Halfway through 2025, investors would be hard-pressed to disagree with the notion that remaining disciplined and aligned with a long-term asset allocation (and rebalancing to it in times of volatility) is a pretty good way to navigate challenges. Indeed, while it seemed to many that the U.S. economy was on the precipice of a sharp deterioration tied to onerous tariffs and heightened geopolitical risk, the real surprise has been investors’ willingness to look beyond current troubles for signs of hope for the coming year.
Shaking off sharp declines in April, the second quarter ended with the S&P 500 up 10.9%, reflecting renewed leadership from technology and communications services stocks, which rose 23.7% and 18.5%, respectively. U.S. small caps lagged somewhat, rising only 8.5%, as tariff worries offset the opportunities presented by deregulation and pro-growth initiatives included in new U.S. tax legislation. Both non-U.S. developed and emerging market equities gained 12% for the quarter—evidence of the shift in investor sentiment. Treasury yields were volatile, but the 10-year Treasury yield closed the quarter essentially flat, at 4.23%, after hitting a high of 4.6% in mid-May. The U.S. Aggregate Bond index returned 1.2%, while municipal bonds were off -0.1% as a rush of supply pressured prices; high yield credit outperformed investment grade issues. Gold closed the quarter with a modest 1.4% return, while both natural gas and oil finished in the red despite a ramp-up in Middle East tensions.1
A key question is whether that comfort—and some would call it complacency—is justified. The average tariff rate being imposed on importers to the U.S. is well over 10%, with some countries and certain goods facing much higher levies. As of yet, there is minimal evidence that production can quickly be relocated to avoid the additional tax burden and eventual impact on consumers. The U.S. labor market is slowing, as job seekers report longer periods of unemployment with little to prompt companies to accelerate hiring. Conflict in the Middle East represents not only a geopolitical, nuclear and humanitarian threat, but also the potential for supply disruptions akin to those created in 2020. Policy measures, both monetary and fiscal, are being complicated by changing global relationships and investor preferences.
In our view, the answer is not clear-cut. Global fiscal policy has become increasingly stimulative, with Europe and China following in U.S. footsteps. While supportive to global growth, higher deficits have attracted the ire of investors worried about authorities “kicking the can down the road.” Consumers have continued to spend, but businesses have been more cautious, waiting for signs of clarity and improved demand before reinvesting. Innovation, too, remains a tailwind, but is also not without risk as disruption moves at lightning speed, and the winners and losers remain uncertain. In short, we believe this is a time for a thoughtful and prescriptive approach to investing; the proverbial low-hanging fruit has been plucked, and the next gains might prove more difficult to earn.
A Big Bounce
Major Market Performance
Source: Bloomberg, through June 30, 2025. The following indices are represented: S&P 500, MSCI ACWI (global stocks), Bloomberg Municipal Bond Index, Bloomberg U.S. High Yield 2% Issuer Cap, Bloomberg EM USD Aggregate, Bloomberg U.S. Aggregate, MSCI Emerging Markets, MSCI ACWI ex-U.S. (international large and midcap stocks) and Bloomberg Commodity.
Consumers and the Demise of American Exceptionalism
U.S. consumers are not exuding confidence. As we cautioned in our spring outlook, “A Bumpy Path,” tariffs have weighed on the consumer psyche, with expectations of higher inflation and concerns around job availability painting a muted picture. On the inflation front, recent data has been relatively soft, with core consumer prices slowing and rent inflation at multiyear lows, even as collected tariffs are running some $60 billion higher (year-over-year) through May.2
While wage growth remains healthy, the labor market is showing mixed signals: Job gains are largely concentrated in select industries like health care, social assistance, and leisure and hospitality, but areas including manufacturing and temporary work are weakening. Initial jobless claims are trending higher, while continuing claims have spiked in recent weeks. The unemployment rate has been holding in a narrow range of 4.0 – 4.2%, but with immigration and labor participation falling, we may see nonfarm payrolls trend lower moving forward.
