Markets and Economy – Halftime Update

by Tim Doyle, Chief Investment Officer, CFP®, MBA

It was around 9:30 pm Eastern time back on February 9th, and my oldest son and I sat huddled together on our family room couch, staring at our television in gleeful bewilderment.  In bold red and green color at the bottom of our TV screen, the score of Super Bowl LIX inexplicably read “KC: 6  PHI: 40”.  With roughly five minutes left in the game, conventional wisdom would indicate that my Philadelphia Eagles were headed for their second Super Bowl trophy since 2017.  However, as a long-suffering (underline suffering) Philly area sports fan, I knew better.  I could plainly see that Chiefs quarterback, Patrick Mahomes, was on the verge of executing the greatest comeback in sports history, and the Eagles were primed to suffer a collapse for the ages.  I was sure to communicate this irrational pessimism to my son, thus ensuring that he’ll represent yet another generation of neurotic Philly sports fans.  The torch, as they say, had been passed.

When I look at stock market returns at the halfway point of 2025, I can’t help but think back to how I felt during the last few minutes of Super Bowl LIX.  Am I pleased?  Of course!  Am I content?  Well, that’s another thing entirely.  After all, when things are going well, there’s always that little voice in the back of my subconscious that whispers, “perhaps a little too well?”.  Since the S&P 500 index bottomed-out on April 8, 2025, we’ve seen the S&P 500 index surge a staggering +26.4% as-of this writing, as seen in the chart below.

This surge is reminiscent of the stock market’s historic ascent in mid-March of 2020 as the U.S. economy was boosted by unprecedented fiscal and monetary stimulus due to the COVID-19 pandemic.  While the market’s rebound is certainly a welcome outcome here in 2025, investors are left wondering if this trajectory is sustainable.  So, in this month’s letter, we’ll conduct a ‘Halftime Update’ of sorts, and we’ll highlight what has driven markets to-date along with what investors should be paying attention to as we navigate the second half of 2025.

U.S. Trade Policy – A Seismic Shift

Perhaps the greatest source of economic uncertainty thus far in 2025 has been the changes to U.S. global trade policy – namely, the broad use of tariffs as both an economic and foreign policy tool.  Many economists and investors were stunned when the United States abandoned the U.S.-Mexico-Canada Agreement (USMCA) and implemented steep new tariffs on its two top trade partners – Mexico and Canada.  According to executive orders from the Trump administration, these new tariffs were enacted in order to influence immigration policy on the northern and southern borders of the United States while also impacting the trafficking of fentanyl and other illicit drugs into America.

The Trump administration then hosted its “Liberation Day” event on April 2nd to announce significant ‘reciprocal’ tariffs on goods imported from nearly all U.S. trade partners across the globe.  This news was not met with optimism by investors, and the S&P 500 index subsequently declined -12% in the five trading days between April 2nd and April 8th.

Perhaps even more concerning was the sharp rise in the 10-Year U.S. Treasury rate which ascended nearly 0.50% in roughly a week, thus sounding alarm bells across bond markets.  Finally, on April 9th, the Trump administration relented and announced a pause on most newly-announced tariffs, while steep tariffs remained intact between the U.S. and its top three trade partners – Mexico, Canada and China.

The chart below helps to give investors a sense of the magnitude of the recent changes to U.S. trade policy.  The orange bar represents the average tariff rate as of April 8th – just prior to the ‘pause’ that was subsequently announced.  Meanwhile, the blue line represents the current average tariff rate as-of the end June.

Source:  JP Morgan Guide to the Markets

As you can see, the average tariff rate resulting from the Liberation Day announcement (orange bar) would have represented the highest average tariff rate in over 125 years.  As things stand now, the average tariff rate still remains historically high at 15%, which rivals levels last seen since the 1930’s when the Smoot-Hawley Tariff Act was enacted.

