Highlights:
- Markets reached new highs in June, but gains were narrow and lacked broad enthusiasm, with the S&P 500 now up 6.2% year-to-date.
- Mega-cap tech stocks led the market in June, driven by strong profitability and renewed enthusiasm for AI, while international stocks maintained their sizable lead over domestic equities year-to-date.
- The yield curve steepened in Q2 as short-term rates dipped in anticipation of possible Fed cuts, while long-term rates rose amid concerns about inflation and budget deficits.
- With inflation likely to rise, confidence falling, and Fed policy uncertain, investors face potential volatility, making fundamentals and valuation critical heading into the second half of 2025.
As the major stock indices ticked up to new all-time highs in late June, something seemed to be missing: euphoria. For one, the S&P 500 Index's 5.1% return in June brought the year-to-date gain to 6.2%, a modest figure compared to the 20%+ returns of the past two years. But more fundamentally, the return of a narrow, tech-driven market overshadowed the less buoyant majority of stocks and didn't reflect the emerging concerns for the remainder of the year. Last month, we remarked on how quickly the market had absorbed and then discounted the surprising tariff regime announced in early April. In June, we saw a similar story as the shock of the U.S. attack on Iran was quickly accepted, and the ramifications dismissed. We believe that investors will be well served by addressing these concerns and remaining vigilant to the potential consequences that issues such as tariffs and acts of war may yet pose. But first, a deeper look at the market.
The familiar mega-cap tech stocks returned to leadership in June, and not without reason. They continue to be extremely profitable and retain the cutting edge in AI development and its necessary infrastructure. However, they weren't the only game in town, as international stocks continued their sizable lead over domestic equities year-to-date. The prospects of the emerging Republican budget bill were particularly daunting to health care companies, and that S&P sector was down sharply in the second quarter. Small and mid cap stocks had a bounce in June but remained well behind the large cap indices for the year. The yield curve steepened over the second quarter as short-term rates dipped in anticipation of a possible second-half Federal Reserve rate cut, while long-term rates rose with the potential tariff-induced inflation and fears of a growing deficit.
Given the characteristics of the market rise in June and the second quarter, broadly diversified and risk-conscious portfolios did not keep up with the cap-weighted indices. At this point in time, with so much unpredictability around trade policies, immigration actions, geopolitics, and the budget, keeping up with the Mag 7-heavy indices is less of a concern than the risks ahead. The Fed is watching whether tariffs re-ignite inflation, while depressed small business and consumer confidence portend an economic slowdown. This scenario puts the Federal Reserve in a bind, reflected in Chairman Powell's hesitancy to predict easing and his constant invocation of the term "uncertainty." With the market price-to-earnings well above historic averages we see an increasing chance of downside volatility, which could hit the highest-valued stocks the hardest. Staying focused on company fundamentals, including valuation, remains our priority as we enter the second half of 2025. Still, the U.S. economy remains the world's strongest and most resilient, and so with an eye on long-term returns, we are investing with a heightened awareness of the potential for market shocks and the resulting selloffs.