additional countries and noted that the July 9 deadline for trade deals could be extended. Finally, the administration expects that its trade negotiations could be finalized by September. Trade developments remain fluid as was witnessed by the President announcing a suspension of negotiations with Canada due to disagreements over tax policy related to digital services. However, over the weekend the two countries agreed to restart negotiations, adding to the optimism felt by some investors.

The news of the abandonment of talks with Canada was largely shrugged off by investors and illustrates what appears to be a broader mindset in the markets. After the sharp sell-off that followed the administration's unveiling of reciprocal tariffs, investors have largely embraced the view that initial concerns about tariffs were overblown and that should the economy show signs of weakening, the Federal Reserve would cut rates quickly to spur growth. The view on tariffs seems to be based on the fact that, so far, hard economic data has largely remained solid even as surveys and other soft data have shown weakness. Likewise, recent tame inflation readings (last week’s excluded) and public comments by some members of the Federal Reserve Board have led many investors to conclude that the Fed will cut rates in September and at least one more time by year end. While these views may prove correct, we believe it is premature to say for certain how things will play out.

However, Federal Reserve Chair Jerome Powell in his testimony on Capitol Hill last week underscored the challenge the Federal Open Markets Committee (FOMC) faces in deciding when to adjust rates given the evolving trade negotiations and the unknown impact they will have. “The effects on inflation could be short-lived—reflecting a one-time shift in the price level. It is also possible that the inflationary effects could instead be more persistent. Avoiding that outcome will depend on the size of the tariff effects, on how long it takes for them to pass through fully into prices, and, ultimately, on keeping longer-term inflation expectations well anchored,” Powell said.

While the Fed has taken a wait-and-see approach with the data before making a decision on rates, it expects to get some indication of how the levies are affecting prices in the near future. "We should start to see this over the summer, in the June [inflation] number and the July number. ... If we don't, we are perfectly open to the idea that the pass-through [to consumers] will be less than we think; and if we do, that will matter for policy," Powell said during the House hearing on Tuesday.

To be sure, inflation data over the past few months has been encouraging. Last week’s Personal Consumption Expenditures (PCE) index, which we discuss later in this commentary, came in slightly higher than expected, but as a whole, price pressures have been on a downward trend since early spring. But while inflation is close to the Fed’s 2 percent target, it isn’t there yet—and hasn’t been in more than four years. Given the expectations that tariffs will likely cause at least a temporary uptick in prices, we believe the Fed will be conservative with rate adjustments until it is clear that inflation is at or clearly headed to its 2 percent target.

In the meantime, while “soft” survey data has yet to show up in inflation readings, it appears top be seeping into other hard measures of the economy. Recent data, including the final revision of gross domestic product for the first quarter and the latest PCE data, both of which we discuss later, shows that consumer spending is slowing. Likewise, while the unemployment rate remains relatively low, other hard measures, such as continuing jobless claims, have been trending higher and are now at or near multi-year highs.

We raise these points not to paint a gloomy picture of the economy going forward but to provide you with a fuller view than reflected in the steady climb of the markets since April. If inflation stays higher for longer or the economy shows more signs of wobbling than many expect, we believe market volatility will return as investors adjust their near-term outlooks.

While the uncertainty, including timing of the impact from various policy changes, remains high, the answer in dealing with unpredictability in the economy and markets remains the same. We do not believe it calls for dramatic changes to your investment plan. Instead, the current environment serves as a valuable reminder that an unpredictable future will lead to unpredictable opportunities for investors in the intermediate and long terms. And capitalizing on these unforeseen opportunities is best done through diversification. This approach was validated during the extreme uncertainty that arrived with COVID, and we believe it will prove to be a prudent approach during the current economic changes.

Wall Street wrap

Pace of economic growth slows as prices continue to climb: Preliminary data from the latest S&P Global Purchasing Managers Index (PMI) showed that the pace of growth slowed modestly in June. The latest preliminary data, which tracks both the manufacturing and services sectors, shows that the Composite Output Index came in with a reading of 52.8 (levels above 50 signal growth), down from May’s final reading of 53.

Manufacturing PMI came in at 52, unchanged from May. The Manufacturing Output Index rose 2.1 points to 51.5, the highest level in four months. It’s worth noting that for a second consecutive month the increase in manufacturing was driven by stocking of inventories, which saw the greatest increase in the history of the survey dating back to 2009; the stockpiling of inventory could be a sign of customers buying ahead of expected price increases tied to tariffs. Meanwhile, the Services Business Activity Index came in at 53.1, down 0.6 points from May but still in expansionary territory. Although readings for both manufacturing and services are at expansionary levels, the pace of growth is subdued by historical standards.

