There can be little argument that the stock market has made a remarkable recovery since the tariff-induced doom days of early April. If my calculator is correct, the S&P 500 has surged +21.95% since the closing low seen on April 7 through Friday's close. And for those of you keeping score at home, the NASDAQ 100 index (where most of the cool tech stuff trades) has gained an eye-popping +31.9% over the same time period. Not bad.

While markets often move swiftly from time to time, the current joyride to the upside is more than a little surprising to many investors. After all, there have been many high-profile headwinds for the market to deal with. Not the least of which was the tariff tit-for-tat game playing out on a social media platform near you. There were the missiles flying back and forth between Israel and Iran (oh, and the bombs being dropped from US B-2 stealth aircraft). There was the surge in inflation expectations from both the US consumer and economists of all shapes and sizes (every analyst agrees that tariffs WILL increase costs and, in turn, inflation). And lest we forget, there has been the never-ending drama between the boys and girls elected to represent us in Washington.

And yet, here we are. Never mind the laundry lists of concerns, fears, and worries. With the halfway point in the year upon us, the S&P opens Monday at a shiny new all-time high.

The question, of course, is why? Why has the mood flipped from gloom and doom to hope and optimism? Why did the market move from "bear territory" (if memory serves, the S&P did briefly tap the -20% mark from high to low on April 7th) to excitement over the possibility of the next bull leg? Why is the current environment SO much better than it was just a couple months back?

While one can never know for sure the answers to such things, I'll use my pixels this morning to type out my $0.02 take.

All About Earnings

First and foremost, there is the subject of earnings. As the tariff tweets flew, Wall Street analysts began to cut their earnings estimates. The thinking was that somebody, somewhere would have to pay the new costs, which, one way or another, were sure to reduce corporate profits. So, the consensus estimate for EPS growth rate in Q1 2025 went from +13.8% to +5.3%. And Q2 guesstimates went from just below +14% to +6.7%.

But a funny thing happened on the way to the earnings crash. It just didn't happen. In fact, EPS wound up trouncing the forecasts in the most recent earnings parade. You see, the extreme tariffs that were supposed to be implemented right away have been largely put on the back burner while the US negotiates with practically every country on earth. So, at the very least, all that tariff negativity has been kicked down the road.

And don't look now fans, but despite the dour outlook, the rate of earnings growth for the coming 12 months looks pretty darn strong. For example, the consensus EPS estimates (which are never right and usually decline over time) for 2026 currently sport a growth rate over +15%. So, with strong earnings expected, it is hard to be overly negative on the stock market, right?

About That Inflation

Next, it is worth noting that the Fed has been talking about cutting rates again starting in September. And with the calendar flipping to July tomorrow, this means that the market is moving ever closer to lower rates. Something that has historically been positive for stocks.

Why is the Fed talking about cutting rates when everyone on the planet agrees that tariffs are inflationary? In short, because the inflation that was sure to have arrived by now simply hasn't. In fact, some of the inflation stats have fallen in four of the last five months. As such, the data show that inflation is trending in the right direction.

Then There Are The Flows

In the business of the stock market, it often pays to "follow the money." And right now, the "big money" has been buying stocks again.

If you will recall, hedge funds reduced their exposure to technology stocks in the first couple months of the year. They basically went from overweight to underweight. The thinking was that all the bad stuff their crystal balls were projecting to happen would surely hit those big tech stocks that had been loved for the past couple of years.

The only problem was that things didn't turn out as planned. No, tech earnings continued to lead the way. Capex expenditures on things like data centers did NOT slow down (nor are they forecast to). And from my seat, the AI movement seemed to pick up steam as company after company talked about the idea that AI revolution is just getting started.

As a result, the hedgies were forced to - at the very least - return their exposure to growth and technology back to normal. Which, again, from my perspective, appears to have produced consistent buying in the tech leaders.

The Bottom Line

In my experience, markets don't tend to decline in a meaningful way when earnings are rising, and the Fed is friendly. And the key here is both are happening right now.

But...

You knew this was coming, right? I'm going to opine that there is a caveat/concern worth noting here. Although valuations are one of the absolute worst indicators to use when "timing" investments, they can provide an excellent view of the fundamental risk backdrop. And while the bulls are clearly on a roll here, I think we need to acknowledge that valuations are once again at lofty or dare I say, frothy levels.

My take is traders are reversing the mistakes they made earlier in the year and hopping back onboard the bull train. However, I will argue that gains in stock prices based on anticipated earnings are being "pulled forward" again here. Just like in late 2024.

Exhibit A in my argument is that the S&P's forward P/E for 2025 currently stands at 24.1, which is quite elevated. Looking ahead at the next 12 months, the forward P/E based on consensus EPS is 21.4. And then if we look at the P/E using those strong earnings estimates for 2026, the P/E is still up there at 20.85.

Yes, forward P/E's have been higher in the past 40 years, such as 1999-2000 and in 2020. And yes, with rates expected to fall, the E in the P/E ratio could certainly improve over time. But that's it. Since 1983, the computers at Ned Davis Research show that forward P/E's have only been higher a couple times.

My point is that with valuations at historically high levels, we must recognize that this is NOT a low-risk environment. Using my "ladder" analogy, it's as if we are up on the 7th or 8th rung of our 10-rung ladder right now trying to paint the gutters. So, if anything bad happens, it will likely be more painful than if we were only 2 or 3 rungs up.

So, here's hoping our balance stays solid, a storm doesn't blow in, and those anticipated earnings show up!

Thought for the Day:

Action is the foundational key to all success. -Pablo Picasso

Wishing you green screens and all the best for a great day,

David D. Moenning
Founder, Chief Investment Officer
Heritage Capital Research, a Registered Investment Advisor

Disclosures

At the time of publication, Mr. Moenning held long positions in the following securities mentioned: None - Note that positions may change at any time.

NOT INDIVIDUAL INVESTMENT ADVICE. IMPORTANT FURTHER DISCLOSURES