Stocks have again defied gravity, with the US market returning more than 6% in May on optimism that a tariff-induced economic disaster may be averted despite lingering risks of slowing growth, sticky inflation, and rising equity valuations.
Stocks are now in the green for the year, with the Morningstar US Market Index up 1.25% since the beginning of January. Since bottoming out on April 8 after President Donald Trump’s sweeping tariff announcement, stocks are up more than 19%.
Strategists caution that gains may be more muted for the rest of the summer, since the potential for good news on tariffs (rollbacks, delays, or outright reversals) is already reflected in prices. “Markets have largely discounted the idea that the tariffs were not going to be as bad as feared,” says Steve Sosnick, chief strategist at Interactive Brokers. In the short term, “the market is more likely to churn, and the risks are probably more to the downside because of how far and fast we came in a short period.”
No Stock Bounce After Tariff Ruling
Perhaps counterintuitively, last week’s news that a US trade court had ruled that the bulk of Trump’s tariffs were illegal did not send stocks soaring. The US market climbed just 0.4% on the trading day following the ruling—a modest gain compared with the more than 2.0% pops investors enjoyed on “good news days” earlier this spring. “[The lackluster reaction] tells me that a lot of the optimism was priced in already,” Sosnick says.
Michael Reynolds, vice president of investment strategy at Glenmede, says he was surprised to see equities jump even a little after that news. “For a moment, investors may have had this super optimistic scenario where the courts pull back on tariffs and the administration throws up their hands and gives up,” he says, which he calls unrealistic.
Stocks still returned 1.9% last week, even after the initial court judgment was paused by an appeals court. Other factors, like Nvidia’s NVDA better-than-expected earnings, likely contributed to that gain.
TACO Trade Risks
Last week’s tariff back-and-forth came as market watchers continued to digest discourse around the TACO trade—a tongue-in-cheek acronym for “Trump Always Chickens Out.” The term, coined by a Financial Times journalist, refers to the phenomenon whereby markets plummet on new tariff announcements, only to recover a week or two later when Trump walks them back or delays them.
“It seems that investors are increasingly unmoved by trade announcements from the White House in the belief that these will be subsequently walked back if asset prices decline,” wrote Morningstar chief research and investment officer Dan Kemp this week.
Strategists say the pattern could hide deeper vulnerabilities within the equities market. Jason Draho, head of asset allocation Americas at UBS Global Wealth Management, likens it to the boy who cried wolf: “The risk it creates is that the market is calling Trump’s bluff [on tariffs].” But what happens if Trump follows through and major tariffs are implemented after all? “There’s a decent chance that over the summer there’s a market pullback, maybe because of this dynamic,” he says.
The Trump administration could still impose significant (if more targeted) levies even if the trade court’s initial ruling is upheld. Tariffs on steel and aluminum are set to double to 50% on Wednesday, for instance.
Lisa Shalett, chief investment officer for Morgan Stanley’s wealth management division, says “equity complacency” remains the biggest risk she sees in markets. “US equity investors continue to behave as if the glass is half full, despite tariff and tax policy uncertainty and warnings from other markets, notably global long rates,” she wrote in a note to clients on Monday.
Can Stocks Rise Higher?
With trade policy gyrations making headlines on a daily basis, strategists warn that the market rally could lose steam over the summer, at least until investors have more clarity around tariffs.
Sosnick points to how valuations have returned to levels comparable with before Trump’s April 2 announcement, while earnings expectations have fallen, inflation expectations have risen, and consumer sentiment has soured. “If markets climb a wall of worry, there are certainly more worries [than at the beginning of the year],” he says.
While the market could move higher, Draho expects the S&P 500 benchmark index to remain range-bound at 5,500-6,000 points for the next month or so. The index closed Monday at 5,936. “Near term, there’s not a lot of upside” because markets are already pricing in good news, he says. Evidence that the economy can withstand tariffs could be a catalyst for further gains.
Reynolds adds that while a near-term stock pullback could be in the cards, he doesn’t expect the market to retreat to the lows of early April.
The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies.