New orders rose again for both sides of the economy, albeit at a slower pace. The increase in orders was driven by domestic demand as export orders continued to weaken. Manufacturing saw a modest dip in export orders, but services suffered the steepest decline over the past three months since 2022. While orders rose, it is unclear whether the pace will be sustainable. “The June flash PMI data indicated that the U.S. economy continued to grow at the end of the second quarter but that the outlook remains uncertain, while inflationary pressures have risen sharply in the past two months,” Chief Business Economist of S&P Global Market Intelligence Chris Williamson noted in comments released with the report. Inventories of products used in the manufacturing process rose at the fastest rate in just over three years. Likewise, inventories of finished goods at factories saw the largest increase in nine months and one of the sharpest increases in the survey’s 18-year history. The rise in inventories may result in a decline in orders in the coming months as companies pull from existing stock.

Input and selling prices for manufacturers jumped, rising at the fastest pace since July 2022. Nearly two-thirds of manufacturers reported facing higher input costs stemming from tariffs. “Prices for goods have meanwhile jumped sharply again, the rate of increase accelerating to a three-year high as firms pass higher tariff-related costs on to customers. Service providers are by no means immune to this tariff impact and likewise reported another jump in prices, often linked to tariffs on inputs such as food,” Williamson said. Of the manufacturers that reported increasing prices to end users, half attributed the decision to covering the cost of tariffs.

Perhaps another possible example of tariffs distorting data, manufacturers and service providers reported strong gains in payrolls. Hiring in manufacturing grew at the fastest pace in 12 months, while hiring in services grew at the fastest clip in five months. We will be watching hiring in the months to come to see if the uptick in payrolls is the result of a temporary surge in demand due to tariffs. This view was echoed by Williamson, who noted, “While domestic demand has strengthened, notably in manufacturing, to encourage higher employment, this in part reflects a boost from stock building, in turn often linked to concerns over higher prices and supply issues resulting from tariffs. Such a boost is likely to unwind in the coming months.”

Capital spending rebounds: Preliminary results for May showed that durable goods orders soared for the month, rising 16.4 percent compared to a 6.6 percent decline the previous month. While economists often shrug off this volatile number, the report also contains nondefense capital goods orders and shipments, excluding aircraft, that are viewed as proxies for overall business spending. That measure rose 1.7 percent after falling 1.4 percent in April. Nondefense capital goods shipments excluding aircraft rose 0.5 percent after remaining flat the previous month.

Consumer confidence falls: The Conference Board’s Consumer Confidence Index released last week came in at 93 for June, down 5.4 points from May. The latest reading was the fifth in the past six months showing eroding confidence. Views of current economic conditions fell 6.4 points from the prior month’s final reading to 135.5.

Expectations for the future declined to 69, down 4.6 points from May. Expectations remain below the 80-point level that has typically served as a threshold, indicating a recession is approaching. The broad-based decline in confidence erased nearly half of May’s rebound, with respondents in all age groups and income levels registering a decline in optimism.

The retreat in sentiment overall was also reflected in the labor differential, which measures the gap between those who find it easy or hard to get a job. The measure fell to 11.1 from May’s final reading of 12.7 percent. The current reading is the lowest since March 2021. It’s worth noting that the labor differential was at 31.7 in January 2024 and eventually fell all the way to 12.7 in September. Typically, a decline in the differential signals a more challenging job market and can coincide with a rise in unemployment (as we saw in the summer of 2024). As we’ve noted in the past, historically significant narrowing of the differential has often coincided with a rise in unemployment. While the erosion on this “soft data” measure has yet to coincide with a rise in the unemployment rate, it bears watching, as there has been other hard data that has shown some softening in the labor market.

First-quarter consumer spending revised lower: The final estimate of first-quarter real GDP from the Bureau of Economic Analysis showed that the economy shrank at an annual rate of 0.5 percent, worse than the previous estimate of a 0.2 percent decline. Among the noteworthy updates to the initial estimate was a drop in consumer spending, which was up 0.5 percent quarter over quarter, down from 1.2 percent in the most recent estimate and less than a third of the 1.7 percent initial estimate and is now at the lowest level since the second quarter of 2020. For further context, consumer spending was up 4 percent in the fourth quarter of 2024. Strong spending in that fourth quarter may be the result of consumers buying ahead of anticipated tariffs and could result in depressed spending in the near term.