Offsetting moderation in the labor market are several tailwinds: Personal income growth, strong equity and housing markets, and slowing services inflation have all contributed to consumer spending. Outlays by middle- and higher-income households have shown few signs of slowing, even as behavior has shifted. Pre-tariff spending in areas such as consumer electronics and autos will likely translate into slower sales over the summer, while travel and lodging volumes have deteriorated recently, perhaps due to heightened geopolitical tensions and the threat of broader tariffs.
You might ask why so much attention is paid to the U.S. consumer—especially when so many other forces are at play in the global economy. The short answer is that the U.S. consumer has been a key driver of American “exceptionalism” since the Global Financial Crisis. Globalization, the broadened use of technology, low interest rates, growth in government spending and a resilient U.S. consumer have all contributed to a wave of GDP growth and investment in U.S. assets over the past decade.
That said, a resurgence in opportunities outside the U.S., building fiscal pressure stemming from U.S. budget deficits, and investors’ structural overallocation to U.S. assets on the back of strong returns have combined to shift investment flows to other markets in recent months. At the same time, the U.S. consumer survives as a meaningful driver of global demand—and spending could accelerate should improved business confidence translate into capital expenditure and hiring.
Is Consumer Confidence Rebounding?
Sentiment Indices (Indexed at 100)
Source: FactSet, data through June 2025. For illustrative purposes only. Historical trends do not imply, forecast or guarantee future results. Due to a variety of factors, actual events or market behavior may differ significantly from any views expressed. Past performance is not indicative of future results.
Looking Ahead
It is difficult to predict where U.S. tariff policy is going, but the Trump administration’s actions since its initial April 2 announcement suggest an economic scenario that could be far better than the one we were modeling in April. The looming threat of a 2025 global recession, built on the U.S. consumer facing price increases and a deteriorating labor situation, appears to have been averted. With that has come the sharp rebound in risk assets, which, in our view, requires tougher decisions as to investment positioning.
U.S. equities are once again trading at valuations that imply continued robust earnings growth, supported not only by reaccelerating revenues, but also defensible profit margins despite higher input costs. Tariffs are still in place, and the revenue they generate suggests that somewhere the costs are being paid. U.S. equity investors also appear to anticipate benefits from lower interest rates and the pro-business agenda evangelized by the Trump administration—an agenda that has yet to “deliver the goods,” but could help to catalyze a long-awaited rally in U.S. small- to midcap equities.
With U.S. equity valuations back to first-quarter levels, we encourage the incorporation of non-U.S. developed and emerging market equities into portfolios. Fiscal measures helped to drive European equity performance through the first half of the year, particularly in sectors and industries that would benefit from greater defense and infrastructure spending. The backdrop for Japanese equities has also improved given expectations for stronger earnings growth in 2026. This, combined with continued U.K. and eurozone spending, should allay investor concerns about missing the recent run-up. In addition, we find Chinese equities to be increasingly compelling, as consumer-focused stimulus and trade negotiations combine to mitigate the threat of dampened growth.
In fixed income, we believe diverging central bank policy, a shifting fiscal approach and a potential uptick in demand for credit could create a fertile plain for investors. Attractive yields and a benign default backdrop have, at times, limited capital appreciation opportunities, but a nimble approach to both credit and interest rate exposure could be useful at a time when multiple factors are driving movement in yields.
Finally, our constructive view extends to private market equity. Admittedly, muted business confidence has slowed the recovery in mergers and acquisitions, but we believe the needs of private companies for capital—through secondaries, co-investments and debt—should create opportunities for investors; indeed, M&A activity has shown signs of life in recent weeks.
Overall, we acknowledge the potential for price volatility in the second half of the year, but also believe that the combined catalysts of the U.S. tax law, lower global interest rates and meaningful non-U.S. fiscal stimulus could temper the negative effects of tariffs and geopolitical unrest.
