In a recent turn of events, U.S. stock markets experienced a notable rebound, primarily driven by easing concerns over tariffs and inflation. The performance of major indices over the past week has been quite impressive, with the S&P 500 climbing 1.47% and inching closer to its historical peak. The Nasdaq composite led the charge with a remarkable gain of 2.58%, while the Dow Jones Industrial Average saw a more modest increase of 0.55%.

This volatility in the markets can be attributed in part to a newly signed memorandum by the U.S. government regarding the implementation of reciprocal tariffs. Although these tariffs were announced, their immediate application was postponed, which seemed to alleviate some selling pressure and boost market confidence. Furthermore, the release of the Producer Price Index (PPI) data, which showed weaker performance than expected, also helped to reduce fears about runaway inflation.

However, shifting the spotlight back to the future, the uncertainty surrounding both tariff policies and their inflationary impacts continues to loom large, causing investors to remain cautious about potential market fluctuations. The reflection of these tariffs on the economy will be critical as stakeholders weigh the longer-term implications of such policies.

The rebound in U.S. stocks cannot be understood without examining the decisive factors behind it. On one side, the delay in implementing reciprocal tariffs provided some comfort, as it suggested that diplomatic negotiations might mitigate trade disputes rather than escalating tensions. On February 13, the U.S. administration announced its intention to impose these tariffs, ensuring that tariff rates between the U.S. and its trading partners would remain equivalent. However, the timing for the actual implementation was left vague, allowing for speculation and discussion among traders.

This announcement has been long anticipated, and while the intention to enforce reciprocal tariffs was reinforced, the directive that day merely launched an investigation into the tariff levels imposed on U.S. goods by other countries. Consequently, this buying time led to a temporary relief, allowing Wall Street to breathe a sigh of relief.

On the inflation front, the narrative proved to be more complex. Observations from early February suggested that inflation was exhibiting an unexpected uptick. The Department of Labor released data indicating a robust core Consumer Price Index (CPI), which climbed 0.5% in January compared to the previous month, marking the most significant monthly rise since August 2023. Year-on-year, inflation ratcheted up by 3%, signaling a reentry into the “3% zone” after a seven-month hiatus. Meanwhile, stripping out food and energy prices yielded a core CPI increase of 3.3%, surpassing the anticipated figure of 3.1%.

Interestingly, the PPI indicated a slight softening in key sectors, which is anticipated to lower the Federal Reserve's preferred inflation measure—a core Personal Consumption Expenditures (PCE) price index. For instance, healthcare prices displayed a month-over-month decrease in January, a significant occurrence since the healthcare sector constitutes nearly 20% of the core PCE price index. Mislav Matejka, the global equity strategist at J.P. Morgan, noted that while certain segments indicated persistent rises, the rate of growth appeared to be tapering.

Despite the temporary relief across the financial markets, the alarm surrounding tariffs has not been fully extinguished. Many analysts, including Mark Malek from Siebert, express skepticism and caution. The positive sentiment emerging from the delay in firearms may merely be a fleeting reprieve. Prominent investment firms like Barclays echoed similar sentiments, unsure whether the postponement truly implies that tariffs will ultimately be avoided.

As of February 7, it became apparent that 61% of S&P 500 constituents had released their earnings reports, which overall were encouraging. The average earnings per share saw a year-on-year growth of 13.1%, surpassing initial forecasts that stood at a modest 8%. According to Wang Xinjie, chief investment strategist of Standard Chartered's wealth planning division, the U.S. market still has potential given the earnings outlook despite fluctuations."Under the 'America First' policy, despite the volatility in yields, corporate profits remain promising," he stated.

Crucially, the extent and severity of tariffs will dictate economic dynamics going forward. During this earnings season, companies across sectors ranging from automobiles to consumer goods have fielded inquiries regarding their positions on tariffs, with discussions surrounding tariffs becoming a frequent highlight. In fact, half of the S&P 500 companies that have released earnings mentioned tariffs when discussing their future projections.

Investors should remain vigilant, as tariffs could represent a significant downside to corporate profitability. Worries from Wall Street banks paint a dire picture: a potential rise in effective tariffs could lead to a 1% to 2% decline in S&P 500 earnings by 2025 and could collectively hinder U.S. GDP growth by a full percentage point, potentially dragging U.S. stocks down by an estimated 5%.

Moreover, if the U.S. imposes tariffs on Canada and Mexico, retaliation could critically undercut earnings across S&P 500 constituents, alarming market participants. Data compiled by Matejka indicates that asset management firms’ exposure to equity futures currently exceeds 40%, notably higher than the less than 10% recorded in 2017.

Turning to valuation metrics, Todd Sohn, an ETF and tech strategist at Strategas Securities, underscored that the market is currently navigating a high-expectation phase three years into a bull cycle. Contrast this with 2017, when the markets were emerging from significant selling pressure. Thus, the occurrence of any form of vulnerability in today’s environment can serve as a substantial catalyst for market disturbances.

The elevated valuations in U.S. stocks suggest they will be more sensitive to shocks stemming from tariff and inflation developments. The S&P 500 had exhibited exceptional growth, with a cumulative increase of 53% in 2023 and 2024. Comparatively, during the early months of 2017, the index climbed merely 8.7% over the preceding two years, indicating more room for growth at that time. Today, however, the market sits precariously high, more attuned to risk influences.