2025 Q2 Market Commentary
Financial Market Performance
The U.S. stock market took investors on a roller coaster ride in the second quarter, with unpredictable trade policy
announcements and growing inflationary expectations creating a sharply volatile market environment. U.S. President Donald Trump proclaimed April 2nd “Liberation Day” and introduced a sweeping array of base and reciprocal tariffs on U.S. imports across all countries in an effort to transform perceived trade imbalances. The scale of changes in trade policy precipitated a volatility spike and an immediate plunge in the venerable S&P 500. Equity prices of multinational corporations with global supply chains were impacted the most, but investor panic was widespread, with negative sentiment pushing the index down over -13% in the five trading days following the declaration. The selloff from the February 19th peak approached bear market territory. On April 9th, Trump ordered a 90-day pause on the reciprocal tariffs for all countries except China and the S&P 500 surged +9.5% on the news. It was a jarring ride, but the S&P 500 climbed the proverbial wall of worry, finishing the quarter with a +10.9% performance and a new record high. The dominance of large cap growth stocks influenced the performance of the broader equity market, with the Russell 3000 up a similar +10.99%.
International developed and emerging market stocks led major asset categories with double digit returns. A confluence
of factors contributed to the outperformance, including inexpensive relative valuations, a weak U.S. dollar and a need to diversify domestic portfolios with a home bias. The prospect of accommodative monetary policies in both the U.S. and abroad supported modest performance from global real estate stocks. However, Federal Reserve Chairman Jerome Powell was consistent from last quarter in his messaging, subscribing to a “wait and see” approach to tariffs that left the Fed on hold with any rate reductions this quarter yet retaining a forecast of two rate cuts later this year based on the dot plot. This aligned with lower U.S. bond market volatility as measured by the ICE BofA MOVE Index and solid quarterly performance that was largely attributable to stable current yields on shorter duration bonds and narrower spreads on investment grade corporate bonds.
With elevated equity valuations and risk, portfolio diversification is crucial.
US Equities
Although U.S. equities sold off to begin Q2, the indexes found their footing within the first month of the
quarter and ultimately finished significantly higher with growth stocks and large caps enjoying most of the gains. Most fund managers are mandated to remain fully invested no matter the market conditions, which can promote some rotation within the U.S. equity style box. Q1 was clearly risk-off as fears of tariffs, higher interest rates, and higher inflation caused large cap value stocks to eke out a modest gain while most other sections of the style box experienced dramatic selloffs. Market participants were forced to use large value stocks as a safer haven to weather the storm. However, Q2 was solidly risk-on as trade fears were eventually quelled and Jerome Powell entertained talks of cutting the fed funds rate later this year. At the same time, the idea of lowering the supplementary leverage ratio would provide more liquidity to the treasury market and continue reducing regulation for the banking sector.1 These prospects lured tactical fund managers back into risk-on assets, namely growth stocks, with the largest and most liquid securities receiving the greatest price appreciation off the bottom.
At quarter end, Jerome Powell revealed that the Federal Reserve would have resumed the easing of monetary policy already if not for the tariff uncertainty caused by President Trump. 2 His tariff policy put the Federal Reserve into a holding pattern, yet many market participants still project three rate cuts by the end of 2025, slightly more aggressive than the Fed’s own dot plot projections. The more dovish forecasts places pressure on those holding large sums in money market funds, which hit a record $7 trillion in assets by the end of the quarter. 3 Lower yields could force flows into riskier asset classes as market participants demand returns on their sidelined cash. With stretched equity valuations, headline risk is showing no sign of slowing down and could be a persistent headwind throughout the rest of the year. A resurgence of tariff announcements, retail inflation or geopolitical risk could push elevated equity markets lower. A proper alignment of risk tolerance with model risk profiles is essential to playing the long game and achieving investment goals more than ever.
