If July is the stock market’s critical test, then so far, so good. Upbeat earnings, lower jobless claims, inflation still under 3% and newly passed tax cuts have all combined to keep the market grinding higher. But is this as good as it gets?

Data have been good, yes, but not spectacular. And there’s still a tariff overhang to deal with. With sentiment so bullish, it’s hard not to expect some kind of disappointment soon. And that doesn’t even include the possibility of Donald Trump imminently firing Fed Chair Jerome Powell, an idea that was making the rounds Wednesday until the president appeared to quash the speculation — for now.  

To discuss:

• Positive surprises on US data are finally beating out negative ones.
• But US stock exuberance is bordering on “extreme greed,” according to one sentiment gauge. 
• That means sentiment can’t get much better. Given higher tariffs are likely coming in two weeks, this creates a tension that should be resolved by lower share prices and higher volatility.
• Bonds, though, may not benefit as a safe haven.

Extreme Greed

This chart is a good lead-in.

CNN Business’s Fear and Greed Index is the most comprehensive such gauge I’ve come across. It takes into account market breadth and volatility as well as relative demand for bonds as a safe haven, plus derivatives-driven sentiment and action in the junk-bond market. What it’s saying now is that investors aren’t very fearful. In fact, they’re downright greedy, chasing winners and bidding up stocks as if there were no risks on the horizon. 

Widening out the lens, you can see the progression from extreme fear in April up to greed in May. The index has oscillated since then:

Most recently, the gauge has edged up to a level indicating that investors are now taking risk at a record pace. Is this justified?

A lot of this bullishness seems to be driven more by how well the economic data have held up in the face of tariffs than how good they actually are.

Trump’s April 2 “Liberation Day” tariff announcement coincided with economic surprises turning more negative. But not only were tariffs paused on April 9, data turned up to their most positive in late May, which tracks well with sentiment. The subsequent increase in negative surprises took some wind out of the stock market’s sails. But as data surprises began turning up in late June, so, too, has sentiment. 

The data themselves are less spectacular. Of particular note is the loss of 33,000 private-sector jobs as measured by payment processor ADP and the paltry gain of 74,000 private-sector jobs measured by the Department of Labor.  Headline consumer price inflation up slightly to 2.7% and core inflation up to 2.9% are less worrying given the baseline 10% tariffs now in place. But they’re still not great numbers. More positive is the recent decline in initial jobless claims, which effectively rules out recession in the near  term without a big negative shock.

Translation: the US economy is holding up but the labor market is decelerating and inflation has stopped declining.

More tariffs are coming

While the ongoing earnings season gives investors a chance to focus on the thing that actually underpins stocks — earnings — there’s still a tariff overhang to contend with.

Despite that, the S&P 500 has rallied about 25% from the April lows, such that it is largely on the same trendline it was before April 2. And betting platform Kalshi shows investors think a recession this year is a remote possibility.

Trump has to see this as vindication of his economic policy. And that makes higher tariffs on Aug. 1 more likely, not less. US tariff revenue is at a record high, filling government coffers to offset the tax cuts. And that has been rewarded with repeated record highs on the Nasdaq 100 and the S&P 500.

In Trump’s mind, then, now must be the time to press his advantage. Therefore, we have to see the proposed 30% tariff on the EU, 30% on Mexico and 50% on Brazil not as bargaining chips, but levels Trump is willing to impose.

The stock market’s momentum may be enough to get through a second Liberation Day-style tariff salvo without as severe a hit to prices. But it was the triple threat of quickening inflation, rising bond yields and a sinking economy that were the toxic mix that cratered stocks. That mix — which hurts revenue and margins and reduces the present value of future earnings — is what it would take to hurt the market again.

The evidence so far is that revenue and margins have held up — and the economy, too. So the recent data work to keep the market in disbelief about any coming recession or earnings hit. The reality, of course, is that the labor market is softening and inflation has only just begun to rise, such that the recently mooted import tax rates Trump has floated are almost certain to create exactly the mix that caused panic in April. If that outcome materializes, the market will catch on to that.

And the Treasury market? Bond traders haven’t been anywhere near as upbeat as stock investors, though bond vigilantes don’t seem to be out in full force.  If you look at the breakeven inflation rate that makes an investor in Treasury Inflation Protected Securities whole versus conventional Treasury bonds, it’s now at levels almost 70 basis points lower than it was after the April 2 tariff announcement.

If inflation accelerates unexpectedly, this would cause yields to shoot higher. As for stocks, unexpected inflation and sky-high tariffs would be a catalyst for a re-appraisal there, too — even if earnings come through ok.

Trump may have successfully helped the stock market reach new highs by delaying Liberation Day tariffs, but eventually he’s going to have to make a decision. Ironically, the stock market’s new highs — predicated on Trump not imposing any draconian tariffs — may be just the thing that cajoles him into imposing sky-high levies, with negative consequences for equities.

Quote of the week

Things on my radar

• The whole saga around Fed Chair Powell is another example where calm markets embolden Trump
• Bitcoin has not cleared the regulatory hurdles which will cause it to take the next leg higher. Still crypto gains show us how risk seeking the market is.
• One last risk? Retaliation. Apparently France wants the EU to go big on retaliation.

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