Global Market Review and Outlook

Total Returns
Source: Factset, William Blair LLC

Market action in the second quarter was a lesson in the rules of long-term investing. Appropriate asset mix and time horizon enables investors to tolerate the unexpected twists and turns of the market to reap the rewards of the long-term upward trend.

The second quarter of 2025 stands out as one of the most eventful and extraordinary quarters of all time. In just three months, the market experienced fears of a global trade war with the “Liberation Day” tariffs, Moody’s downgrading of American debt from AAA to Aa1 (the final agency to do so), the breakout of a war between Israel and Iran, and the bombing of Iranian nuclear enrichment sites by the U.S. military.

Against that backdrop, it is not surprising that early in the quarter market volatility hit the third-highest reading of the past 35 years (below only the readings experienced at the onset of COVID and during the Great Financial Crisis), and stocks suffered a harsh downturn with the S&P 500 dropping 19% from the February highs to the April 8 low. What is surprising is that after a doozy of a beginning to the quarter, the S&P 500 finished the period up 11%, reversing the negative return of the first quarter to bring the S&P to hit all-time highs at the end of June with a positive 6% return year-to-date.

In the U.S., market breadth broadened out beyond the Magnificent 7 with impressive returns from industrial and financial companies, but smaller companies continue to face headwinds from high interest rates and a tight labor market. For the first time in many years, international and emerging equities are outperforming U.S. equities with a benefit from a weaker dollar but also the prospect of increased local government spending on defense and impetus to be more economically independent. Time will tell if that trend is sustainable. While U.S. fixed-income markets were also volatile, reacting to worries over liquidity and tariff-induced inflation, U.S. bonds remained a relative safe haven and ended the quarter up modestly. Despite concerns about the size and growth trajectory of the U.S. deficit, the 10-year Treasury declined to end the quarter at 4.2% from 4.6% at the end of 2024.

While headlines on policy shifts and geopolitical concerns whipsawed markets seemingly daily, the rollercoaster ultimately proved to be a rewarding ride for those patient enough to stay the course. U.S. stocks bounced back strongly as the president announced a 90-day pause on tariff deadlines, signaling that ultimate negotiated rates would be much lower than what was proposed. Congress then got to work ironing out the One Big Beautiful Bill (OBBB), which brought with it the promise of the extension of low tax rates from the Tax Cuts and Jobs Act, and other business- and consumer-friendly perks. Over the course of the quarter, investors and corporate executives seem to have gotten used to the daily headlines and instability and found comfort that there was a line that would not be crossed.

With most country tariff rates still in flux (only five have been announced—U.K., China, Vietnam, Indonesia, and Japan), companies have largely been in a wait-and-see mode from both a planning and hiring perspective, and the uncertainty has caused the lowering of corporate earnings expectations for the year. However, initial fears of a tariff-induced inflation spike have been quelled by in-line consumer price index readings the past few months. In addition, overall expectations for tariff rates and the ultimate impact have moderated significantly since April. With most tariffs set to go into effect August 1, there remains concern that inflation will rise in the second half of the year. That concern has kept the Federal Reserve on the sidelines from lowering interest rates, much to the chagrin of the president, who has been vocal that he believes the Fed should be more stimulative in the face of slowing growth.

Tariffs are expected to increase input costs for manufacturers and retailers, reducing corporate margins and passing higher prices to consumers, which could dampen demand. Consumer spending, which accounts for nearly 70% of U.S. GDP, may weaken in the face of tariff-driven price increases on imported goods like electronics, clothing, and autos. The housing market, already strained by elevated mortgage rates (30-year fixed at 6.8%), faces further challenges from declining affordability and reduced construction activity. Fortunately, despite these headwinds, the economy is broadly on good footing. Employment is solid with minor signs of weakening, and corporate and consumer balance sheets are both in good shape. While we see GDP slowing to 1.5%-2% for 2025, a near-term recession is unlikely barring an exogenous shock.

Moderating economic growth is a natural part of the economic cycle. Typically, lower demand eases inflation. If inflation moves closer to the 2% target (latest reading 2.7%), the Federal Reserve has more flexibility to lower interest rates, which will stimulate both consumer spending and business investment. In addition, as tariffs push companies to search for efficiencies, a rebound in productivity—potentially driven by advances in artificial intelligence, increased business investment, and ongoing digital transformation—could further boost output and corporate profitability. Lastly, should global trade tensions ease or new trade agreements be reached, lower tariffs could enhance export competitiveness and reduce input costs for U.S. firms, supporting broader economic momentum.

Slowing growth coupled with valuations near cycle highs (22x price/earnings) may suggest a more modest return profile for U.S. equities for the second half of 2025. S&P 500 earnings growth is pegged at a respectable 9%, supported by AI-driven productivity and a weaker dollar boosting multinational profits. However, tariff-related cost pressures, particularly for firms exposed to global supply chains, and high valuations pose risks, potentially capping upside. Conversely, small- and midcap equities, which are less expensive than their larger brethren and poised to benefit from deregulation and AI-driven innovation, continue to look attractive on a relative basis.

International equities are presenting opportunities, particularly in Europe, where economies may benefit from stimulus efforts and investment. While we still believe these countries are structurally disadvantaged compared with their U.S. counterparts, lower valuations and higher dividend profiles of international companies offer a reasonable risk/reward profile in the current environment.

Bonds are integral to balanced portfolios and provide income and stability, enabling investors to better tolerate the ups and downs of the market. Municipal bonds remain compelling because of their attractive yields and tax advantages, and investment-grade corporates offer value, but tight spreads warrant caution. Over a longer period, the size and trajectory of the U.S. deficit may elicit concern and elevate yields. We are watching this closely.

Last, we would be remiss not to highlight the recently passed OBBB. At nearly 900 pages, this sweeping legislation touches nearly every corner of the U.S. economy. We highlight below a few elements that are most relevant to our clients.

1. The lifetime estate tax exemption has been made permanent and is increased to $15 million per individual, or $30 million for married couples, starting in 2026, and will be indexed to inflation. This is a step up from the current lifetime exemption of $13.99 million per person.
2. Individual income tax rates from the 2017 Tax Cuts and Jobs Act are made permanent, with the top marginal income tax rate remaining 37%.
3. Beginning this year, the State and Local Tax (SALT) deduction increases from $10,000 to $40,000, offering benefits to those residing in high-tax states. The cap increases by 1% though 2029. However, the deductions phase down to $10,000 at higher income levels ($500,000-$600,000), and the increased deduction runs through only 2029. In 2030 it reverts to $10,000.
4. From a charitable perspective, starting in 2026 itemized filers will be able to claim a tax deduction only to the extent their qualified contributions exceed 0.5% of their adjusted gross income. In addition, the tax benefit of itemized deductions will be capped at 35% for those in the 37% bracket. If you are thinking about a large charitable contribution and are a high earner, it may make sense to accelerate your gift to this year rather than wait until 2026. In the future, making larger gifts with less frequency may be more effective under the new rule.

This year has already delivered its fair share of surprises. While U.S. and global markets faced significant policy-driven volatility, the recovery in equities and stabilization in fixed-income markets underscore the value of a disciplined investment approach. Our core message remains to stay committed and focused on your long-term goals. Volatility can be unsettling, but it also creates opportunities.

Thank you for your continued trust. We wish you a wonderful summer!