From strong Q2 earnings to PPI spike: Unpacking the financial markets’ current expectation gap

Picture this: I’m seven years old, bubbling with excitement as my grandfather and father take my younger brother Sam and me on a fishing trip at Lake Michigan. Growing up in the Midwest, this lake was our playground, and the idea of fishing was all Sam’s. I can only imagine the visions dancing in his head – casting a line and reeling in fish after fish, celebrating our bountiful catches. But wisdom often comes with age, and my grandfather, a seasoned angler, tried to teach us the virtues of patience. Naturally, we didn’t listen. Our anticipation soared as we approached the lake, only to confront a harsh reality: The fish weren’t biting that day. What started as smiles quickly turned to tears – a familiar scene for any parent.

Investing mirrors this experience in many ways. The emotional waves of financial markets are often influenced by the "expectation gap," or the dissonance between reality and what investors hope to see.

Recent economic data can feel like a storm cloud hovering over this fishing expedition, casting shadows on investor expectations. The market is a lively dance, reacting not just to the nature of news – good or bad – but to how that news measures against expectations. This dynamic has been particularly pronounced during the current earnings season. While earnings are often lagging indicators of growth, forward guidance and earnings beats have propelled market movements higher.

To date, over 90% of S&P 500 companies have reported for Q2 2025, with approximately 82% exceeding earnings estimates. This performance surpasses the five-year average of 78% and the 10-year average of 75%. For example, S&P 500 earnings growth is now projected at around 12% – a significant jump from just 4.9% as of June 30. Initially, earnings estimates were negatively revised in March and April due to anticipated tariff impacts on the economy, product availability and margins. However, as companies have consistently exceeded these revised expectations and provided optimistic forward guidance, markets have responded positively, achieving 10 all-time highs in July alone.

Conversely, the August jobs report was a splash of cold water. It revealed only 73,000 jobs added in July, far below the anticipated 105,000. This unexpected shortfall, along with a downward revision of 250,000 jobs from the prior two months, sent the S&P 500 tumbling by 1.6% in just a day – a stark reminder that market waters are not always calm. Before this report, investors had priced in a 40% chance of an interest rate cut from the Federal Reserve. Suddenly, the data shifted the tides, pushing the probability of a cut to over 80%.

Inflation, lurking beneath the surface like an elusive fish, has also contributed to this expectation gap. June's Consumer Price Index was softer than anticipated, with a headline rate of just 0.2% month-over-month, bringing the year-over-year (YoY) rate to 2.7%. However, the Producer Price Index (PPI), which measures average inflation for wholesalers, told a different story. The July reading far exceeded the expected 0.2% rise, showing a surprising 0.9% month-over-month increase. This surge in producer prices may signal inflationary pressures ahead, complicating the broader inflation narrative that investors are grappling with. Tariffs and their impact on financial markets and consumer sentiment continue to stir the waters. We anticipate that tariff-related price pressures will push inflation above 3% on a YoY basis by year-end, but this effect is expected to be short-lived. This will allow the Fed to normalize policy later this year, even as ongoing tariff impacts may keep them cautious about rate cuts.

Patience is essential in investing, just as it is in pursuing long-term goals. The part I left out of the story before is that after our initial fishing trip, my father took us to a trout farm, which was fun but set unrealistic expectations about fishing. Unfortunately, there is no trout farm for investors; the market can be volatile, and while expectation gaps can create bumps or drawdowns, they are not necessarily negative. Market moves often stem from results that are better or worse than anticipated, and consensus is rarely spot-on. With millions of participants influencing financial markets, and each with unique goals, it’s crucial to stay grounded and focus on what you can control. Remember, patience is a virtue in investing – those bumps tend to smooth out over time.

Past performance is no guarantee of future results. It is not possible to invest directly in an index.

All market and economic data as of 08/20/2025 are sourced from Bloomberg Finance L.P. and FactSet unless otherwise stated.

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