Inflation rises modestly: The latest reading of the PCE index from the Bureau of Economic Analysis showed that headline inflation rose 0.1 percent in May, equal to April’s increase. The measure is up 2.3 percent on a year-over-year basis, up from April’s year-over-year pace of 2.2 percent. Core inflation, which strips out volatile food and energy prices and is the measure that the Fed has the greatest influence over, was up 0.2 percent—after being up 0.1 percent in April. On a year-over-year basis, core inflation was up 2.7 percent, up from April’s 12-month pace of 2.6 percent.

The cost of goods rose 0.1 percent in May, equal to April’s pace and the fifth time in the past six months that goods prices have risen. Services prices rose by 0.2 percent, up from April’s pace of 0.1 percent. On a year-over-year basis, inflation for services came in at 3.4 percent, unchanged from April’s final reading. Meanwhile, goods prices are up 0.1 percent from the same period a year ago. Finally, so-called super core services prices, a measure that strips out shelter, was essentially unchanged for the month (down 0.02 percent) but remained elevated at more than 3 percent on annualized three- and six-month bases.

While the inflation data remained relatively mild, the report offered more evidence that consumers were pulling back on spending. The latest data showed consumer expenditures adjusted for inflation fell 0.1 percent in May. On a year-over-year basis, consumer spending grew 2.2. percent, down from April’s reading of 2.9 percent and the slowest pace since April.

A potential warn(ing) for the labor market: In addition to the better-known employment reports like the weekly jobless claims and the Bureau of Labor Statistics (BLS) Nonfarm and Household reports, we also track less popular reports. One such example is data captured from filings under the Worker Adjustment and Retraining Notification (WARN) act. This rule requires employers with 100 or more employees to provide public notice 60 days in advance of plant closings and mass layoffs. The latest analysis from the Cleveland Federal Reserve Bank shows that in May large employers filed notification for 43,387 expected layoffs in the coming 60 days. The total is up sharply from April’s total announced layoffs of 26,502. With the exception of a few months during the height of COVID when layoffs spiked, May’s total marks the highest level since a few months at the end of 2008 and into early 2009 during the Great Financial Crisis. As we often note, it is impossible to draw conclusions based on a single month of data, but the size of the spike warrants keeping an eye on this measure in the coming months.

Continuing jobless claims rise: The latest data from the Department of Labor shows that continuing jobless claims (those people remaining on unemployment benefits) stand at 1.974 million, up 37,000 from the previous week’s revised total and the highest total since November 2021. The four-week rolling average of continuing claims came in at 1.941 million, an increase of 16,750 from last week and also the most since late November 2021. Meanwhile, initial jobless claims were at 236,000, a decline of 10,000 from the previous week’s upwardly revised total. The four-week moving average of initial claims numbered 245,000, down 750 from last week’s revised total. As we’ve noted in prior commentaries, we believe continuing claims are a more reliable indicator of the labor market, as they measure workers who are facing long-term challenges in finding a job and, as such, filter out some of the temporary noise that can be found in initial claims data.

Existing home sales rise: The National Association of Realtors reported that existing home sales in the U.S. rose 0.8 percent in May to a seasonally adjusted annual rate of 4.03 million units. The increase snaps a two-month streak of declining sales. On a year-over-year basis, sales of existing units are down 0.7 percent. Home sales declined across most price categories; however, houses at the $750,000 to $1 million level increased 1 percent. This highlights how higher interest rates are weighing on less affluent consumers while having a less significant impact on wealthy households.

The inventory of unsold homes was 1.54 million units, up 6.2 percent from April and a jump of 20.3 percent from year-ago levels. Unsold inventory is equal to a 4.6-month supply. Historically, a six-month supply of inventory is consistent with moderate price appreciation. The latest inventory numbers suggest prices may continue to climb but at a slower pace. Despite the decline in sales, the median price for existing single-family homes rose to $427,800 in May, an increase of 1.3 percent from year-ago levels.

Cooling home prices: The latest S&P CoreLogic Case-Shiller Index report shows that home prices nationally fell 0.4 percent on a seasonally adjusted basis from the prior month. April’s reading shows home prices are up 2.7 percent on a year-over-year basis compared to March’s year-over-year pace of 3.4 percent. Year-over-year gains have steadily eased since July 2024 as mortgage interest rates remained elevated.

The week ahead

We will be monitoring economic releases over the next week, including the employment reports from the BLS. There will be no commentary next week as we enjoy the holiday (and hope you will as well). We’ll be back the following week to dissect the latest economic data and market movements.

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