What Did We See?
- U.S. Large Cap stocks, or the S&P 500 index, were up about 8.1% in Q2.
- The developed market of Japan was up about 11%.
- Europe and the U.K. were up about 2.8% and about 6.9% respectively.
- Emerging Markets and Asia (Ex-Japan) were up about 10.9% and 11.1% respectively.
- Global fixed income returns ended the quarter mixed from up 4.4% (Emerging Markets) to down 0.2% (Euro Gov).
Where Do We Stand?
- The market has now reached 28 new all time highs during 2025 in a continued recovery from the Q1 mini bear market.
- 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 remainder 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.
Patient investors were rewarded with a calmer and better third quarter after suffering through the market volatility we saw in the first half of 2025. Despite those volatile markets earlier in the year, the overall market was able to reach 28 record highs thus far in 2025. This has caused some investors to worry that the inevitable pullback is due. However, markets can trend in one direction or another for much longer than anyone expects.
For example, in 2021 the market saw 70 all time highs before correcting through much of 2022. With the Federal Reserve expected to provide about 100 basis points of rate cuts over the next 12 months, markets seem “priced to perfection” right now. Anything that could de-rail those rate cuts could have an adverse effect on equities and change the market narrative with extreme expediency. Reaching new highs is a normal part of any market cycle and not necessarily a harbinger of a downturn ahead.
The Divergence
The economy is seemingly on a different path than market expectations. Suddenly weaker labor markets over the past few months is the main culprit. We are seeing waning labor demand, lower numbers of job openings, lower numbers of people finding jobs, slower wage growth and a general malaise in the job market. Whether that is due to a lack of demand for workers by companies or a lack of supply due to new immigration policies is yet to be determined. One thing is sure. Job growth is one of the pillars of a growing economy and it has begun to show some cracks. Demand is softening and one can only hope it is temporary.
Data Shutdown
Further exacerbating the issues at hand is the more recent government shutdown. Due to the shutdown, the systems and people that normally provide market participants with economic data are no longer doing that work. Thus, the markets are flying a little bit blind right now. Should the government re-open in a few weeks or more there will be a glut of delayed data that markets will have to digest all at once. If the data (that is eventually released) is mostly weak we could see a quick, overly emotional reaction in the markets. Something that bears watching.
Protective Measures
If we are in fact in an economic slowdown it will likely not result in the same environment we have seen in prior slow or recessionary periods. That is because the Federal Reserve today has a lot of tools at its hand to protect the economy. The Federal Reserve’s target rate is now set at 4.25% – 4.5%. Hence. there is still a lot of room to cut rates and spur on economic growth, barring any other major issues.
Even more promising, economic slowdowns in conjunction with a rate cutting environment (like we see today), is great for equities. That is assuming there is no profit recession at the same time. Even if revenues were to go flat for a period, corporations can leverage their balance sheets while enjoying falling borrowing costs. This would allow them to still provide shareholder returns until the economy improves. This is likely a primary driver of the disconnect we see between stocks and the economy.
Stalled Tariff Inflation
There still remains a real risk that the markets are underestimating the inflationary impact of tariffs. Much of the effect of tariffs are still working through the system to the consumer. In fact, a recent survey by the Federal Reserve shows the persistent risk of spikes in inflation expectations. That is because the estimates for future inflation is not being driven by typically volatile items like food and energy. Households are now worried about the cost of things that are imported, which make up a large portion of US consumer spending. That could be sticky inflation and much harder to tame than the more volatile items like food and energy. If inflation were to remain persistent then the Fed has a much harder time lowering interest rates. Without lower rates, companies may find it harder to produce shareholder returns in a slowing economy.
In Conclusion
The economic and market landscape remains complex. There are opportunities today in areas such as Artificial Intelligence, Technology, Real Assets and Industrial companies. At the same time tariff effects, consumer sentiment, labor weakness and the oft-cited inflation expectations will remain as a damper on market sentiment. Markets are riding a razors edge of positivity for the time being and those that have remained invested have been rewarded. Looking forward, the rest of the year and beyond will likely bring more of the same. Challenges that need to be addressed and opportunities to be exploited.
A good portfolio in these times will be able to manage both sides of the ongoing story. The key will be having the right portfolio that can benefit from any of the above scenarios, whether it be surviving a downturn or thriving during times of plenty.
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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