The S&P 500 recovered 25% since President Trump’s social media post, “It is a great time to buy!” on April 9, 2025.
Anxiety about government policy has dissipated, and markets have recovered strongly over the last two months. Despite uncertainty surrounding tariffs, which has cooled economic growth in recent months, as reflected in weaker GDP growth in the first half of 2025 and a modestly rising unemployment rate, markets have shown resilience. We are comforted that the slowdown has been mild, with real GDP growth rebounding to a 2.6% annual rate in the second quarter as estimated by Atlanta Fed’s GDPNow after a trade-induced -0.5% slump in the first quarter.
Still, the 1.1% average over the first half is well short of the relatively stable 2.8% growth rate enjoyed in the previous ten quarters. Early in 2025, weather and fires may have contributed to a decline in first-quarter numbers. In Q2, the decrease in immigration and the imposition of tariffs are likely equally to blame for the business and consumer caution. Some drag from these policies was always anticipated and will be offset by stimulus from new and sustained tax cuts, as well as the positive effects of deregulation. Unfortunately, the one big, beautiful bill does not include the 15% corporate tax rate that many had hoped for, and fresh stimulus is limited, though front-loaded, with a larger deficit expected again in 2026.
- A Volatile Summer?
- One Big Beautiful Bill
- The Impact of the NATO Summit
- Upcoming Earnings Seasons
- Balancing Bond Duration
- U.S. Dollar Weakness
- The Next Fed Chairman
- Our Portfolio Positioning
A Volatile Summer?
While our constructive view on stocks has continued to play out, investors should also be prepared for a corrective phase. With the S&P 500 up nearly 25% in under two months, the market appears ripe for a setback. While it’s difficult to pinpoint the exact catalyst for a potential pullback, we see three plausible triggers:
- The 90-day tariff pause deadline, which expires on July 9, may spark renewed market anxiety if no substantial trade deals are reached.
- A rebound in bond yields could disrupt the current equity rally and weigh on valuations. Although so far, the bond market reaction to Trump’s Big Beautiful Bill has been muted.
- And while we don’t expect a recession anytime soon, we may experience a soft economic patch, which could result in earnings growth falling short of expectations.
Any of these developments could lead to a temporary setback for stocks, but none are likely to inflict lasting damage on the broader market. At the same time, the “Trump Put” remains in play, with many of his tariff threats increasingly viewed as negotiation tactics rather than firm policy. Over time, financial markets may become more desensitized to his rhetoric, especially as repeated threats lose credibility. Meanwhile, with falling core inflation, any spike in bond yields will likely be temporary. While a softer economy could pressure earnings expectations, slowing growth tends to push bond yields lower, providing support for equities.
One Big Beautiful Bill
The approval of President Trump’s key budget bill will extend many tax cuts and will add additional fiscal stimulus by further expanding the budget deficit in 2026. Although the bill includes many spending cuts over the next 10 years, they are mostly backloaded. This means that the spending happens now, while the cuts will only happen in 5 to 10 years. In short, the cuts are the next administration’s problem.
On the positive side, federal duty receipts have surged. At an average tariff rate of 10%, tariff revenues could reach $360 billion a year, compared with total corporate income tax receipts of $500 billion. This is one of the reasons why the bond market did not riot after the budget bill passed.
The Impact of the NATO Summit
At the June 25th NATO Summit in The Hague, member states agreed to increase defense spending to 5% of GDP, up from the current 2%. 3.5% of the 5% is allocated for military spending, and 1.5% is reserved for additional investments in infrastructure.
This is a significant development for the European economy, as most of NATO’s 32 members are European countries. To meet their commitment, most countries will need to borrow to fund the additional spending. This is actually a positive for Europe, as European households are saving too much, and now governments will spend more. This is large scale fiscal stimulus that will give a significant boost to the European economy. Also, investments in the military complex often lead to positive side effects for the economy in terms of innovation that spills over to the civilian sector.
Upcoming Earnings Season
In the coming weeks companies will start reporting second quarter earnings, which we think will again be solid despite the tariff-related turmoil in Q2. Expectations have been lowered materially over the last 3 months and companies have a low bar to beat this quarter.
Heading into the second half of the year, several factors could support a move to new highs in equities.
A weaker U.S. dollar may boost earnings. Earnings per share (EPS) tend to rise 2 to 3 quarters after the dollar begins to weaken. This implies that a dollar-induced rebound in corporate earnings could begin to materialize in the second half of the year.
Lower oil prices will ease energy costs. This is the first time oil production has continued to grow despite a substantial decline in WTI prices. Gasoline prices have dropped 11% year-over-year and nearly 40% from their 2022 peak. Lower gas prices will provide relief to households and help sustain consumer spending. But lower energy costs will also support corporate earnings.
Looking beyond the current business cycle, we see scope for non-U.S. stocks to outperform over the remainder of the decade. Non-U.S. stocks trade at a fairly large discount to the U.S. stock market based on price-to-earnings and price-to-book. European equities, in particular, should see stronger returns in the years ahead. European banks are in much better shape than they were a decade ago, which should support stocks and the broader economy. Efforts to hasten economic integration and adopt pro-market reforms should also benefit European equities. Although emerging markets could suffer temporarily during an economic downturn, their superior long-term economic growth profile and relatively cheap valuation should help them to deliver decent returns as well.
