What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up about 10.9% in Q2.
- The developed market of Japan was up about 3.8%.
- Europe and the U.K. were up about 10.2% and about 9.1% respectively.
- Emerging Markets and Asia (Ex-Japan) were up about 15.6% and 14.8% respectively.
- Global fixed income returns ended the quarter all up from 0.8% (US Treasuries) to 4.7% (Global Inflation-Linked).
Where Do We Stand?
- The market recovered from the Q1 mini bear market to reach all time highs.
- Valuations moved higher and still remain elevated versus historic averages with earnings growth still needed to support further gains.
- Market participants have seemingly ignored the volatility around tariffs and Fed Policy for the time being, which leads one to caution for the second half of the year.
- We remain in a position to weather future volatility with client holdings in Gold and Cash while looking to be more active in opportunities when they present themselves.
The second quarter of 2025 saw significant volatility that pulled markets down to multi-quarter lows and then all the way up to all-time highs. Tariff policy uncertainty and war in the Middle East drove markets lower early in the quarter while pauses in tariffs and strong earnings drove markets higher later in the quarter. It was a “tale of two markets” during the quarter that illustrated the variance of risks our markets have and will continue to face in the coming quarters. As we look to the second half of 2025 many questions remain unanswered. Will the full impact of tariffs begin to be felt in Q3? Will the Federal Reserve continue to hold rates higher in the face of looser Fiscal Policy?
Tariff Schmariff
The effective tariff rates on US imports now sits at the highest level since the 40’s. Yet, there is still extreme uncertainty around how these tariff are implemented. For example, in late May a US trade court ruled against the President’s use of emergency powers to enforce reciprocal tariffs. However, there are multiple legal routes for them to still enact these reciprocal tariffs. So, likely they will remain for the time being. Further complicating the issue is the fact that the revenue derived from these tariffs are now in the projections for the One Big Beautiful Bill (OBBB) recently signed into law.
OBBB-scurification
The OBBB will extend the tax cuts enacted in 2017 and add further fiscal gifts. Based on CBO estimates, the bill will add approximately $5.3 Trillion (with a T) of tax cuts and spending. This is estimated to be offset by about $2.9 Trillion in revenue increases (including the aforementioned tariffs) and spending cuts. With interest, the OBBB is expected to add about $4 Trillion to the national debt over the next 10 years. These are not trifling numbers. Further confusing the analysis, the bill relies on typical budget gimmicks to obscure its potential impact. For example, key tax breaks are set to arbitrarily expire in 2028. If we know anything about our government, once a tax break is given it is rarely taken away. Just look at what this bill did to the 2017 tax cuts that were supposed to expire in 2026.
Truss the Bonds
The Bond Market is understandably weary of the direction our Fiscal and Monetary Policy are heading. 10-Year Treasury Yields rose slightly over the quarter as the implications of the OBBB were digested. Adding $4 Trillion to the debt was seen by many as mis-guided at a time that our debt already represents 100% of GDP. There is a lesson in all this afforded to us by Liz Truss in 2022. Liz Truss became Prime Minister of the UK in late 2022. She immediately enacted substantial tax cuts, extreme deregulation and increased borrowing at a time when their economy was near full employment. Sound familiar? When an economy is near full employment, fiscal loosening only results in higher borrowing costs. The Bond market is telling us this loud and clear.
Currency Risk
In the UK experiment, we saw their currency fall precipitously, government borrowing costs rise and Liz Truss resigning in 49 days. With the US Dollar still reigning as the reserve currency around the world one cannot expect a precipitous fall of the Dollar. However, we have seen the US Dollar fall significantly over the first half of the year. The US Dollar index fell more than 10% over the first six months capping its worst first half performance since 1973. The US Dollar will not lose its status as a reserve currency overnight but it is certainly trading much more like a “risky” country than a stable one.
Inflation Revisited
The global economy remains for the time being on relatively stable footing. In the face of soaring inflation and high interest rates over the past few years, households and companies have managed to maintain strong balance sheets. However, from a spending perspective households and companies are leaning more towards “wait and see” than “party like it’s 1999”. This will likely lead to a slowing of the US economy rather than recession. However, migration policies could very well lead to a supply shock (less labor force growth equals pressure on wages to move higher and less goods being created all equals higher inflation). In conjunction with a demand shock from looser fiscal policy, we may be on the precipice of another inflation boom.
Bearing Caution
This is the real risk today to the US economy. Higher inflation, slowing growth and a waste of $4 Trillion. While much of this may sound like armageddon, the ship is not sinking. Strength around the world remains. China has been able to navigate the tariff storms while Europe remains in recovery mode. The UK has several tailwinds including a huge amount of savings and favorable trade backdrops. Furthermore, Bonds, while volatile at times recently, remain a considerable downside protector that also happens to pay us while we wait for sunnier days ahead. This all speaks to maintaining a strong asset allocation to many different investment opportunities as we are presently at Shorepine Wealth Management.
If you have any questions or have experienced any changes in your financial situation please do not hesitate to Contact Me.
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