“Nervous energy is a great destroyer of wealth.” – Fayez Sarofim, noted financier
Mercurial Markets
Spring of 2025 was a roller coaster, both in the U.S. and globally. After an initial drawdown, most asset categories rallied sharply then continued higher through the balance of the quarter. After enduring a mini-bear downturn of 20% before a quick V-shape rebound, the S&P 500 rallied 10.9% in the second quarter. The NASDAQ and foreign markets exhibited similar behavior, with bonds rising modestly. Commodities rose, but oil slipped late and finished lower.
“Liberation Day” occurred on April 2nd with sharply higher reciprocal tariffs by the U.S. Administration on most countries. The global Average Tariff Rate (ATR) went from 2.5% to about 26-28%. Most economists factored in a 10% baseline ATR, and subsequently the equity, fixed income markets and the U.S. dollar sold off, which is rare. Fortunately, the White House delayed the tariffs for three months, with the exception of China. The ensuring tariff escalation between the two countries was eventually diffused with a broader agreement in mid-May.
In June, the Israel-Iran conflict reached a boiling point, with the Israelis launching pre-emptive air strikes on Iranian nuclear facilities. After Tehran responded with missile attacks and the U.S. sent its heaviest bombs to penetrate the Fordow nuclear installation, Iran retaliated by launching missiles at the Qatari U.S. air base. A ceasefire finally ensued, with negotiations slated to begin in coming weeks. After it became evident that Iran would not try to attack ships in the Straits of Hormuz, West Texas Intermediate (WTI) Oil, which earlier traded in the mid-50s, spiked to $78 per barrel before falling back to the mid-60s.
Other Developments
The new tax bill was passed ahead of market expectations, making most of the 2017 tax cuts permanent. Overall, it is a short-term stimulus for the economy and pushes out the August debt ceiling for at least another year. However, this may turn out to be a long-term negative for the federal budget deficit, unless tariff revenues are significant.
The deregulatory process is beginning, with larger banks given looser capital requirements to free up more capital for lending, dividend increases and share buybacks. Beyond the financial sector, additional moves could include freeing up government-owned lands for oil and rare earth exploration.
Meanwhile, the economy and employment continue to grow at a modest pace. Consumer spending has been distorted by “pull forward” demand or hoarding, with consumers buying ahead of expected higher prices due to tariff. As this also impacts corporate inventories, this may result in some giveback for both in the second half of the year.
A clearer indicator of the economy right now is the labor market, which is tepid but not weakening significantly. The uncertainty of what the overall tariff policy will be is causing companies to put hiring plans on hold. However, many CEOs remember the post-Covid employment problem, when corporations had great difficulty rehiring the same workers they had previously let go. In essence, employers are not aggressively hiring — nor are they firing workers.
Perhaps the biggest surprise of 2025 so far is the weakness of the U.S. dollar. Although economists and strategists foresaw a correction in the greenback due to overevaluation, the magnitude surprised everyone. Foreign repatriation of assets and massive fiscal stimulus in the Eurozone (caused by increased defense spending in NATO countries) were major factors in the dollar’s decline. Germany, in particular, has run low fiscal deficits, so it has considerable room to boost economic growth.
Meanwhile, the Federal Reserve has been in the background since the inflationary outlook is extremely unclear. With the tariff process still ongoing, Fed officials are cautious about lowering short-term interest rates. Standard economic theory maintains that tariff impacts are temporary. However, in the current situation, the price effects are more protracted and may last awhile.
The Second Half Outlook
- It is our forecast that the Fed will begin to lower rates once or twice later this year, probably after the summer.
- With the passage of the new tax bill and deregulation occurring, much will depend on the end point for the tariff policy. Currently, the global ATR for U.S. imports is between 13-15%, with changes occurring almost daily. A pessimistic outcome would peg the ATR closer to 18%, whereas a more optimistic one would settle closer to 10%.
- Trade is significant but not as important to the U.S. as it is to many of our trading partners. The contractionary effects on economic growth will be offset by both the tax bill and deregulation. After the volatility of Liberation Day, we assigned a 50-50 probability of a recession. However, with the overall de-escalation of the tariffs, we now see about a one-third chance of a recession within the next 12 months, similar to where we forecasted it for most of the last two years.
- We re-emphasize the importance of diversification in portfolio construction. This quarter we continued to add to International Equities from domestic stocks. Core Equities featured a move back to AI (Artificial Intelligence) exposure, after the DeepSeek threat receded. Always looking for improvements to portfolios and the fixed income component of nontaxable accounts, we have switched to a less expensive ETF (Exchange Traded Fund) which provides less exposure to longer maturity U.S. Treasury debt, a concern of the recent tax bill passage.
Final thoughts. Although stocks may experience a correction due to tariff headlines, keep in mind that a rapid but quick drawdown of 20% has already occurred in April. Following similar scenarios in 2011, 2016, 2020 and 2022, the market rose to all-time highs. Indeed, the April 9th reversal saw the S&P 500 jump 10% in one day – normally, the average return for one year. Time in the market is a concept worth keeping in mind.