How investors went from stagflation panic to bull market euphoria

Yahoo

30-07-2025

The stock market has pulled a 180 in the last few months.
Investors went from worrying about stagflation to cheering the bull rally in a matter of months.
Market pros say two things have helped brighten the outlook, but warn investors may be getting too excited.
The market has gone through a stark transformation in the last few months. A crescendo of panic about the economic impacts of tariffs has slowly but surely given way to a chorus of euphoric voices on Wall Street calling for a new bull market.
What happened? How did markets go from fearing the dreaded S-word to shrugging off the most dramatic upheaval of trade policy in a century?
A few months ago, recession calls were springing up on Wall Street, and investors were fretting over stagflation, a situation where inflation remains stubbornly high while economic growth slows, and which economists warn is even worse than a normal recession.
Those fears have seemingly been wiped off the table, even more so now that second-quarter GDP data released on Wednesday showed the US economy returned to growth mode this spring.
Goldman Sachs, Bank of America, and other forecasters have lifted their economic outlooks in recent weeks, and most investors now expect the economy to avoid a recession, with 65% of global fund managers saying they expected a soft landing, according to a July BofA survey.
Meanwhile, meme stocks have come roaring back, another sign that animal spirits have returned to markets.
And yet, Donald Trump's tariffs are still on. The US tariff rate is about 18.2%, according to the latest update from the Yale Budget Lab. That's the highest the overall tariff rate has been since 1934, the researchers said.
"If you'd had told me a year ago or six months ago that we were going to have 15% across-the-board tariffs, I would have thought the S&P 500 would be considerably lower than where it is now. I certainly wouldn't think it would be making new highs," Doug Peta, the chief US investment strategist at BCA Research, told Business Insider.
Market pros who spoke to BI say two things led the market to stage a dramatic turnaround.
Tariffs aren't as bad as feared
The fact that tariffs are still on hardly matters to the market. It's more so that they aren't as bad as initially feared, Peta said.
Stocks have climbed as Trump has announced more trade deals with key partners, generally setting tariff rates below what he had initially proposed.
"Perhaps it is a tribute to the administration's salesmanship, that if you tell people things are going to be really horrible — it's going to be 50%, it's going to be 125%, which is what we got to during the tit-for-tat with China — and then you say, 'Oh, you know what? It's just going to be 15%.' I think markets have really relaxed on that," Peta said.
And even when Trump has dialed up his tariff threats, like when he posted letters to 23 countries on Truth Social, markets have been confident in the TACO Trade, Peta added. He was referring to the idea that investors have been buying stocks despite the president's unfriendly policies, due to the assumption that Trump Always Chickens Out.
Paul Hickey, the co-founder of Bespoke Investment Group, told BI that the apocalyptic mood that accompanied Liberation Day was due to the "shock value" of Trump's tariffs.
"Market doesn't just rally 20% in a short period of time for nothing," he said. "Usually there was either a major event to cause that, or else there was a major sell-off beforehand where there was an overreaction."
The improbably strong US economy
And then there's the economy, which has bucked calls for a dire slowdown alongside higher tariffs fueled by inflation.
While fears of stagflation were running rampant several months ago, GDP is expanding again after contracting in the first quarter.
Bank of America recently dialed down its stagflation calls, saying it sees a number of reasons the economy could thrive in the coming quarters, including Trump's pro-growth agenda and big capex plans among US companies.
Meanwhile, inflation has drifted slightly higher but overall price growth is relatively close to the Fed's 2% inflation target.
The final and most important leg of any stock market rally—corporate earnings—has also been holding up well. Of the S&P 500 companies that have reported results so far this quarter, 80% have beaten earnings estimates, according to the latest update from FactSet.
"People were expecting just terrible commentary from companies reporting and a weakness in the economy and that didn't materialize," Hickey said.
Is there a shoe to drop?
It is still possible that the full impact of tariffs has yet to be felt in markets and the economy.
"I think most right now are just sort of waiting for the effect of the tariffs to become more clear," Parag Thatte, director of global asset allocation and US equity strategy at Deutsche Bank, told BI.
That also means there's a chance investors could be getting ahead of themselves, BCA's Peta said.
"I do think some of the optimism is unwarranted," he told BI, adding that he was skeptical some of the US's recent trade deals would counterbalance the negative growth impact of tariffs.
Talk of a pullback has been swirling on Wall Street since major indexes climbed back to record highs. Evercore ISI, Stifel, Pimco, and HSBC are among the firms that have recently flagged the risk of a stock correction, even as major indexes power past record after record in the last several weeks.
In the short term, Hickey also believes optimism could soon start to fade, especially considering that the market is entering historically weak seasonal stretch from late July through September.
"The pendulum has really shifted," Hickey said of the market's seasonal backdrop. "It wouldn't surprise us to see the market rally pause in the short term."
Read the original article on Business Insider