As I’ve written previously, the global economy is like an intricate Rube Goldberg machine, and implementing tariffs is like tipping over the first domino to set the process in motion.  Once tariffs are enacted, it can be difficult to anticipate how disparate elements of the global economy might be impacted further down the line.  For investors, the bottom line is that a tremendous amount of uncertainty still remains when considering the path ahead for U.S. trade policy, and this is something we will all have to wrestle with for the remainder of 2025, and perhaps longer.

The Big Beautiful Bill

Typically, the significant trade policy changes outlined above would be more than enough for investors to digest in a single year. Yet, investors now must gauge the investment implications of a hugely consequential piece of legislation – the Trump Administration’s One Big Beautiful Tax Bill. 

Tax cuts are considered ‘fiscal stimulus’ and are intended to boost economic growth by putting more spending dollars in the pockets of individuals and corporations.  The expectation of tax cuts, which were officially signed into law on July 4th, spurred investor optimism.  This optimism subsequently influenced the surge that the stock market has experienced since mid April as investors started to price-in the positive benefits of tax cuts – particularly the corporate tax cuts which have the potential to boost bottom lines.

The chart below helps to outline some of the bill’s other key features around deductions, credits, State and Local Tax (SALT) deductions, tip and overtime pay, and more.

Souce: CNBC

Yes, this tax bill has likely influenced the stock market bounce investors have seen over the past few months, and that’s a positive thing for investors.  However, at Destiny Capital, we tend to take the ‘long view’ as it relates to this bill’s impact on the U.S. economy.  If you’ve read any of our investor letters or watched our markets & economy webinars, you’ll know how often we state that the U.S. government has a budget problem.  This tax bill does nothing to address this problem and, based on estimates, it is likely to exacerbate this issue over time by adding considerably to the federal deficit.

According to the Congressional Budget Office, the Yale Budget Lab, and the Penn Wharton Budget Model, this newly signed tax bill is anticipated to add between $3.0 to $3.4 trillion to the federal deficit between 2025 and 2034.  Below is a bit of a bullet-point outline of how consistent deficits can harm the fiscal health of the U.S. over time.

• When individual and corporate taxes are cut, the Federal government reduces its primary source of revenue.
• Without equivalent cuts to spending, deficits will likely continue to increase because the U.S. government will have expenses that exceed revenues.
• To cover this budget shortfall, the federal government must borrow by issuing U.S. Treasury securities which are purchased by central banks, pension funds, endowments, retail investors, and more.
• The U.S. budget forecasted a $1.865 trillion deficit for fiscal year 2025.  That deficit is expected to rise to well over $2 trillion in the years to come.
• This debt accumulates over time, and the total U.S. public debt is currently approaching $37 trillion.  To give you some context, the U.S. public debt was roughly $20 trillion in 2017.
• The U.S. must pay interest on this debt to investors.  With interest rates elevated, this means that the cost of servicing this debt is elevated. 
• The Net Interest Expense (interest paid to U.S. Treasury bond holders) is $952bn in fiscal year 2025.  This represents 14% of the total federal budget.  As a point of reference, Medicare represents 16% of all federal spending, so the net interest expense will soon be the largest budget line item only behind social security.
• The One Big Beautiful Tax Bill includes a $5 trillion increase in the debt ceiling, so this pattern of spending and borrowing is expected to continue for the foreseeable future.

As you can likely glean from the summary above, the current path of constant deficit spending is likely untenable over the long-run.  However, it’s nearly impossible to say when this government spending problem may start to impact investors.  Japan, for example, has been operating with government debt that is over 200% of Gross Domestic Product (GDP) for decades.  As we’ve said many times, this is a solvable problem, and it doesn’t necessarily preclude a catastrophe for the U.S economy.  Regardless of which party is in power in the United States, we view the financial security of the largest economy in the world as an important focus for investors, so we’ll continue to provide updates on this important topic over time.

International Stocks – Is It Their Time to Shine?

