The S&P 500 index rose for the ninth consecutive day last Friday, setting a new record for the longest winning streak since 2004. This surge came after strong employment reports and signs of easing U.S.-China tensions, which helped alleviate Wall Street’s worst fears regarding tariffs. The Friday trading session also completely erased all the losses from April 2, when President Donald Trump’s “Liberation Day” tariff policy led to a sharp global market downturn.
Given the bleak outlook, the stock market’s full recovery from April’s sharp decline has surprised some Wall Street experts. Although most of Trump’s “reciprocal” tariffs have been paused until early July, tariffs on Chinese goods remain prohibitively high, and the White House has little time left to negotiate dozens of trade deals. Additionally, nearly all U.S. imports face a 10% global tariff that took effect on April 9.
Due to ongoing concerns about tariffs’ impact on the economy and corporate profits, investors have been waiting for further tariff developments, and the stock market opened lower this week.
Trade Positions Turning Milder, Profit Outlook Strong
Morgan Stanley analysts noted on Monday that the recent rally in stocks has been driven by two positive developments from their list of four key indicators for sustaining the stock market’s upward trajectory: growing optimism about the de-escalation of tensions with China and improved profit prospects.
U.S. Treasury Secretary Scott Bassett’s remarks calling the U.S.-China trade war “unsustainable” spurred optimism that the trade dispute might ease, contributing to the stock market’s rise. Trump has repeatedly stated that he expects tariffs on Chinese goods to decrease, and China has also expressed a willingness to negotiate. Later Tuesday, the U.S. Treasury announced that Bassett would visit Switzerland later this week and meet with China’s “chief economic affairs representative.”
Meanwhile, first-quarter earnings came in better than expected. S&P 500 companies are projected to see more than a 10% increase in profits for the previous quarter, with some market drivers—such as the ever-growing demand for artificial intelligence—remaining strong.
The Federal Reserve Could Play a Key Role
Morgan Stanley suggests that two additional conditions need to be met for the market to maintain its upward momentum: 1) The U.S. and China must reach a trade deal that convinces investors and businesses that de-escalation is not just a verbal promise, and 2) The Federal Reserve must signal its willingness to cut interest rates to support economic growth.
Morgan Stanley states, “In the late-cycle environment of slower economic growth, stock returns could still be quite strong,” which seems to be the case at the moment. However, this environment typically only occurs once the market begins to digest a more dovish response from the Federal Reserve.
Unfortunately for the optimists in the room, Morgan Stanley’s forecast comes with a large asterisk: “It’s worth noting that our economists believe the Federal Reserve will not cut interest rates this year (meaning this is a difficult issue to resolve).”
The Federal Open Market Committee will conclude its two-day meeting on Wednesday, with markets generally expecting the Fed to keep its benchmark interest rate unchanged. Investors will be closely watching for the Fed’s comments on how tariffs are affecting the economic outlook and monetary policy.
Other Risks: Labor Market Pressure and Rising Interest Rates
Another risk is that tariffs could harm the labor market. Small businesses, which employ nearly half of all U.S. workers, are not as well-equipped to absorb tariffs as larger firms, which benefit from greater flexibility in pricing and financing.
Despite tariff uncertainties, the job market remained strong in April, but experts warn that the full impact of tariffs may take months to materialize.
Rising interest rates also pose a threat to this market rally. Morgan Stanley analysts pointed out, “Despite the backdrop of slowing economic growth expectations, Treasury yields have unexpectedly remained steady.” If the 10-year U.S. Treasury yield rises above 4.5%, it could lead to a negative correlation between stock returns and bond yields, which would put pressure on valuations.
