By: Darren W. King | Wealth Management
The second quarter began with “Liberation Day” on April 2nd. The surprisingly high level of initial tariff levy rates saw equity markets correct 20% in the first part of April. As president Trump backed off initial tariff rates and allowed further negotiation; buy the dip investors propelled the equity markets to new all-time highs. The S&P 500 ended the first half of the year up 6.2%. The Technology-heavy NASDAQ was up 5.86% by the end of June, while the DOW Jones Industrial Average ended the first half up 4.55%. The Russell 2000 Small Cap Index finished the second quarter down 1.79% and has been the laggard thus far in 2025. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCI EAFE), closed the second quarter up 19.94% in US dollar terms. The MSCI Emerging Markets Share Price Index closed the first half of 2025 up 15.52%. Money flow into international markets coincided with weakness in the US dollar as non-US assets gained increasing investor attention.
The first half of 2025 witnessed consumer, energy, and health care shares underperform while value sectors posted a period of strong performance. S&P 500 sector results through the 2Q2025: Telecommunications Services 17.9%, Industrials 12.7%, Utilities 9.4%, Financials 9.2%, Technology 8.05%, Consumer Staples 6.4%, S&P 500 6.2%, Materials 6%, Real Estate 3.5%, Energy .8%, Health Care -1.1%, Consumer Discretionary -3.9%. The second quarter saw growth sectors rebound strongly from the April correction, while energy and health care sectors corrected. For the second quarter, the S&P 500 returned 10.9%, wiping out the losses that reached almost 20% in April.
Based on current consensus earnings forecasts, the forward 12-month P/E ratio for the S&P 500 is 21.9X, more expensive than the five-year average P/E of about 18.4X. Currently, the market is estimating 9.1% earnings growth on 4.2% revenue growth in 2025. However, we started the year expecting 14% earnings growth on 5.8% revenue growth as the inflationary and slower growth aspects of tariff policy are starting to be factored into 2025 earnings outlook. Profitability remains high for S&P constituents, with net profit margins currently at 12.3%, compared to 5-year average profit margins at 11.7%. Average equity strategists’ bottom-up price targets for the S&P 500 in 2025 are at 6,679, currently 7% higher than current trading levels. We expect forward price targets to move lower as companies provide more conservative forward guidance for 2025, with tariff pricing lessening corporate profits in the third and fourth of this year. After 2 years of S&P 500 returns greater than 20%; we see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Strategic moves out of domestic large capitalization investing into international stocks took center stage in the first two quarters of 2025 as valuation discounts for international markets proved hard to ignore. The weakness in the US dollar has also seen international investors diversify out of their overweight in the American economy.
Not bowing to political pressure, the Federal Reserve held rates steady at 4.25% to 4.5% at their June meeting and reiterated the same 50 basis points of interest rate cuts in 2025 that they communicated in December. However, more members prefer one more 25 basis point cut in 2025, with inflation expectations expected to move higher later in the year. The Fed also indicated in their June meeting a fed funds rate of 3.5% for the end of 2026 and a longer-term neutral rate around 3%, as inflation expectations inch higher following tariff policy updates. Forecasts for economic growth have slowed because of trade policies. The Fed estimates full year 2025 GDP to be 1.4% in 2025, revised down from 2.1% GDP growth estimates that were forecasted in December. Fed core inflation is estimated to end 2025 at 3.1%, higher than fourth quarter projections at 2.5%. Year-end 2025 unemployment estimates were revised to 4.5% from 4.3% in December. In short, while the labor market remains strong, uncertainty around the economic outlook has increased and recession probability odds have moved from near zero at the end of 2024 to higher in the near term. Consumer spending, that was growing at 4% in the fourth quarter of 2024, has slowed to .5% growth in the first half of 2025 and begs the question if inflationary pressures and interest rates have finally exhausted the consumer.
The 10-year treasury yield has fallen in 2025, starting the year at 4.57% and ending the quarter at 4.23%. Longest duration bonds underperformed shorter duration issues as yields remained more stable for longer maturities as longer-term inflation expectations moved higher. 20+ year treasuries were up 2.59% in the first half of 2025, while intermediate treasuries were up 3.98%. In a risk-off trade, higher credit quality underperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up 4.02% so far in 2025, while Baa rated bonds returned 4.32% during the same period. Despite market uncertainty, credit spreads have not moved appreciably and indicate a growth and inflation reset and not a full-blown recession in 2025.
The Bloomberg Dollar Spot Index finished the first half of 2025 with the dollar having weakened 9% compared to our trading partners. International investors are forecasting slower growth and higher inflation in the US following the election and no longer believe the US economy will outperform the rest of the world. Light crude oil futures are down roughly 9% in 2025, with WTI oil futures falling to $65.11 from $71.72 over the first half of the year. 30-year mortgage rates fell from 7.28% at the end of 2024 to 6.80% by the end of June, while 30-year treasury yields remained steady at 4.78% over the first half of 2025.
