Market Commentary | Q2 2025
The second quarter gave long-term investors plenty of headlines to digest. The short-term noise of daily news, sudden market swings, and unexpected policy shifts can be both confusing and emotionally taxing. A quarter that began with an abrupt escalation in US tariff policy evolved into a textbook lesson on market resilience: a historic four-day sell-off, an equally dramatic single-day rebound, and by the end of June, record highs for many global equity benchmarks.
Despite the whiplash of the news cycle, a core tenet of our investment philosophy was reinforced: well-diversified portfolios can thrive even when policy winds blow unpredictably. Through the noise, themes including healthy corporate earnings, surprisingly tame inflation, and a surge in artificial intelligence spending stood out.
Q2 Recap: From Tariff Declines to New All-Time Highs
President Trump’s “Liberation Day” tariff announcement on April 2 triggered a swift repricing of risk. In the four trading sessions that followed, the S&P 500 shed just over 12%, its steepest four-day drop since the pandemic era. Markets regained their footing just as quickly. When the White House paused most of the tariffs on April 9, the S&P 500 surged +9.5%, which represented the index’s largest one-day gain since 2008.[1]
Behind the dramatic headlines, fundamentals proved more stable than sentiment. An impressive 78% of S&P 500 companies announced first quarter earnings that were above analysts’ estimates, which exceeds both five- and ten-year averages.[2] Most companies gave forward guidance that, while cautious, did not suggest an imminent earnings recession. Additionally, management teams announced continued spending plans, particularly in projects tied to automation and artificial intelligence.
The rebound broadened as the quarter progressed. By June 27, the S&P 500 and Nasdaq Composite closed at new highs, fueled by a combination of rate-cut optimism and easing trade anxieties. International stocks benefited as well, aided by a continued slide in the dollar. In short, Q2 highlighted that markets often price worst-case scenarios quickly, but can recalibrate just as quickly when positive data arrives.
Q2: Let’s Do the Numbers
- US Large Cap Stocks (S&P 500 index): +10.9% during the quarter. A dramatic rebound following the “tariff-pause” coupled with strong earnings from the largest technology names helped to erase the Q1 declines and allowed the index to finish +6.2% during the first half of the year, even reaching new record closes by June 30.
- US Small Cap Stocks (S&P 600 index): +4.9% during the quarter. Small caps participated in the late-quarter rally, but persistently higher borrowing costs and tariff sensitivity kept gains modest relative to large-caps, leaving valuations attractive but sentiment cautious. YTD, the index was still down -4.5% at the midpoint of the year.
- International Stocks (EAFE index): +11.8% during the quarter. A weaker US dollar, fiscal stimulus in Japan and Europe, and relative containment in key geopolitical conflicts all helped international stocks continue to outpace the US this year. The index finished the first half of the year up +19.5%, highlighting the value of global diversification.
- Broad US Bonds (Bloomberg Aggregate Bond Index): +1.2% during the quarter. Rates spiked after April’s trade-policy shock, but retreated in June on cooler inflation data, letting core bonds finish modestly higher while continuing to cushion equity volatility. The index was up +4.0% as of the midpoint of the year.
- US Real Estate (FTSE NAREIT index): -1.1% during the quarter. While the index still finished the first half of the year positive at +1.2%, REIT performance was weighed down in Q2 by “higher for longer” interest rates and lingering office space concerns. Data-center and industrial companies rallied late in June but couldn’t fully offset declines earlier in the quarter.
Tariffs Haven’t Lead to Inflation (Yet)
One surprise this quarter was how little the tariff turmoil affected consumer prices. Core PCE, the Federal Reserve’s preferred gauge of inflation, rose just 0.2% in May, and the three-month annualized pace is running below 2%.[3] With this benign backdrop, investors are turning their attention to the possibility of lower interest rates, which could help to stimulate the economy. Currently, the Fed is projecting two quarter-point cuts by year-end, offering a potential catalyst for further shifts in both equity returns and bond yields.
Nevertheless, inflationary pressures may be merely deferred, which is why Jerome Powell and the Fed are remaining patient. Many companies entered Q2 with pre-tariff inventories, choosing to hold prices steady for competitive and political reasons. As those buffers wane, the burden of tariffs may start to show up in the form of higher consumer prices, thinner profit margins, or some combination of the two.
AI-Fueled Growth, AI-Fueled Risk
If tariffs were Q2’s headline risk, artificial intelligence was the headline opportunity. The four largest cloud providers – Amazon, Alphabet, Meta, and Microsoft – are on pace to invest roughly $320 billion in data center and semiconductor infrastructure this year, a thirteen-fold increase from a decade ago.
Beyond the obvious boon for chipmakers such as Nvidia and Broadcom, data center construction is fueling a growing industry of suppliers for cooling, power, and network equipment. Recent Congressional testimony from Sam Altman (CEO of OpenAI) and Eric Schmidt (former CEO of Google) emphasized that energy, not computing power, is the ultimate constraint on AI’s growth.[4] With AI data centers requiring vast and steady power supplies, the demand for reliable baseload generation and transmission infrastructure is growing rapidly.[5] This increase in demand presents an opportunity for renewable energy companies as well as traditional energy producers.
Financial services offer another example of how AI’s benefits are showing up in industries outside of the tech sector. Large banks are currently forecasting that as much as a quarter of their expected profit growth through 2028 could come from efficiency gains from adopting AI tools for online banking service delivery, fraud detection, and risk modeling.[6]
Even as AI improves efficiency in a variety of industries, there still remain significant questions about how broader adoption and development will increase the risk of cyber threats or negatively impact employment and hiring trends. For diversified investors, AI has provided a growth tailwind, but current lofty valuations argue for measured exposure rather than unbridled enthusiasm.
Patience and Process
As we move into the second half of 2025, healthy fundamentals coexist with an unsettled policy backdrop. In the short term, risks remain. Trade talks could stall, rate expectations could pivot, and another bout of volatility like the one we experienced in early April could cause prices to retreat from current highs. In the long term, the larger arc bends toward progress: businesses keep reinvesting, technology keeps compounding, and patient investors have historically been rewarded for staying the course.
When it comes to investing, patience is rarely the most exciting strategy in the moment, and yet it has proven to be the most rewarding over time.
Resources
[1] US stocks surge, dollar gains in dramatic relief rally as Trump pauses tariffs. Reuters
[2] S&P 500 Earnings Season Update: Q1 2025. FactSet
[3] US reports benign PCE inflation in May. Reuters
[4] The AI Revolution Isn’t Possible Without an Energy Revolution. Time
[5] AI-oriented data centers could account for up to 12% of domestic electricity demand by 2028, accelerating investment in both traditional baseload generation and renewables. US Dept of Energy
[6] Banks enter agentic AI era as tech race heats up. Bloomberg
