Investment Insights

 — Steve Orr 

Neighborhood

After May’s 6%+ gain for the S&P 500, one would expect a pause in the stock market’s rebound rally. History is a guide, but it does not dictate. And most of our history library suggests that June is a month to go on vacaction from the markets. Over the past 70 years, stock performance for the month ranks 9th out of 12.  Hey, its not last (September!). The Dow Industrials, S&P and NASDAQ all average flat to less than 1% gains. Add in the following: last quarter of the month, quad futures and options expiration, another federal holiday and prep for quarter-end tax payments. Oops, we left out target rebalancing and earnings blackouts.

These events are a permanent, seasonal set of bricks in the market’s Wall of Worry. Every item in that list either pulls funds from the stock market or prevents more from coming in. Thankfully mid-July kicks off second quarter earnings season, and companies will start buying back their stock late in the month. Most of the time, media and tape watchers clutch worry beads over news events like the Ukraine drone strikes. Watching the “silent” bricks is just as important for trend and valuation in markets.

History also helps the Bulls: When the S&P 500 rises more than 2% in May, generally the returns are positive for the rest of the year, averaging near 9%. That fits our thesis, that tariff reactions pulled forward an economic and earnings slowdown, and growth should pick up later in the year. Our charts suggest either a triple top is forming in stocks (Bearish) or they are building energy to run higher (Bullish). All of our indicators suggest neutral now and a bumpy summer. 

Dial 899

Social media entered a new world last week — a ringside seat to big egos squabbling over the Big Beautiful Bill. For the record, the BBB is not a spending bill. The spending for this fiscal year was set last year by the prior administration. Before “budget season” in the fall, all that can be done is fiddling with the rules and methods for raising revenues — changing the tax code. The policy geek name for these bills is “reconciliation.” While Congress finding new ways to fleece us taxpayers is hard for us to reconcile, we cannot readily change the process.

Spending, reconciliation, rescission. Those are your main categories. Elon Musk was upset, apparently, because a number of the spending reductions his DOGE group found were not included in the BBB. Well, they are supposed to go in the next rescission bill. Those are for when Congress appropriates, but the Executive does not need the money or requests to spend it on something else. Sorry, Elon, we want cuts too.

The BBB keeps in place the tax rate reductions from 2017. The Congressional Budget Office and some congressmen call this a “spending cut.” In other words, you getting to keep your lower tax rates cuts tax revenue to us. Does Congress dislike us as much as we, the public, dislike them?  Please discuss.

One aspect of the BBB that is of concern to our clients and their vendors is possible changes to Section 899 of the tax code. The Senate parliamentarian allowed these rule changes to stay in the House bill on Sunday night. Briefly, the changes would allow the administration an additional tax, up to 20%, on foreign company earnings in the U.S., if that company’s home country is placing “unfair” or “discriminatory” taxes on American businesses.

The section would cover the EU’s digital services taxes (think Google and Apple apps) and the OECD’s Undertaxed Profits Rule. The tax would take effect at the beginning of next year. Clearly there is a lot of subjectivity in which country gets labeled a bad tax actor, but the concept does resonate with a number of our firms that experience these taxes when doing business overseas. Sounds like dialing for dollars to us.

Small steps

While the arguing goes on in D.C., the rest of the economy is rolling along in first gear. Yes, the excitement of second gear last fall has downshifted. Spoiler alert: We only have two of 10 economic signals in recession territory; in second gear we usually just have one. So no sign of imminent recession. Last Friday’s example is the May jobs report. Unemployment in the Household survey held steady at 4.2%. That was despite data showing just under one million foreign-born workers have left the workforce this year. Since overall employment was little changed, that implies native-born workers took their place. In other words, the composition of the workforce is shifting back toward its pre-shutdown mix.

Non-farm payrolls increased in May by an estimated 139,000, slightly above estimates. Ahh, but the prior two months were revised down by 95,000. When you are not sure where you are, step back and look at a bigger picture. The past six months, the NFP has averaged +157,000 net-new jobs, so May’s number reflects the softening tone of business leaders in the Fed’s Beige Book survey and our Dallas Fed surveys. Businesses are reluctant to hire in the middle innings of tariff trauma. One point we believe: There will be tariffs. But on who, what, how much and how long? 

That other stuff

An unemployment rate of 4.2% is much closer to full employment than recession. We think the rate drifts higher in the coming months toward 4.6% but will not flash a recession signal. Well, that’s what we think today.

Maintaining stable prices is the other task assigned by Congress to the Fed. Inflation and deflation are changes in all prices thanks to too much or too little money printing by the Fed. This Wednesday’s Consumer Price Index report should show headline inflation slowing to 2.5% and core (no gas or food for you) staying at or above 2.9%. Plentiful oil supplies thanks to several OPEC countries jumping over their production quotas have held a lid on pump prices. We think that continues, but housing, food and medical care will likely drift higher in the fall. Call year-end just north of 3% for inflation.

Both inflation and unemployment may not be “perfect” for the Fed — we think that is 2% and 3.5%, respectively, but certainly “good enough” to keep short-term rates on hold for most of this year. There will be two more inflation reports before the Fed meets in late July. Tariff changes may change some producer prices, but we think the Fed will find the summer economy in good shape and not lower short-term rates.