Balancing Bond Duration
A “Golden Rule” says that one should overweight duration if one expects the Fed to cut rates over the next 12 months by more than what the market is discounting. Currently, the market is discounting a 1.2% rate cut. Stronger-than-expected June employment data rules out a July Fed cut, but the report does not derail the case for having some long-duration bonds in the portfolio. Nonfarm payrolls printed at 147k, with the two prior months revised up by 16k, leaving the 3-month average at 150k. The unemployment and underemployment rates fell to 4.1% and 7.7%, respectively. However, job gains were concentrated in government, education, and healthcare, while aggregate weekly payroll growth was flat.
Private sector dynamics were softer, and the overall labor market remains in the “low hiring, low firing” regime of the past few quarters. While the labor market has not collapsed, its momentum has slowed as it sits at a pivotal point where broad measures of slack are roughly balanced.
The overall strength of this report rules out a cut at the July FOMC meeting. The Fed remains in wait-and-see mode on tariff-related inflation, despite growing support within the FOMC for looking through short-term price pressures.
If we experience a recessionary scenario, we would expect the Fed to bring rates down to circa 2% over the next 12 months. Even in a non-recessionary scenario, we expect the Fed to cut rates one or two times, given that the inflation shock from higher tariffs is likely to be temporary. By this logic, it makes sense to have some long-duration exposure in the portfolio.
U.S. Dollar Weakness
We expect international investors to continue reducing their exposure to U.S. dollar-denominated assets. That said, the U.S. dollar is typically a countercyclical currency. If global growth weakens, the dollar is likely to stabilize and strengthen modestly over the next few quarters. Over a structural horizon, we expect the dollar to resume its weakening trend, as it remains 17% overvalued based on its Purchasing Power Parity (PPP) exchange rate – the exchange rate that equalizes the price of a representative basket of goods and services across countries.
The Next Fed Chairman
There are market rumors that President Trump might announce a new Fed Chairman soon, many months before the end of Jay Powell’s term, thus undermining his authority.
A dovish early Fed nominee would increase volatility in rates and FX as markets reassess the credibility of U.S. monetary policy. Lower short-term rates are positive for markets, but if seen as politicized, the signal that the Fed is less committed to its inflation mandate would drive long-end yields higher and stocks lower. Market reaction will depend on whether the nominee is selected for their loyalty or their credentials. The Senate is unlikely to confirm a candidate lacking credibility. No reaction, or a drop in long-term yields, would signal market acceptance. A bear steepening curve, by contrast, would point to diminished confidence in the Fed’s independence.
However, no matter who will be nominated, looser monetary policy is about to become a tailwind to the already bullish brew that includes Trump’s repeated step-downs from a global trade war, irrelevant geopolitical risks in the Middle East, and a fiscal policy that is no longer as alarming to bond markets as initially feared. Investors should be cautious about becoming overly bearish in either bonds or stocks. However, that also means that something must give, and over the longer term, it likely means more U.S. dollar weakness.
Our Portfolio Positioning
Markets have continued to recover in June, and most are now in positive territory for the year, measured in USD. However, as the Euro continued to strengthen (now up more than 14% year-to-date), gains are more muted for non-U.S. dollar investors.
Our core portfolio has performed well since the start of the year. Fixed income is recovering on slightly lower yields, despite the Big Beautiful Bill adding to the U.S. budget deficit. We are comfortable holding a balanced interest rate position, including a small position in long-dated U.S. Treasuries as a hedge against further weakening economic data.
In stocks, we remain slightly defensively positioned for the coming months as we expect markets to remain volatile and prone to swings. Given the recent sharp rise, we could see a consolidation period over the summer. However, despite this and the risk of an economic soft patch, we are not bearish. Maintaining a globally diversified portfolio and staying invested is the right strategy in this type of market.
DISCLOSURES
The information provided is for educational purposes only. The views expressed here are those of the author and may not represent the views of Leo Wealth. Neither Leo Wealth nor the author makes any warranty or representation as to this information’s accuracy, completeness, or reliability. Please be advised that this content may contain errors, is subject to revision at all times, and should not be relied upon for any purpose. Under no circumstances shall Leo Wealth be liable to you or anyone else for damage stemming from the use or misuse of this information. Neither Leo Wealth nor the author offers legal or tax advice. Please consult the appropriate professional regarding your individual circumstance. Past performance is no guarantee of future results.
This material represents an assessment of the market and economic environment at a specific point in time. It is not intended to be a forecast of future events or a guarantee of future results.
Indices are unmanaged and investors cannot invest directly in an index. Unless otherwise noted, performance of indices does not account for any fees, commissions or other expenses that would be incurred. Returns do not include reinvested dividends.
The Standard & Poor’s 500 (S&P 500) Index is a free-float weighted index that tracks the 500 most widely held stocks on the NYSE or NASDAQ and is representative of the stock market in general. It is a market value weighted index with each stock’s weight in the index proportionate to its market value.
West Texas Intermediate (WTI), also known as Texas light sweet, is a grade of crude oil used as a benchmark in oil pricing. This grade is described as light because of its relatively low density, and sweet because of its low sulfur content.
