U.S. Equities at a Crossroads: Can the Rally Survive Trade Deals and Fed Fears?

The S&P 500 has clawed its way to record highs, fueled by AI euphoria, trade deal optimism, and a resilient labor market. Yet beneath the surface, cracks are emerging. With June's jobs report and Federal Reserve policy decisions looming, investors face a critical question: Is this rally built to last, or is it a house of cards waiting for a geopolitical or economic gust to topple it?

The Job Market: Resilient, But Slowing

The June jobs report offered a mixed picture of a labor market that remains strong but is losing momentum. Non-farm payrolls grew by 139,000—a slight beat of estimates—but the 12-month average dipped to 144,000, signaling a cooling trend. Healthcare and leisure sectors thrived, but government jobs shed 22,000, and manufacturing and retail continued to struggle.

The most critical metric, wage growth, held firm at 3.9% year-over-year. This is both a blessing and a curse: it sustains consumer spending but risks reigniting inflationary pressures if sustained. The labor shortage persists, with the unemployed-per-job-opening ratio at 0.97—a red flag for companies' ability to fill roles without raising wages further.

Inflation: Treading Water, But Tariffs Lurk

May's CPI data revealed a 2.3% annual inflation rate—the lowest since 有史以来的最低点 since 2021—but this masks underlying tensions. Shelter costs, up 4.0% year-over-year, remain the dominant driver, while energy and food prices saw mixed swings. Crucially, tariffs have yet to significantly impact consumer prices, as businesses absorb costs. But warnings from Walmart and Ford hint at a reckoning:

The Federal Reserve, holding rates steady in June, is playing a waiting game. Chair Powell has emphasized that “data dependency” rules the day. If tariffs force a sudden spike in goods prices, or wage growth climbs past 4%, the Fed's patient stance could vanish—and the equity rally with it.

Backtest the performance of the S&P 500 when 'buy condition' is a Federal Reserve rate decision holding rates steady, and 'hold for 30 trading days', from 2020 to 2025.

Historically, when the Fed has held rates steady, the S&P 500 showed an average increase of 0% over 30 trading days—a stark reminder that stability in policy does not guarantee market gains. This aligns with the Fed's dual challenge: maintaining growth while curbing inflation. Investors should note the strategy's maximum drawdown of -29.92%, highlighting risks even in stable rate environments.

Trade Deals: A Double-Edged Sword

The market's exuberance is partly rooted in eased trade tensions. A hypothetical U.S.-China “phase two” deal, for instance, could boost industrials and tech stocks reliant on cross-border supply chains. The semiconductor sector, already benefiting from AI demand, would see further tailwinds.

But geopolitical instability remains a wildcard. A flare-up in Taiwan tensions or a breakdown in U.S.-Europe trade talks could upend manufacturing and tech sectors overnight. Investors must weigh the benefits of trade optimism against the fragility of global supply chains.

Investment Strategy: Split the Difference

The path forward demands a balanced approach. For bulls, AI-driven tech (semiconductors, cloud computing) and industrials (transportation, machinery) offer leverage to trade optimism and cyclical growth. These sectors have already led the rally—NVIDIA's stock is up 60% year-to-date—and could extend gains if the Fed stays dovish.

For the cautious, defensive sectors like utilities and consumer staples provide insulation against a rate hike or trade shock. Short-dated Treasuries or inverse equity ETFs (e.g., SQQQ) could hedge against a correction. The backtest's Sharpe ratio of 0.01 underscores the need for caution: risk-adjusted returns are weak, and volatility remains a threat.

The Crossroads Moment

The June jobs report and Fed's next move will define the market's next chapter. If wage growth moderates and tariffs stay muted, the rally could extend. But if inflation surprises upward—or geopolitical risks materialize—the S&P 500's gains may evaporate as quickly as they arrived.

Investors must ask themselves: Are we at the dawn of a new tech-led boom, or are we dancing on the edge of a policy and geopolitical abyss? The answer will be etched in the data—and in the decisions of central banks and diplomats alike.

Act now:
- Bullish bets: Overweight AI stocks and industrials, but pair with put options to limit downside.
- Hedging: Allocate 10–15% to inverse ETFs or Treasury bills.
- Avoid: Overvalued consumer discretionary stocks reliant on wage growth and stable spending.

The market's next move hinges on data—and the resolve of policymakers. Stay vigilant.