According to the Bureau of Labor Statistics, the June employment report showed 147K jobs gained during the month, well above estimates for 110K. Service sector employment was most of the job gains, as manufacturing job growth remains weak and job growth came from public education and health care. The June jobs number reported unemployment at 4.1%, falling from 4.3% in May, but well off the cycle low unemployment rate at 3.5% in March or 2023. The labor force participation rate in June was 62.3%, up from the pandemic trough of 60.2% in April of 2020. For June, average hourly earnings rose 3.7% over the past year, below the recent wage inflation numbers that were averaging greater than 5% for most of 2023. In short, the June number showed surprising resilience and likely took a July interest rate cut off the table.
Retail sales in May fell .9% from the prior month, surprising economists who had predicted a much lower .6% decrease. Monthly sales were particularly weak as consumers bought big ticket items in earlier months to front run future tariff price increases and savings rates have increased on general unease over where the economy is headed. Annualized retail sales were up 3.6% over the past year, compared to the consumer price index’s measure of inflation up 2.4%. Seven of the report’s 13 categories posted declines for the month, with motor vehicle sales and spending on building materials particularly weak in May. Consumer sentiment and consumer spending habits have grown more cautious as consumers are tightening their belts on concern for the impact of the global trade war on future prices paid. However, the latest retail sales report remains positive for many categories, despite all the pessimism. Gasoline station sales were down 4.2% from the prior year as energy prices fell, providing a boost to consumer discretionary spending on other items. Department store sales were down 2.8% from the prior year. Building materials and supplies were down .7%. E-commerce and mail-order houses ended the 12-month period with a 6.5% sales gain. Auto sales were up 5.1% from the prior year. Restaurant spending was up 4.7%, furniture store sales were up 6.8%, health care spending was up 6.5% and clothing and accessories were up 3.9%. With consumer spending two-thirds of our economy, we are seeing consumption growth still rising above inflation and income gains surpassing inflation levels. Consumers are saving more with all the trade concern. With wage growth up 4.7% over the prior year, real disposable income also up 1.7%, personal income up 4.5%, and the personal savings rate ballooning to 4.5%; the income side of the equation is helping to defray some of the inflationary and higher financing pressures that we all are now expecting to stay higher in 2025.
Equity markets have exhaled a huge sigh of relief as the Trump administration’s “shock and awe” tariff policy announced in April have been tabled to August as global trading partners negotiate less severe tariff levels. Trump always chickens out, known as the TACO trade, has been the story of 2025. Buy the dip investors have rallied equity markets in the US back to new market highs following resilient corporate earnings, a better-than-expected job growth print and unemployment numbers falling, and extension of corporate and individual tax rates in Trump’s “big beautiful bill”. While inflation is expected to be elevated, growth is expected to slow with the tariff policy, and tax legislation increases our national debt; corporate earnings still are growing at almost 10% for 2025 with the S&P 500 up 6.5% through July 9. Additionally, the weak US dollar is a tailwind to multinational corporate earnings as international earnings outside the US are benefitted by the weaker dollar. We see a somewhat range bound equity market as we all await news on the negotiated tariff rates and the market makes tactical changes to account for winners and losers in the “big beautiful bill”. If negotiated tariff rates don’t move lower as the market is pricing, equity markets could be set up for a major disappointment. Cuts to Medicaid and tariffs on imported drugs appear to be to the detriment of the health care sector. Renewable energy credits expiring was a major hit to the renewable energy market. Technology, financials, defense spending and the traditional energy sector are the winners in the new legislation. With muted US growth and dollar weakness, diversification into less richly priced international markets continues to deserve the attention. We continue to favor cyclical sectors over defensive stocks and advise the continued diversification into a larger international allocation.
Within the fixed income markets, interest rate, fed policy, and market traders see one to two more twenty-five basis point interest rate cuts in 2025. The Fed is indicating two 25 basis point cuts, despite some dissent from voting members for one cut. The issue is how much inflationary pressure will the trade war induce. With tariff deadlines walked back to August and tariff price increases not yet hitting consumers wallets; the Fed is still in a wait to see inflation materialize before lowering rates mode. As of July 9, 10-year investment grade corporate bond spreads to the treasury have tightened and are back to historically low levels. In short, the bond market isn’t remotely close to pricing a recession, despite expectations for slower GDP growth and higher inflation. Additionally, the Trump tax bill, which adds $3.3 trillion to the deficit over the next 10 years, puts pressure on interest rates remaining higher in the long run. The corporate bond market is still offering yields greater than 5% for maturities greater than 7 years. We remained strategic and active in the bond market in May when rates peaked. For reference, the 10-year treasury reached 4.6% in May and is now trading at 4.37% on July 9. We see rates relatively attractive at current levels. Despite some inflation worry towards the end of the year and inflation possibly rising from the current 2.5% level to 3%; the economy is holding up but is poised for much slower growth into the future. If the economy falters with tariff pressure and a cost weary consumer; the Fed has ample room to move rates lower from current restrictive Fed fund levels at 4.25%, to a level closer to the current 2.5% inflation rate.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.