Market Recap: A Resilient First Half Amid Global Crosscurrents
Despite a backdrop of geopolitical tension, policy uncertainty, and economic crosswinds, global financial markets delivered a surprisingly strong performance in the second quarter of 2025.
The S&P 500 surged 10.6% in Q2, bringing its year-to-date gain to 5.5%, a remarkable turnaround after nearly a 20% drawdown earlier in the year.
International equities outperformed: the MSCI EAFE Index rose 11.8% in Q2 (4.8% in local currency terms), while the MSCI Emerging Markets Index gained 12.0%.
In fixed income, the Bloomberg U.S. Aggregate Bond Index returned 1.2% in Q2, bringing its year-to-date return to 3.7%. The 10-year Treasury yield ended the quarter at 4.24%, fluctuating between 3.9% and 4.6% during the quarter.
The U.S. Dollar Index (DXY) declined 6% in Q2 and is down 10.8% year-to-date, marking its worst first-half performance since 1973. The dollar’s weakness reflected investor concerns over rising fiscal deficits and the economic impact of tariffs, prompting a shift toward international assets.
This market resilience occurred despite several headwinds: the ongoing conflict in Ukraine, renewed tensions between Iran and Israel, and the economic implications of the recently passed tax package.
While the Liberation Day tariff pause offered temporary relief, trade policy remains uncertain. Volatility was high, with sharp intra-quarter swings reflecting changing expectations around Federal Reserve policy and global growth.
Nevertheless, markets have largely climbed the proverbial “wall of worry.”
Investor Questions: Tariffs, Rates, Valuations, and Risk
As we move forward, several questions remain prominent in our discussions with clients: How will tariffs affect the economy? Will the Fed cut rates? Are stocks overvalued? And how should we approach risk? Let’s start with tariffs. Although the Liberation Day pause provided relief, the effective U.S. tariff rate remains at its highest level since the 1930s, and further increases seem probable. According to BCA Research, these tariffs are already reducing real incomes and could subtract up to 1.7% from median household purchasing power. While inflation has remained contained, this is largely because importers have absorbed the costs. That dynamic may not be sustainable, leading to higher inflation.
Regarding interest rates, the Federal Reserve has held steady, but markets are pricing in possible rate cuts later this year. BCA estimates a 60% chance of a U.S. recession within the next 12 months, and in such a scenario, the Fed could cut rates by as much as 225 basis points. However, fiscal policy – especially the deficit-expanding tax bill – may keep yields under upward pressure, complicating the Fed’s path.
Valuations remain high. The S&P 500 trades at 21.8x forward earnings, well above historical averages and inconsistent with recession risk. Profit margins are also cyclically high, leaving limited room for upside surprises. International equities, while more cyclical and thus vulnerable during a downturn, offer more attractive valuations. We continue to allocate to both developed and emerging markets to enhance future returns. Given these factors, we believe investors should remain diversified and exercise thoughtful risk management. Equity exposure should focus on quality and stability, but remain flexible to pivot as conditions change. Fixed income continues to provide ballast, although we are not yet overweight on duration given fiscal headwinds.
Looking Forward: What Could Go Right?
While risks remain elevated, it’s important to consider what might go right. Several scenarios could help sustain market gains:
- Policy moderation: If the administration significantly reduces tariffs or strikes meaningful trade deals, it could boost business confidence and consumer spending.
- Fed flexibility: A well-timed rate cut cycle could support the economy without reigniting inflation, benefiting both stocks and bonds.
- Global stabilization: Easing tensions in the Middle East and a lasting ceasefire in Ukraine would lower geopolitical risk premiums.
- Resilient consumers: Despite headwinds, U.S. households still benefit from a strong labor market and rising wages, especially in services.
- Technological progress: While AI’s economic impact is still emerging, ongoing innovation could boost productivity and earnings over time.
In summary, although risks remain, staying invested provides the best path to meet client goals. Our approach remains disciplined, diversified, and focused on the long term. We appreciate your continued trust and look forward to navigating the second half of 2025 together.
