Markets have meaningfully recovered from their April 8th lows. The majority of domestic stock indices are up between 20-30% and this rebound following a 20% sell-off has been significant when compared to the average recovery following a bear market.
Central to the prospects for further gains is the ongoing tug of war between the economic cost of tariffs, which are providing a drag on growth, versus the positive forces of the recent tax bill: making the 2017 tax cuts permanent, plus accelerated expensing of research and development for corporate capital spending. When one adds in the likelihood of lower interest rates as an additional source of stimulus, it would seem the prospects of recession have declined significantly since the tariff liberation day.
As of the latest data in June, the average U.S. tariff rate is nearly 10%, up from 2.5% on January 1st. The latest estimates with announced tariffs put the likely average tariff rate at 14-15%. That equates to an indirect tax increase of $400-$500 billion. In contrast, the tax cuts and easier monetary policy are largely offsetting the cost of tariffs in 2025. The larger impact from the tax and monetary stimulus is expected to have a greater impact in 2026.
Regarding the cost of tariffs, past experience has implied that for every $100 in tariff cost, producers absorb roughly $30-$40 of the cost, and pass on $60-$70 of the cost to the end consumer. This, of course, varies by industry; however, past tariff costs have been absorbed more by households than by businesses. In the end, the tariff is nothing short of an indirect tax on the U.S. economy.
Noteworthy for investors to consider is the potential net impact of tariffs versus tax cuts on corporate profitability. Early results are encouraging on the corporate earnings front. The majority of S&P 500 Index companies have reported second-quarter profits and, in aggregate, they are +11% versus year-ago levels. Moreover, estimates for the next year look favorable. One measure to closely monitor for corporate profit and cash flow success is the free cash flow margin of the S&P 500. Encouragingly, free cash flow margins have been steadily improving for the last decade, even longer, correlating well with the success of the U.S. stock market. The following chart depicts the steady progress free cash flow margins have witnessed, continuing into the second quarter.
S&P 500 Index Price & Free Cash Flow Margin
The success of corporate free cash flow generation, owing in part to better capital allocation for U.S. businesses, is perhaps the most important metric when assessing the prospects of the stock market. The latest estimates have free cash flow per share growth of +11% in 2025 and continued low double-digit growth into 2026. When valuing the tradeoff between the cost of higher tariffs versus the stimulus in the latest tax bill, I expect this will be a key metric for assessing current portfolio holdings and potential new investments.