Market Commentary

• It seems almost a certainty that, in at least the near and intermediate terms, tariffs on a broad swath of U.S. trading partners will be going up, not down.
• For now, consider trimming overvalued sectors and asset classes like Industrials, Consumer Discretionary, and U.S. Small Cap Equities. We expect better buying opportunities later this year.

As the markets were watching the president sign the One Big Beautiful Bill Act (OBBBA) into law, much of the tariff news was put on the back burner as tariffs might still be postponed or negotiated away. Now, with the OBBBA behind us, tariffs are showing they’re back as policy priorities. As we enter the early stages of the second-quarter reporting season, investors are going to be laser-focused on how the tariffs have impacted and/or will impact corporate earnings.

It seems almost a certainty that, in at least the near and intermediate terms, tariffs on a broad swath of U.S. trading partners will be going up, not down. The president has set August 1 as the date when some of the most important U.S. trading partners (Mexico, Canada, and the European Union) will see tariffs ranging from 30% to 35% implemented. The U.S. has also sent letters threatening potential tariffs as high as 40% to a number of other countries. The administration has made it a point to repeatedly remind these countries that the U.S. is always open to negotiate trade terms for any that are willing to come to the table and address U.S. concerns of unfair practices and barriers.

So if tariffs are going up, investors are going to need to have some clarity on corporate margins and on price increases to consumers. In other words, if what you sell or the components you purchase to build your product are subject to tariffs, how much of this additional cost is ultimately going to being passed on to the downstream customer? Operating profit margins for the S&P 500 Index have been hovering in the 14% – 15% area (or better) since the third quarter of 2021. That compares to the average operating margin of 12.4% going back to January 1990 according to Bloomberg data.

That means companies do have the ability to absorb some of the cost of any applied tariffs in their margins. During this second-quarter earnings reporting season, investors will want to know first if tariffs will affect the company now or will likely affect it in the future. Secondly, they will want to know how much of that cost is going to be passed on to the buyer and what the magnitude of damage will be to earnings. Those are reasonable questions to be sure.

Our analysis suggests a midsingle-digit earnings growth rate result in the second quarter. That is down from the first quarter and reflects a slightly slower economy but also attempts to take into account tariff headwinds. While many companies are still selling inventory that they “bought ahead” to beat tariff increases, others are starting to see bottom line headwinds.

The Bloomberg consensus shows that two of our favored sectors, Information Technology and Communication Services, are expected to post the best year-over-year earnings results. We look for improved earnings comparisons as we move through the end of this year and into 2026 from Energy (most favorable rated) along with the Utilities and Financials sectors, our other favored sectors.

For now, consider trimming overvalued sectors and asset classes like Industrials, Consumer Discretionary, and U.S. Small Cap Equities where we expect better buying opportunities later this year, likely at the end of the year and into 2026. 

Each asset class has its own risk and return characteristics. The level of risk associated with a particular investment or asset class generally correlates with the level of return the investment or asset class might achieve. Stock markets, especially foreign markets, are volatile. Stock values may fluctuate in response to general economic and market conditions, the prospects of individual companies, and industry sectors. Foreign investing has additional risks including those associated with currency fluctuation, political and economic instability, and different accounting standards. These risks are heightened in emerging markets. Small-and mid-cap stocks are generally more volatile, subject to greater risks and are less liquid than large company stocks.

Sector investing can be more volatile than investments that are broadly diversified over numerous sectors of the economy and will increase a portfolio’s vulnerability to any single economic, political, or regulatory development affecting the sector. This can result in greater price volatility. Communication services companies are vulnerable to their products and services becoming outdated because of technological advancement and the innovation of competitors. Companies in the communication services sector may also be affected by rapid technology changes; pricing competition, large equipment upgrades, substantial capital requirements and government regulation and approval of products and services. In addition, companies within the industry may invest heavily in research and development which is not guaranteed to lead to successful implementation of the proposed product. The Energy sector may be adversely affected by changes in worldwide energy prices, exploration, production spending, government regulation, and changes in exchange rates, depletion of natural resources, and risks that arise from extreme weather conditions. Investing in the Financial services companies will subject an investment to adverse economic or regulatory occurrences affecting the sector. Risks associated with the Technology sector include increased competition from domestic and international companies, unexpected changes in demand, regulatory actions, technical problems with key products, and the departure of key members of management. Technology and Internet-related stocks, especially smaller, less-seasoned companies, tend to be more volatile than the overall market. Utilities are sensitive to changes in interest rates, and the securities within the sector can be volatile and may underperform in a slow economy.

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