Insights

Quarterly Commentary

2Q 2025

The second quarter was extraordinary. US stocks had already declined 9% from their mid-February highs before the April 2^nd Liberation Day tariff announcements shocked and confused businesses and investors alike. Stock indexes plunged, falling 10% in just two days. Views on the probability of a recession quickly shifted from possible to likely.

Stocks began their recovery the next week when the president delayed implementation of the punitive duties, leaving in place 10% tariffs on nearly all imports (most notable exception: a 30% rate on goods from China). The three-month delay was meant to allow time to negotiate agreements with America’s trading partners.

Some observers thought the president might quit at 10% and call it a win. The US government collected an estimated $30 billion in the month of June, three times what was brought in a few months earlier.

Events elsewhere briefly diverted attention from the tariff drama. Oil momentarily gained 5% and stocks fell 1% in reaction to Israel’s attack on Iran June 13^th, a muted reaction compared to market responses to similar events in the past. That day aside, US indexes saw no big drawdowns from April 22^nd through the end of the quarter.

On June 27^th, the S&P 500 registered a new closing high, completing the fastest recovery from a 15+% (close-to-close) or a 20% (intraday) decline in modern stock market history.  

How can we explain the turnaround?

1. 1. The current tariff regime hasn’t yet had a visible drag on the US economy, nor has inflation been pushed meaningfully higher.
2. 2. Optimists believe the best is yet to come for Trump’s policies – deregulation and lower taxes could stimulate the economy in the second half of the year.
3. 3. The broadening use of AI and other new technology is a tide lifting many stocks that matters more to many investors than the risk of an economic setback, whatever the cause.
4. 4. Many of those who sold stocks in early April were slow to realize they were missing out on a rally of historic proportions. Their buy orders on the way back up were met with a limited supply of sellers, which naturally resulted in higher prices.

These and no doubt other factors combined to create a bullish narrative - evident today with the benefit of hindsight. Markets have their own internal rhythms that can propel them in surprising ways. This past quarter provides yet another lesson why investing is best practiced over a long time horizon and why our opinions and expectations must be held lightly.

Foreign stocks kept pace with US markets in the second quarter, even after surging in the first three months of the year. US small caps were the only major category of stocks in the red as of June 30^th. Oil and natural gas tumbled in the second quarter as Saudi oil and US gas production more than met demand, despite the jitters over conflict in the Middle East.

Looking ahead

The demand for stocks indicates that investors are betting that the economy will remain resilient. They expect that consumers will continue to spend and that businesses will maintain their profit margins. The consensus view is that inflation may temporarily jump, but will remain contained, enabling the Fed to cut rates by at least 0.5% at some point this year.

With the arrival of the three-month negotiation deadline on July 9^th and only a few deals reached, the president chose to threaten Japan and South Korea with 25% tariffs to be implemented August 1^st. We really don’t know how this might turn out, nor do the countless businesses in the US and abroad that engage in international trade.

Higher tariffs will lead to higher prices. Some businesses stockpiled products in advance, allowing them to maintain prices for a while. Many retailers have been reluctant to raise prices, opting to wait for more clarity on policy and the associated repercussions. It’s a matter of wait-and-see for nearly all businesses and consumers, as it is for the Federal Reserve, which is holding back on further interest rate cuts until it has a better handle on how tariffs and other government policies are affecting inflation and economic growth. If the impacts are benign, the Fed will have more flexibility to resume cutting rates, which should be supportive of stocks and bonds alike.

The Fed’s cautious stance has earned the ire of Mr. Trump. Powell’s term ends next May. Should Trump take steps to remove Powell from his post early, market reactions would likely be negative. Central bank independence is critical to maintaining trust in America’s finances.

Federal deficit

The recent budget debate surfaced concerns over the widening federal spending deficit. The federal government is now spending 7% more than it takes in, despite an economy that is running at close to full speed. A 3% shortfall was the norm just a few years ago.

The deficit has been a concern for many years – we hesitate to even bring it up. Today our government has increased its borrowing even as it is paying higher interest rates. Absent a willingness to cut spending and raise taxes, there will be more spent on interest and less spent on everything else. Similarly, federal borrowing now constitutes 60% of the US bond market. At some point, this may start to “crowd out” other borrowers, including businesses, state and local governments, and consumers, who will have to pay higher rates to borrow – not a good thing for the economy.

It is important to note that tariffs are a form of corporate taxation. Should they remain in place for years, the US government will likely collect hundreds of billions or even trillions of dollars (offset by declines in other tax receipts).

There is no doubt that the overall direction is perilous, and each day’s drama means the can has been kicked a little further down the road.

Strategy

It appears that the course of the president’s tariff negotiations will have an outsized influence on financial markets over the rest of the year. Will today’s uncertainties be resolved so that businesses can plan, hire, produce and invest with confidence? We’ve seen enough to know that we don’t really know. That leaves us hoping for the best while preparing for more turbulence. This is not a time to be lulled into complacency.