Second Half of 2025 Outlook: A Market Balancing Act After an Eventful Start

The first half of 2025 delivered no shortage of volatility, testing investor resolve while ultimately rewarding investors who maintained composure and stayed in the market. 

The equity market drawdown that bottomed in April — nearly breaching bear market territory with a peak-to-trough decline of over 19% — was triggered by the Trump administration’s announcement of reciprocal tariffs. Markets also endured the sustained geopolitical friction in Eastern Europe and weathered a re-escalation of Middle East tensions and military actions. The global policy backdrop, once again unsettled, challenged assumptions around inflation persistence, supply chain resilience and earnings durability.

And yet, just as sentiment appeared to be unraveling, markets staged a notable reversal. The S&P 500 rallied sharply into midyear, finishing June up 6.2% year to date, lifted by better-than-expected inflation and employment data, as well as increased policy clarity from Washington. Treasury yields stabilized, credit spreads narrowed, volatility moderated, and many of the worst-case scenarios embedded in asset prices proved too dire. 

Still, the rally has left investors facing a familiar puzzle: How much optimism is already priced in, and what risks remain underappreciated?

A Shift in Policy — and Its Market Implications

The centerpiece of the policy landscape heading into the second half of the year is the passage of the “One Big Beautiful Bill” (OBBB), which was signed into law on July 4, the president’s deadline. While the political theater surrounding the bill’s path was no small contributor to earlier market volatility, its final form delivered more continuity than upheaval. Most notably, the OBBB makes the individual tax cuts enacted in the 2017 Tax Cuts and Jobs Act (TCJA) permanent, thereby avoiding what would have amounted to a large, broad-based tax hike on businesses and consumers starting in 2026.

Corporate provisions, including extensions to bonus depreciation and R&D incentives, could bolster investment spending, particularly among capital-intensive industries. In that sense, the bill may modestly support earnings growth over the next 12 to 18 months. However, markets will also have to reckon with its longer-term implications: The legislation lifts the debt ceiling to $40 trillion and raises questions about upward pressure on yields as fiscal borrowing accelerates.

The net impact of the bill is still to be determined, but at a minimum, it removes a significant source of uncertainty. As a result, financial conditions have eased, and investor focus has pivoted toward the traditional levers of growth and valuation.

Markets: Caught Between Momentum and Maturity

Equity markets enter the third quarter on strong footing but also on stretched valuations. The S&P 500 is trading at 22.3 times forward earnings — well above historical averages — while optimism has returned in force, particularly around the technology and communication services sectors. Despite the continued rally, late-June market activity flashed overbought signals, particularly if earnings or macro data disappoint. There’s plenty of potential for the equity market to finish higher this year, but we doubt it will be a straight line.

So which tailwinds remain? Corporate earnings in the second quarter are expected to show modest year-over-year growth, and while some compression in margins is likely, especially in the consumer-facing sectors with sensitivity to imports, many large-cap companies continue to benefit from productivity gains and pricing power, even with pressure on input costs from pending tariffs. The breadth of the market remains narrow, with outsize contributions from mega-cap names in AI and software, which have staged a rally of over 30% from the bottom in April. However, a gradual broadening could occur if the economic backdrop continues to stabilize.

Earlier in the year and relative to international markets, U.S. equities underperformed, but since market lows in early April, the gap is narrowing, with the U.S. outperforming developed markets. Trade tensions and geopolitical instability remain key risks abroad, particularly in Europe and parts of Asia. Emerging markets could benefit from the current level of the dollar, but that tailwind has moderated. The U.S. dollar, after declining meaningfully through the second quarter, appears to have found a near-term floor, supported by relative growth differentials and the Federal Reserve’s cautious posture. After all, the U.S. continues to have one of the highest 10-year yields across the developed world. 

Inflation, Labor Markets and the Fed: Policy Patience in Focus

On the macro front, inflation remains a central focus. The disinflationary trend has continued, albeit unevenly, with the May consumer price index and producer price index both surprising to the downside. Yet supply chain disruptions and tariff-related pass-through effects have reintroduced upside risk. Our base case calls for inflation to end the year between 3% and 3.75%, slightly above the Fed’s comfort zone.

The labor market remains resilient on the surface, but signs of softening are beginning to emerge. June’s unemployment rate fell, but underlying data — such as reduced federal workforce participation and weaker private hiring intentions — suggests some cooling. While this is not yet cause for concern, it does reduce the urgency for further rate hikes.

Accordingly, the Fed has adopted a holding pattern. The July 30 meeting is expected to leave rates unchanged, as policymakers evaluate the full impact of tariffs and fiscal policy. Markets are pricing in the potential for one or two rate cuts before year-end, but the bar remains high. Any cut will require either a material deterioration in the labor market or a sustained drop in inflation closer to the target.

Looking Ahead: A Constructive but Unsettled Path

The outlook for the second half of 2025 remains constructive but still very unpredictable. Investors must navigate a landscape defined by sharp reversals — both in price and policy — and maintain flexibility in positioning. The supportive forces of continued easing  financial conditions, fiscal stimulus and still-decent earnings must be weighed against valuation risk, uncertain global trade policy and the potential for inflation to reassert itself.

For diversified portfolios, U.S. equities — particularly high-quality large caps with pricing power and balance sheet strength — remain a core allocation. Fixed income, bolstered by attractive yields and modest credit risk, offers ballast. International exposure, despite its significant first-quarter 2025 outperformance, still requires more selectivity given uneven macro conditions and currency volatility.

Above all, while many of the early-year fears have not materialized, new questions are emerging. The path forward may not be as smooth as the recovery from April’s lows, but neither is it likely to be as treacherous. As always, those who stay focused on fundamentals, policy context and long-term goals will be best equipped to weather what comes next.