Q2 2025 Market Perspective

Markets started the second quarter in a tailspin as the deadline for tariff negotiations loomed imminently. The first quarter saw investor sentiment deteriorate amidst concerns of a bubble in artificial intelligence and tech sector valuations, and trade policy uncertainty triggered a selloff that saw the S&P 500 index trim nearly 20% of its value in a few weeks. On April 9^th, President Trump announced a pause to new tariffs previously instituted through an executive order, and the market began a near V-shaped recovery. At around this time, in our first quarter commentary, we stated that it seemed the uncertainty around tariffs was a bigger market risk than the tariffs themselves.

With tariff uncertainty beginning to recede, equity market volatility has also contracted dramatically. By the end of the second quarter, equity markets had rebounded sharply as the tariff threats de-escalated, and investors became more receptive to the ongoing constructive trade discussions with other nations. Furthermore, geopolitical tension had eased slightly (specifically with Iran), economic data was proving to be resilient, and corporate earnings were pacing ahead of expectations. Today, in the early part of the third quarter, many stock market indices are at or near all-time highs, investor sentiment has improved, and the focus appears to be back on economic data and the path forward for the Federal Reserve’s (Fed) interest rate policy.

The Fed has maintained its wait and see stance on interest rates, stating that it is in no hurry to act to stimulate the economy by lowering short-term rates. After cutting rates 1.0% during the latter part of 2024, the Fed has held rates steady thus far in 2025. However, current expectations still call for a 0.50% reduction in rates by the end of the year and additional cuts in 2026. We will discuss the current economic landscape in more detail, but according to recent Fed comments, the strength of the economy affords them the luxury of waiting while closely monitoring the effects of tariffs before making any adjustments to policy.  

The fixed income market, on the other hand, can be characterized by higher rates and elevated volatility. A byproduct of this environment is that long-end U.S. treasuries have not provided the hedge we have come to expect during equity market dislocations, underscoring the importance of managing portfolio duration (i.e. the bond’s price sensitivity to changes in interest rates). While long duration is not currently the reliable hedge it once was, the outlook for other parts of the fixed income market is encouraging. 

For the second half of the year, we expect resilient economic activity and corporate earnings to support equities, yet tariff uncertainty and potential de-risking from investors may be a near-term headwind. Furthermore, bonds will continue to play an important role within portfolios with the potential to generate compelling yields with managed risk.

Source: Q2 2025 Total Return and Last Twelve Month returns as of 06/30/2025, Bloomberg

• U.S. large cap stocks rebounded nearly 11% in Q2, with the S&P 500 index up more than 25% from its April low. Industrials, utilities, and technology are the leading sectors year to date. Mid and small cap stocks have trailed this year due to sensitivity to interest rates, recession concerns, and reduced favorability compared to large cap tech-oriented companies. [1]
• International markets have significantly outperformed U.S. markets, with most of the outperformance occurring in Q1. A few drivers of the outperformance include a weaker U.S. dollar, fiscal policy changes in some international markets, and relatively more favorable valuations to start the year. [1]
• It was a volatile first half with fixed income assets selling off in early April amid concerns of weakness at the long end of the treasury curve due to supply/demand imbalances. As these concerns abated, focus shifted to downside risks for the economy which led to a rally in bonds with most segments showing strong gains for Q2 and the full year. [1]
• Investment grade corporate bonds were the best performing segment, followed by mortgage-backed securities and treasuries. Municipal bonds continue to underperform, as the market was rattled by the Trump administration’s threat to eliminate the tax-free status (which did not happen) as well as an influx of supply in the new issue market. [1]

Q2 MARKET RECOVERY – TARIFF TIMELINE

While the threat of increased tariffs was a campaign talking point of President Trump, the wide-ranging reciprocal tariffs announced on April 2nd were perceived to be harsher than expected and created immediate uncertainty and volatility in global markets. Investor sentiment turned sharply negative, and economists immediately declared that the tariffs would lead to a recession. Equity markets, which were already under some pressure, quickly corrected and for a moment entered bear market territory (down 20% from its previous peak).

On April 9th the S&P 500 posted its best day in over 17 years, up more than 9%, on the news that President Trump would back off the planned tariffs on most nations for 90 days. A staggering rally in the equity markets ensued and the index has reached multiple record highs this summer. While negotiations are ongoing and the ultimate economic impact of the tariffs are unknown, investors are anticipating a resolution to trade tensions and tariffs. The chart below highlights this V-shaped market recovery.[1]

Source: Q2 2025 Total Return and Last Twelve Month returns as of 06/30/2025, Bloomberg

All market sectors outside of healthcare have participated in the rally, with technology and communication services leading the way. Due to the large contribution of a select few companies to the overall index returns (i.e. “Magnificent 7” stocks), market breadth continues to be an area of focus when reviewing portfolio diversification and concentration risk. While valuations for these mega-cap tech companies may be considered expensive, analysts who are bullish on the tech sector argue that other industry and company specific tailwinds remain to support these stocks (such as resilient spending on artificial intelligence).