Fixed Income
The macroeconomic backdrop was a key driver of bond market activity. Trade policy uncertainty and growing recessionary fears spurred a selloff in risk assets and was a catalyst for a strong rally in shorter duration bond prices as investors sought a safe haven. Headline inflation lingered but generally trended lower. The Consumer Price Index for the month of June came in slightly higher than anticipated, with the annual rate nudging up to 2.7%, but core CPI that excludes food and energy prices increased less than expected. In the past five months, core prices are up at just a moderate 2.1% pace.4 Nonetheless, the potential inflationary impact of reciprocal tariffs kept the Federal Reserve in a holding pattern. The FOMC met twice during the quarter and took no action, maintaining the benchmark federal funds rate at 4.25% - 4.50%. The Bloomberg U.S. Aggregate Bond Index finished the first quarter with a +1.21% return and once again demonstrated the power of portfolio diversification.
Within the index, performance was led by spread product. Investment grade corporate bonds provided higher current yields and price appreciation that was reflective of tighter spreads, generating a 1.82% return. Securitized assets returned 1.18% and signified continued strength in consumer credit.5 The broad U.S. Treasury market registered a gain of 0.85% and the yield curve shifted as follows:
Higher yields per unit of duration and lower price sensitivity may be found in short bond maturities, but entail reinvestment risk. Municipal bonds remain a sector of choice for investors in high marginal tax brackets.
International Equities
International equities managed to shrug off the April 2nd Liberation Day tariff announcement and climb higher throughout the second quarter with developed and emerging markets outpacing the broad U.S. market. Both the MSCI World ex USA and the MSCI Emerging Markets indexes suffered a sharp decline following President Trump’s announcement, but a V-shaped recovery brought both benchmarks back into positive territory for the quarter before the end of April. The strong double-digit returns of roughly +12% for both developed and emerging markets brings the YTD performance to +18.99% and +15.27%, respectively per YCharts.
One theme that emerged last quarter centered around European defense expenditures and European defense stocks. Geopolitical threats and unease related to the war between Russia and Ukraine, as well as conflict in the Middle East, continues to be front of mind for leaders in Europe. Per an article from CNBC, countries in the NATO alliance reached an agreement in late June to increase defense spending from the current 2% of GDP ratio to a target of 5% over the next 10 years. The European defense sector, as proxied by the STOXX Europe Aerospace & Defense ETF (EUAD), had another strong quarter with returns of +28.69% contributing to the attractive +12.05% return of developed markets.6 Another theme that has continued through the first half of the year is that of a weakening U.S. dollar. The DXY fell another -7% during the second quarter, boosting international returns on a USD basis.7
Tariffs will continue to be a subject of influence as we move into the 3rd quarter and while there hasn’t been much bite from the tariff threats thus far, the newly appointed August 1st deadline and letters being sent by the president and his administration may cause another shakeup in markets. Even so, international equities remain attractive from a relative valuation standpoint. According to J.P. Morgan, broad international equities are trading at a -35% discount compared to the S&P 500, well below the average discount of just -18%. Active management may provide an advantage during this time of uncertainty as managers can look for companies with pricing power to pass through increased costs related to tariffs or find those that operate in areas unaffected by tariffs.
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Unless otherwise noted, data for charts and tables sourced from YCharts. 1Federal Reserve 2CNBC 3YCharts 4First Trust. 5Columbia Threadneedle. 6YCharts. 7YCharts. Market segment as follows: US Stock Market (Russell 3000 Index), International Developed Stocks (MSCI World ex USA Index), Emerging Markets (MSCI Emerging Markets Index), Global Real Estate (S&P Global REIT Index), US Bond Market (Bloomberg US Aggregate Bond Index), and Global Bond Market ex US (Bloomberg Global Aggregate ex-USD Bond Index). Quarterly commentary and investment advisory services are provided by Simplicity Wealth, LLC a SEC Registered Investment Adviser. The information contained within has been obtained from various sources and is believed to be accurate at the time of publication. This commentary cannot be redistributed or republished. The views expressed herein reflect the views of the author as of the date of publication. These views may change and should not be construed as investment advice. This material is for educational purposes only.