One outcome that most analysts and investors didn’t have on their ‘BINGO card’ heading into 2025 was the fact that global stocks have significantly outperformed U.S. stocks on a year-to-date basis.  For example, as-of the end of June, the MSCI All Country World Index Ex-U.S.A Index has outperformed the S&P 500 index by +12.4%.  Getting a bit more regional and granular, Eurozone stocks have outperformed U.S. stocks by a hefty +19.1%. 

For roughly fifteen years, U.S. stocks have absolutely dominated their international and emerging market counterparts.  Is the era of American stock market exceptionalism over, as some are beginning to claim?  Not so fast.  We must consider the underlying source of these returns in order to gauge whether or not this international rally has legs.  To do this, we’ll look at total returns in the aforementioned Eurozone, which is highlighted in red in the chart below. 

Source:  JP Morgan Asset Management – Guide to the Markets

As you can see, total returns for Eurozone equities have been largely impacted by currency tailwinds due to the 10% decline in the U.S. dollar in 2025.  When the dollar falls relative to a currency like the Euro, this provides a boost to Euro-denominated stocks due to what’s referred to as a ‘currency translation benefit’.  European stocks also pay relatively strong dividends, so it’s not a surprise to see dividends contributing roughly 2.5% to 3% to total returns.  Finally, according to the grey bar in the chart above,returns have been significantly boosted through ‘multiples’ or ‘multiple expansion’ which simply indicates that investors have been willing to pay more and more for each dollar of corporate earnings.  In short, this multiple expansion indicates that Eurozone stocks have gotten more expensive, but are these higher prices justified?

What’s missing from the Eurozone return breakdown in the chart above?  Earnings.  Earnings growth is THE key driver of shareholder value over time, and the lack of earnings as a contributor to Eurozone returns is alarming.  Typically, we’ll see multiple expansion occur due to strong earnings.  In that case, the investor optimism and higher prices are based on fundamentals and, therefore, may be justified.  In the case of Eurozone stocks, we are not seeing the earnings (yet) to justify higher valuations, so we view this surge in international stocks with some caution.  In our view, the American economy and U.S. stocks remain the most compelling opportunity for investors, and we believe that this brief international surge does not necessarily represent the beginning of a long-term trend.

Inflation & The Fed

Over the past two years, both inflation and Fed policy were the key drivers of stock market returns.  In the summer of 2022, inflation peaked over 9%, and caused the Fed to significantly raise interest rates in an attempt to pump the brakes on the U.S. economy.  Yet, here we are in 2025, and inflation continues to slowly descend closer to the Fed’s 2% target as you can see in the chart below.  Meanwhile, the Fed has lowered interest rates by 1.00% over the past year, and the effective funds rate has fallen from 5.3% to 4.3% today.

Are inflation worries a thing of the past?  That remains to be seen, as inflation could largely be influenced by U.S. trade policy in the months and years ahead.  When foreign imports are subjected to tariffs, these tariffs are paid by U.S. companies like WalMart, Home Depot, IKEA, Target, Lowes, and many others.  Ultimately, tariffs make these goods more expensive. 

Therefore, assuming these importers can’t source goods elsewhere, companies like WalMart have two options.  They can simply ‘eat’ these higher costs, which will reduce profitability – or – they can pass these added costs on to consumers in the form of higher prices.  As we all know, corporations do not like to report lower profits during quarterly earnings calls.  Therefore, it is likely that higher prices will be passed-on to consumers.  Over time, the new wide-ranging tariffs may increase aggregate prices which, in turn, could cause inflation to move higher.  This is something the Federal Reserve is watching closely.

The Fed is currently under pressure from the Trump administration to lower interest rates, but the Federal Open Market Committee (FOMC) is hesitant to do so at this time.  The FOMC is closely watching price data to see if and how tariffs are affecting aggregate prices.   The next few PCE and CPI inflation reports will be crucial.  Thus far, inflation has largely remained in-check, but tariffs have only been in place for a few months.  For now, I expect the Fed to remain very conservative and exude patience as they navigate policy decisions over the second half of the year.  Investors are forecasting two 0.25% rate cuts between now and year-end, with the first expected to occur after the Fed’s September meeting.