SECOND HALF THEMES

Inflation, Economy and the Fed

Inflation remains in check, with the most recent Core PCE reading coming in at 2.7% for June, which was in line with expectations, but represented an uptick from prior periods.[2] This inflation reading is the preferred indicator for the Fed, and while it has shown a significant improvement from the post-COVID spike, the Fed does not appear ready to cut rates further and declare victory over inflation (especially with tariff uncertainty looming).

Meanwhile, economic activity appears heathy with a favorable outlook. Current indicators are stable, such as the labor market, consumer spending, consumer and business sentiment, and GDP growth. Furthermore, potential tailwinds exist from continued AI spending, outlook for improving M&A activity, tax relief (passing of the OBBBA in July), and the possibility of lower interest rates. Internationally, it has also been reported that NATO spending commitments are set to increase, which may be the start of a period of significant global stimulus.

Earnings

Corporate earnings estimates have been revised lower over the past couple of months in response to tariff uncertainty and the impact on consumer and business spending. This sets the stage for a potential acceleration of growth this year, starting with Q2 reports in July, depending on the actual negative impact of tariffs on earnings reported. Earnings guidance should be particularly important this quarter. If earnings are resilient, this should support stocks, yet if tariff concerns take over headlines this may motivate short-term investors to take profits from the most recent rally. 

U.S. vs International Stocks

U.S. dollar weakness appears to be the main contributor to the outperformance of international stocks (both developed and emerging markets) relative to domestic assets. Furthermore, when comparing valuation multiples, the international developed market continues to trade at a favorable discount to the U.S. (MSCI EAFE vs. S&P 500). This is a result of significant outperformance of the U.S. markets over the past 14 years, led in large part by the high growth mega-cap companies which have warranted premium valuation levels.

Most of the divergence in returns this year occurred during the peak of tariff uncertainty, with international stocks outpacing U.S. markets by more than 20% through mid-April (currently the spread is roughly 13% YTD). While U.S. stocks have broadly outperformed international markets for well over the past decade, this is a healthy reminder of the benefits of portfolio diversification.

Fixed Income Investments

The environment for investing in bonds has changed. Inflation has run above the Fed’s target rate for years, debt and deficit levels have pushed up the supply of Treasury debt, and concerns have been stoked that foreign banks are not buying as many U.S. bonds as in years’ past. With long-term treasuries losing their reliability as a hedge to stocks, we believe investors should prioritize income over duration.

Investors can lock in short-term and intermediate-term yields from high quality issuers with little duration risk. Even with inflation running higher than historical levels, the bond market is offering “real yields” at levels we have not seen since 2008. Municipal bonds have underperformed year to date, but we see relative value in this segment of the bond market, currently offering attractive tax-equivalent yields. Thus, we believe the current fixed income environment provides a great opportunity for bond allocations given the ability to generate attractive levels of income and stability.

SUMMARY

It should come as no surprise to say the second quarter was a volatile one for investors in 2025. Much of the volatility appears to have been driven by concerns of potential negative outcomes (soft data), rather than the manifestation of those outcomes (hard data). Fears that trade policy tightening and uncertainty would trigger an immediate recession have abated, and Q2 economic growth is expected to bounce back nicely following the first quarter contraction.

Along the way, we were reminded of established investor fundamentals, like the benefits of portfolio diversification and rebalancing, and the importance of adhering to long-term investment targets. Also, when utilizing robust tax management strategies, we can actively take advantage of market volatility. Finally, we were reminded that consistent communication between investors and advisors is critical to the success of a long-term plan.

For the next few months, at least, investors will be closely monitoring corporate earnings as well as hard economic data, searching for any impacts from tariffs. Meanwhile, the Fed has four more scheduled meetings this year where they may adjust interest rate policy (expectations suggest they will lower rates). For now, investor sentiment appears poised to remain positive and when combined with historically slower trading activity in the summer months, market volatility is expected to remain subdued. Yet, as always, we are mindful that volatility can show up at a moment’s notice and it is important that we stay in touch, ensuring that we remain prepared for when sentiment shifts. We hope you enjoy the remainder of the summer, and we look forward to speaking with you soon.

APPENDIX

Chart A: 2025 Total Return of Major Asset Class Indexes

Source: Bloomberg; 2025 Total Return, MSCI EAFE, MSCI Emerging market, S&P 500, Barclays Agg & Barclays Muni index; 06/30/2025

1 – Source: Bloomberg: S&P 500 Total Return Index; Emerging Markets Stock Index = MSCI Emerging Markets Net Total Return Index; International Markets Stock Index = MSCI EAFE Total Return Index. Bloomberg Barclays Aggregate Bond Index

2 – Source: https://tradingeconomics.com/united-states/unemployment-rate; https://tradingeconomics.com/united-states/core-pce-price-index-annual-change; https://www.atlantafed.org/cqer/research/gdpnow.

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