Inflation Cooling and Trade Truces: A Bullish Signal for Cyclical Stocks

The U.S. economy is at a pivotal juncture. After years of volatile inflation and trade tensions, recent data and policy shifts suggest a confluence of factors that could reignite growth in cyclical sectors like industrials and technology. With inflation cooling, trade relations improving, and the Federal Reserve's hawkish stance softening, high-beta stocks—those sensitive to economic cycles—appear poised for a sustained rebound. Let's unpack the dynamics at play and what they mean for investors.

The Inflation Chill: A Foundation for Rebounding Growth

The latest inflation data for May 2025 paints a picture of stabilization. The annual Consumer Price Index (CPI) held steady at 2.4%, with core inflation (excluding food and energy) at 2.8%. While these figures remain above the Federal Reserve's 2% target, the trendline is clear: after peaking in 2023, inflation has entered a gradual descent. S&P Global forecasts further easing to 2.2% in 2026 and stabilization near 2.3% by 2027.

This moderation is critical for cyclical sectors. High inflation erodes corporate margins and consumer purchasing power, while elevated interest rates—used to combat inflation—compress equity valuations. With inflation cooling, the Fed is likely to begin trimming its 4.5%-4.75% federal funds rate later this year. Such rate cuts would reduce borrowing costs for businesses and households, fueling demand for cyclical goods and services.

Trade Truces: Unshackling Supply Chains and Profit Margins

The recent temporary reduction in U.S. tariffs on Chinese goods—from 145% to 30%—marks a pivotal shift in trade dynamics. While these tariffs remain elevated at 14% on average, the partial rollback has already eased pressure on supply chains and corporate input costs. For industries like industrials and tech, which rely on global components, this respite is transformative.

Consider the semiconductor sector: tariff-induced cost spikes once forced companies to absorb margin hits or pass costs to consumers. Now, with supply chain bottlenecks easing and input prices stabilizing, profit margins are likely to rebound. Similarly, industrial manufacturers—reliant on steel, aluminum, and energy—are benefiting from lower energy prices (down 3.5% annually) and reduced trade friction.

Consumer Confidence: The Catalyst for Cyclical Demand

Lower inflation and stable prices are also boosting consumer sentiment. The University of Michigan's consumer sentiment index has risen for three consecutive months, reflecting optimism about spending power. This bodes well for cyclical sectors:

1. Industrials: Rising demand for capital goods, logistics, and infrastructure projects.
2. Technology: Increased spending on enterprise software, cloud computing, and consumer electronics.

A virtuous cycle is emerging: as consumers spend more freely, businesses reinvest in growth, creating a tailwind for sectors tied to economic expansion.

The Case for Cyclical Stocks: Where to Look

For investors, the playbook is straightforward: tilt toward sectors and companies that thrive in improving economic conditions.

Industrials: Target Efficiency and Global Exposure

Focus on industrials with exposure to infrastructure spending and automation. Companies like Caterpillar (CAT) and 3M (MMM), which benefit from rising global trade and U.S. infrastructure projects, are prime candidates. Additionally, logistics firms like FedEx (FDX) could see gains as global commerce normalizes.

Technology: Prioritize Innovation and Scale

In tech, favor firms with durable competitive advantages and exposure to secular trends. Microsoft (MSFT) and NVIDIA (NVDA)—key players in cloud computing and AI—are well-positioned to capitalize on rising enterprise spending. Avoid smaller, margin-sensitive firms reliant on discretionary consumer spending.

ETF Plays for Diversification

• SPDR S&P Aerospace & Defense ETF (XAR): Tracks companies benefiting from defense spending and global rearmament trends.
• First Trust NASDAQ Technology ETF (FTC): Offers broad exposure to tech leaders.

Risks and Considerations

While the outlook is bullish, risks remain. Persistent tariff uncertainty, a sharp Fed policy misstep, or a resurgence in inflation (driven by, say, geopolitical shocks) could derail momentum. Investors should:
1. Monitor the July CPI release (scheduled for July 15) for signs of further disinflation.
2. Watch trade negotiations: Extended tariff relief is critical for sustaining cyclical gains.
3. Stay selective: Avoid overvalued names or sectors with cyclical exposure but weak fundamentals.

Conclusion: A Bull Market in the Making

The convergence of cooling inflation, improving trade relations, and a Fed poised to ease rates creates a compelling case for cyclical stocks. For investors willing to navigate near-term volatility, sectors like industrials and tech offer asymmetric upside. As the economy transitions from stabilization to expansion, high-beta names—properly selected—could lead the next leg of the bull market.

The time to position for this shift is now.

Data as of June 2025. Past performance does not guarantee future results. Consult a financial advisor before making investment decisions.