“The art of being wise is the art of knowing what to overlook.” – William James
When I first started out as a credit analyst, one of my mentors counseled that of all the risks that investors face when making an investment, legislative risk is one of the most difficult to quantify. It is challenging to predict what a group of legislators will enact into law and how that will impact companies and the economy. Legislative risk was front and center in the second quarter, as the first half of the quarter was focused on legislative risk in the form of daily changes in tariff policy, and the second half of the quarter focused on legislative risk in the form of new tax legislation. Part of the challenge of being a good investor is being able to sift through the vast amount of news stories that we are bombarded with each day to focus on what truly matters. The second quarter served as a timely reminder that, while negative news stories of rising tariffs, Middle East flare-ups, and credit rating downgrades may seem daunting, strong earnings, moderate inflation, and resilient consumer spending, along with a surprise late-June ceasefire in the Israel-Iran conflict, can lead to a strong market performance.
Equities – Reduced Fears of High Tariffs Lead to Focus on Strong Fundamentals
The tariff-induced downturn in April, which left the US equity markets on the brink of a bear market, was quickly forgotten, allowing the S&P 500 and Nasdaq notch fresh records, while most overseas bourses participated in the relief rally.
News that large tariff increases would be paused caused investors to tiptoe back into risk, with small and midcap stocks as well as large cap stocks performing well. By late June, growth stocks had erased their year-to-date deficit versus value and nine of eleven S&P 500 sectors were in positive territory for the quarter.
Fixed Income – a Round-Trip in Yields
Interest rates ended the quarter largely unchanged, as news stories that would have led to higher or lower rates were largely balanced. Rates climbed out of the gate after a solid May payrolls report. A downgrade of the U.S. credit rating by Moody’s from Aaa to Aa1, as well as fears of higher oil prices, pushed the yield on the US 10-year Treasury note to 4.58%. Then in June, cooler inflation readings, along a dovish tone from the Federal Reserve and fading geopolitical risk pulled yields lower, with the yield on the 10-year Treasury note ending below where it ended last year at 4.23%, according to the Board of Governors of the Federal Reserve System (US) via FRED..
Economy – Moderating but Resilient
Most price gauges surprised on the downside, with May core CPI rising just 0.1%, bringing year-over-year inflation to 2.8%. Core Personal Consumption Expenditure Price Index, the Federal Reserve’s preferred inflation gauge, advanced a modest 2.5% year over year in the second quarter, per the US Bureau of Economic Analysis. Softer data allowed the Fed to keep the funds rate steady at 4.25–4.50%, with officials now penciling in two rate cuts before the end of the year. Cooling labor markets may also give the Fed reason to lower short-term interest rates, as weekly jobless claims crept higher at the end of June.
Looking Ahead: Things Look Good, and Markets Reflect It
While headlines have been volatile, underlying trends are encouraging: inflation is edging lower, monetary policy is likely to shift from restrictive to neutral, and earnings expectations are stabilizing at a strong growth rate. We will be watching to see how the recently passed tax bill affects consumer and business spending. Our investment strategy enables us to remain invested in a diversified portfolio, benefiting from market upturns.
As always, we appreciate your trust and partnership, and we remain focused on helping you navigate markets with clarity and discipline. Please reach out with any questions.