Geopolitical Conflict

I’d be remiss if I didn’t mention geopolitical conflict as a potential risk for investors as we move into the second half of 2025.  In fact, I’ve been quite surprised at how markets have largely shrugged-off the escalation in conflict between Israel and Iran, which has included direct participation by U.S. forces which launched attacks on Iranian nuclear development sites.  When news of this bombing emerged on Sunday, June 22nd, I was anticipating that the S&P 500 might open sharply lower from Friday’s closing prices.  That volatility didn’t emerge and, surprisingly, the stock market continued its ascent to new highs.  This reaction, or lack thereof,  helps to support Destiny Capital’s thesis that you simply can’t ‘time the markets’ or anticipate how investors might react to headline news.

Moving forward, investors remain concerned about regional spillover both in the middle east and in the conflict between Russia and Ukraine.

Asset Class Returns & Corporate Earnings

We’ll close this month’s letter on a positive note as we review asset class returns and some brief earnings data.  As we all know by now, financial market returns do not always follow a linear path, and market activity throughout 2025 has not been for the faint of heart.  Back in December of 2024, if I had told investment managers that they’d be looking at a +6% return for the S&P 500 at mid-year, I think most would’ve signed up for that in half-a-heartbeat. 

Yet, when you look at the chart below, you can plainly see that this year hasn’t been without its challenges.

Still, nearly all major indexes enter July in positive territory with only perpetually suffering small caps (Russell 2000 Index) slightly in negative territory.  I would also like to highlight the U.S. Aggregate Bond Index, which is represented by the fucshia line in the chart below.  As you can see, bonds were the one asset class that remained extremely resilient and did not dip into negative territory when markets sold-off between March and early April.  As an asset class, served two key purposes by producing strong, reliable income for investors while also providing portfolios with ballast during times of elevated volatility. 

When considering corporate earnings thus far in 2025, Q1 blended earnings growth for the S&P 500 index was 13.6%, well above consensus estimates of 7.3%.  This represented the second consecutive quarter of double digit earnings growth.  Not only is earnings growth strong, but profit margins for U.S. equities remain elevated and at all time highs, as you can see in the chart below with the U.S. represented by the green line.

Among other things, high profit margins are an indicator of the strong financial health of a corporation and their ability to generate revenues while keeping expenses in check.  As you can see in the chart above, the U.S. remains the world leader in this regard, which helps to support our thesis that, over the long run, U.S. stocks provide investors with the best opportunity to generate strong public market returns relative to their global counterparts.

It’s also important to note that, since the bear market in 2022, investors have experienced over two consecutive years of very strong returns in 2023 and 2024.   Like me watching my Philadelphia Eagles build a 34 point lead in the Super Bowl, this may lead investors to grow pessimistic and begin to question whether a catastrophic collapse is imminent. 

To address this, I’ll close with one final chart that details the length and severity of seven bear and subsequent bull markets since 1973.  As you can see below, the average bear market lasts 14 months with an average loss of -38%, whereas the subsequent bull markets average 70 months in duration with a 221% return.

Source:  JP Morgan Asset Management Guide to the Markets

We are roughly 30 months into the latest bull market which, according to historical averages, at least, would indicate that there could be more room for this bull to run.  We are also in the early stages of a period of innovation (Artificial Intelligence) which has the potential to be the most impactful since the introduction of the personal computer or the advent of the internet.  For investors, opportunities abound, and the second half of this year promises to be just as exciting and heartburn-inducing as the first six months of 2025.

Important note and disclosure: This article is intended to be informational in nature; it should not be used as the basis for investment decisions. You should seek the advice of an investment professional who understands your particular situation before making any decisions. Investments are subject to risks, including loss of principal. Past returns are not indicative of future results.  Advisory services offered through Destiny Capital Corporation, an Investment Adviser registered with the U.S. Securities & Exchange Commission.

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