By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
The second quarter of 2025 was one for the record books. The S&P 500 reached all-time highs and returned 10.9% despite tariff-induced trade war fears, contentious budget bill negotiations, the Moody’s US credit downgrade, and the bombings in Iran. The quarter began with a nearly 19% decline from market highs, but the period from April 8th to the new highs on June 27th was the fastest market recovery ever following a 15% correction. Overseas companies fared even better over the quarter, with developed markets returning 12.1% and emerging markets returning 12.2%.
Additionally, the Bloomberg US Aggregate Bond Index rose 1.2% with the 10-Year Treasury Rate falling to 4.24%, gold prices rose 5.8%, and WTI crude oil prices fell from $71.2/barrel to $65.1. No one could have expected to see these numbers given the quarter’s headlines.
The barrage of policy changes this year has led to record uncertainty (see chart below), and the trend will likely continue. Historically, uncertainty spikes have led to strong forward equity returns, but we’re still waiting to see what the effects of all the changes will be once they flow through the economy. In the case of the tariffs, which have easily been the biggest wild card of the year, the constantly evolving situation has made it difficult to predict inflation, economic growth, foreign relations, and the level of spending cuts needed by the tax bill. Tariff revenue has been surging into the US Treasury, but it is unclear at this point whether the price is ultimately being paid more by consumers or corporations. The economic impact does not seem disruptive so far, but S&P earnings growth estimates have been trending down since the start of the year.
Source: Strategas Research Partners LLC
The roughly $700bn/year level of tariffs proposed in April has fallen to around $270bn/year as of the end of June, with more updates to come as trade deals are negotiated. This level would largely pay for the tax cuts in the new budget, but there are still challenges to come from the courts. The Trump administration does have back-up plans if a tariff injunction is imposed, but the whole process could be dragged out for a long time while tariff revenue keeps pouring in.
Due to the high degree of policy uncertainty, the Federal Open Market Committee has opted to keep rates unchanged all year, and we expect that will continue through the summer. There are legitimate concerns that inflation could resurface and/or the economy could slow down, but they are opting to wait for hard data and risk acting too late instead of too early. Recession odds have fallen as tariffs have come off the table, and we’ve only seen minor labor market cracks, so some patience is justifiable.
The highly controversial One Big Beautiful Bill Act should be pro-growth to the degree that it extends the 2017 tax cuts, but affording its hefty price tag depends on continued tariff revenue. The bill on its own does not help address our ballooning national debt, and it could weigh on lower earners in the coming years by cutting spending on safety nets and likely making healthcare less affordable.
The escalation of conflict in the Middle East in recent months is certainly concerning, but not surprising. It appears that there will not be major retaliation for the bombing of Iran’s nuclear sites, but any degree of peace will be fragile and could leave tensions brewing for some time. The decision of European NATO allies to increase their defense spending targets from 2% of GDP to 5% by 2035 is another sign that we can continue to expect an environment of global tensions.
Increasing deglobalization, tariffs, and a worsening US fiscal situation have led to concerns that the US dollar could lose its status as the world’s reserve currency, and indeed the first two quarters were its weakest since 1973. Our guess is that, even though weakening versus other currencies could continue, the dollar is too deeply entrenched in world trade to lose its reserve status any time soon, and there are no viable replacements at this point.
Investment Allocation
For years we have expressed concern over the level of concentration risk in the S&P 500. Concentration began to unwind with the April dip, but it quickly popped back near all time highs again. In the same vein, valuation multiples returned to their highs despite a softening earnings outlook. For this reason, we believe there is value in diversifying away from the high-flyers with higher quality stocks that carry more palatable valuations. These companies performed well in the first half of the year.
Another trend we have been adding exposure is to the increasing demand for energy, especially as data centers keep being built and requiring more electricity. As shown below, data centers are projected to take up over 10% of national power demand within the next five years, and we will likely need new sources of power to meet that demand, such as nuclear or other renewables.
Source: J.P.Morgan Asset Management
We continue to be cautious with small cap stocks, largely because they can be economically sensitive and there is still considerable economic uncertainty, but there are certainly high quality stocks worth owning. The same can be said for the mid cap space, which has the advantage of lower valuations than large caps and typically more resilient business models than small caps.
International markets are a fascinating space in this environment of increasing deglobalization and trade wars. We expect all the uncertainty to create ample opportunities and ample risks, and we freely admit that we do not know which countries or companies will benefit the most. We strongly believe international stocks are worth owning in a diversified portfolio, but we tend to let active fund managers with more granular insight make the decisions on where to invest in this space.
On the fixed income side, we have maintained our lower duration stance to avoid excessive rate risk in this uncertain environment, but we have gradually increased duration over the course of the year. The same can be said for our credit positioning – we have opportunistically added credit but are hesitant to add too much given how tight spreads are.
Bonds look attractive because of high rates, but the trend of higher correlation to stocks has worsened over recent years (see chart below). This continues to make the case for adding uncorrelated alternative assets to diversified portfolios.
