2nd Quarter 2025: Market and Economy

Many quarters go by when watching the market can feel like the same old rerun. Not this one! In early April, the White House announced sweeping new tariff policy, upending a nearly century-long trend towards free trade and open borders, and triggering a spring swoon that knocked the S&P 500 down 20% from its recent highs.

If you’ve been following the news, there clearly has been no shortage of headline risks, most of which the market has shrugged off. The bear market was short-lived as stocks quickly recovered to post a strong 10.9% return for the quarter and are now up 6.2% for the year. 2025 has been an interesting year for sure, and we’re only halfway through it.

Looking through the returns in 2025, large US growth stocks, headlined by the high-tech Magnificent 7, had a great second quarter, but the best returns have come from outside the US. After trailing for much of the previous 15 years, international stocks have been an important part of any diversified portfolio this year. The MSCI All Country World Index excluding US stocks has outpaced the S&P 500 by nearly 12 percentage points so far this year. And if the year ended now, 2025 would be the index’s best return this decade.

The Tariff Tango

President Trump promised tariffs and now they’re here. The average tariff rate surged to a level not seen since the 1930s, even as officials negotiate trade deals on a country-by-country basis.

In the near term, businesses must choose between raising prices or thinner margins. Longer term, businesses will review their supply chains and shift to wherever they can get the best price—but building that new infrastructure can take years.

But there’s also another side to this coin. The US Dollar Index, which values the US dollar relative to global currencies, is down 10.7% in 2025, largely due to tariff fears. A weaker dollar may sound bad, but it means prices for US goods are now 10.7% more competitive abroad, which could help boost US exports.

Negotiations are ramping up ahead of the July 9 deadline when the 90-day tariff pause expires. A deal with the United Kingdom has been signed, and a preliminary agreement with China has been reached, but there is still much to be determined. Wall Street is clearly betting that the highest reciprocal tariffs are off the table.

Big Beautiful (and Possibly Expensive) Bill

Congress just passed the so-called “Big Beautiful Bill,” a major reconciliation package aimed at cutting taxes, reducing government spending, and extending the debt ceiling. The tax cuts, in particular, will likely stimulate the economy over the next year; however, the Congressional Budget Office estimates the bill will add an additional $3.3 trillion to Treasury debt over the next decade. That would lift the federal deficit to 7% of GDP, well above Treasury Secretary Scott Bessent’s stated 3% target.

The US government hasn’t balanced a budget since the 1990s, so this isn’t exactly a new phenomenon. It is, however, becoming an increasingly significant issue, thanks to Treasury rates holding at 15-year highs. Interest payments have doubled since the beginning of 2020, and the Treasury now spends more on debt than on Medicare or defense.

Less Economic Room for Error

US GDP slipped 0.5% in the first quarter—our first contraction since early 2022. The headline number may look scary, but the report contains a bit of an accounting quirk: imports are subtracted from GDP. Many companies planned ahead and stepped up orders for foreign goods and materials ahead of expected tariffs. Overall GDP may have fallen but consumer purchases actually rose at a 1.9% rate, making this a hazy pulse check at best.

We are closely watching the jobs numbers. Unemployment has stayed low, down to 4.1% in June. Yet there are signs the labor market is cooling off. Layoffs haven’t substantially risen, but job openings have steadily fallen for the last three years and job seekers are staying unemployed for longer as they look for new work.

Consumer spending drives the economy, but people can’t spend if they are out of work. Unemployment is staying low, but the labor market is teetering at a point where a slight shift either way could strengthen our economy or push it over the edge.

The Fed’s Tightrope Act

The Federal Reserve has two mandates: maximum employment and price stability. The problem is that the tools at the Fed’s disposal can’t work towards both objectives at the same time. It can either lower rates to grease the economy to help hiring, or boost rates to stem spending and quash rising prices.

Normally, fading momentum in the labor market would justify further rate cuts, but Fed governors are worried tariffs will raise prices. The Fed is still expected to cut rates once or twice later this year. If and when they are enacted, tariffs are still more or less a one-time hit to prices that the Fed can’t really counter. Stimulus caused by tax cuts, on the other hand, could force the Fed to keep interest rates high for longer, as could rising wages caused by a shrinking workforce due to falling immigration.

Feeling Disrupted

Somehow, I have made it this far without mentioning the hype surrounding AI. The ways we work and live are being altered on a daily basis by this improving technology whether we realize it or not. Between that and change in Washington, we are muddling through a major transition period. Uncertainty feels pervasive, but we should get more clarity in the coming months.

Despite all of the volatility, 2025 has rewarded disciplined investors thus far. Any time returns are in the green after a 20% drawdown is always a good result. Clearly markets are looking past any upheaval and are staying focused on the fact that fundamentals are holding up. On that end, S&P 500 earnings are projected to grow 9.1% over the course of 2025 after growing 10.6% last year, according to FactSet.

The good news is that a diversified portfolio looks more attractive than it has for a long time. The best US companies continue to drive growth. International stocks are showing some life, and valuations remain attractive. Bonds are actually paying investors while providing ballast to any portfolio. Looking ahead, the playbook looks much the same and hopefully, we will continue to reap the rewards.

This information is believed to be accurate at the time of publication but should not be used as specific investment or tax advice as opinions and legislation are subject to change. You should always consult your tax professional or other advisors before acting on the ideas presented here.