Source: Strategas Research Partners LLC
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
Second Quarter 2025 Commentary
By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
The second quarter of 2025 was one for the record books. The S&P 500 reached all-time highs and returned 10.9% despite tariff-induced trade war fears, contentious budget bill negotiations, the Moody’s US credit downgrade, and the bombings in Iran. The quarter began with a nearly 19% decline from market highs, but the period from April 8th to the new highs on June 27th was the fastest market recovery ever following a 15% correction. Overseas companies fared even better over the quarter, with developed markets returning 12.1% and emerging markets returning 12.2%.
Additionally, the Bloomberg US Aggregate Bond Index rose 1.2% with the 10-Year Treasury Rate falling to 4.24%, gold prices rose 5.8%, and WTI crude oil prices fell from $71.2/barrel to $65.1. No one could have expected to see these numbers given the quarter’s headlines.
The barrage of policy changes this year has led to record uncertainty (see chart below), and the trend will likely continue. Historically, uncertainty spikes have led to strong forward equity returns, but we’re still waiting to see what the effects of all the changes will be once they flow through the economy. In the case of the tariffs, which have easily been the biggest wild card of the year, the constantly evolving situation has made it difficult to predict inflation, economic growth, foreign relations, and the level of spending cuts needed by the tax bill. Tariff revenue has been surging into the US Treasury, but it is unclear at this point whether the price is ultimately being paid more by consumers or corporations. The economic impact does not seem disruptive so far, but S&P earnings growth estimates have been trending down since the start of the year.
Source: Strategas Research Partners LLC
The roughly $700bn/year level of tariffs proposed in April has fallen to around $270bn/year as of the end of June, with more updates to come as trade deals are negotiated. This level would largely pay for the tax cuts in the new budget, but there are still challenges to come from the courts. The Trump administration does have back-up plans if a tariff injunction is imposed, but the whole process could be dragged out for a long time while tariff revenue keeps pouring in.
Due to the high degree of policy uncertainty, the Federal Open Market Committee has opted to keep rates unchanged all year, and we expect that will continue through the summer. There are legitimate concerns that inflation could resurface and/or the economy could slow down, but they are opting to wait for hard data and risk acting too late instead of too early. Recession odds have fallen as tariffs have come off the table, and we’ve only seen minor labor market cracks, so some patience is justifiable.
The highly controversial One Big Beautiful Bill Act should be pro-growth to the degree that it extends the 2017 tax cuts, but affording its hefty price tag depends on continued tariff revenue. The bill on its own does not help address our ballooning national debt, and it could weigh on lower earners in the coming years by cutting spending on safety nets and likely making healthcare less affordable.
The escalation of conflict in the Middle East in recent months is certainly concerning, but not surprising. It appears that there will not be major retaliation for the bombing of Iran’s nuclear sites, but any degree of peace will be fragile and could leave tensions brewing for some time. The decision of European NATO allies to increase their defense spending targets from 2% of GDP to 5% by 2035 is another sign that we can continue to expect an environment of global tensions.
Increasing deglobalization, tariffs, and a worsening US fiscal situation have led to concerns that the US dollar could lose its status as the world’s reserve currency, and indeed the first two quarters were its weakest since 1973. Our guess is that, even though weakening versus other currencies could continue, the dollar is too deeply entrenched in world trade to lose its reserve status any time soon, and there are no viable replacements at this point.
Investment Allocation
For years we have expressed concern over the level of concentration risk in the S&P 500. Concentration began to unwind with the April dip, but it quickly popped back near all time highs again. In the same vein, valuation multiples returned to their highs despite a softening earnings outlook. For this reason, we believe there is value in diversifying away from the high-flyers with higher quality stocks that carry more palatable valuations. These companies performed well in the first half of the year.
Another trend we have been adding exposure is to the increasing demand for energy, especially as data centers keep being built and requiring more electricity. As shown below, data centers are projected to take up over 10% of national power demand within the next five years, and we will likely need new sources of power to meet that demand, such as nuclear or other renewables.
Source: J.P.Morgan Asset Management
We continue to be cautious with small cap stocks, largely because they can be economically sensitive and there is still considerable economic uncertainty, but there are certainly high quality stocks worth owning. The same can be said for the mid cap space, which has the advantage of lower valuations than large caps and typically more resilient business models than small caps.
International markets are a fascinating space in this environment of increasing deglobalization and trade wars. We expect all the uncertainty to create ample opportunities and ample risks, and we freely admit that we do not know which countries or companies will benefit the most. We strongly believe international stocks are worth owning in a diversified portfolio, but we tend to let active fund managers with more granular insight make the decisions on where to invest in this space.
On the fixed income side, we have maintained our lower duration stance to avoid excessive rate risk in this uncertain environment, but we have gradually increased duration over the course of the year. The same can be said for our credit positioning – we have opportunistically added credit but are hesitant to add too much given how tight spreads are.
Bonds look attractive because of high rates, but the trend of higher correlation to stocks has worsened over recent years (see chart below). This continues to make the case for adding uncorrelated alternative assets to diversified portfolios.
Source: Strategas Research Partners LLC
Material discussed is meant for general/informational purposes only and it is not to be construed as tax, legal, or investment advice. Although the information has been gathered from sources believed to be reliable, please note that individual situations can vary therefore, the information should be relied upon when coordinated with individual professional advice. Past performance is no guarantee of future results. Diversification does not ensure against loss. The opinions and forecasts expressed are those of the author, and may not actually come to pass. This information is subject to change at any time, based on market and other conditions.
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