Q2 2025 Investment Tally & Perspective

Economic Activity

The second quarter witnessed significant policy and geopolitical volatility, yet despite this backdrop, ongoing trends remained intact. Since President Trump instituted a 90-day pause to reciprocal tariffs in early April━with the expiration date in flux as of this writing━questions remain how the upcoming deadline will be managed (note: the U.K. deal is the sole agreement to date). While originally not included in the pause, China and the U.S. came to a separate agreement to ratchet down trade tensions though both sides are skeptical of the other’s commitment.

The consensus view was that tariffs would push inflation higher and growth lower, but there has been scant evidence of these dynamics to date. In May, the consumer price index, excluding food and energy, advanced at a 2.6% annualized pace, in-line with recent readings. Q2 GDP is projected to expand nicely with 2.9% growth (Atlanta Fed estimate). However, this is driven by an unwinding of factors that detracted from Q1 2025 growth, specifically inventory and imports. Inventories are projected to be worked down, subtracting 2.2% from GDP growth, while net exports (exports minus imports) are expected to add 3.5% to GDP (lower imports add to GDP growth). Net of these items, Q2 GDP growth would be in the 1.6% range, compared to 1.5% in Q1 excluding these same items.

Critically, personal consumption expenditure still appears to be growing modestly aided by a job market that is delicately balanced. The job market has been accurately described as ‘low hires, low fires’. This environment has led to elevated unemployment rates amongst younger workers. As of now, the status quo seems likely to persist.

Monetary Policy

With current inflation and employment behaving well, there has been little incentive for the Fed to lower rates while the tariff impact remains unresolved. The Federal Reserve has maintained its position as one of the few global central banks not cutting interest rates. As Fed Chairperson Jerome Powell has admitted, without the tariff hike the Fed would have continued to cut interest rates through the first half of 2025.

Nonetheless, expectations for future rate cuts have increased as inflation has remained benign and the prospect of an energy spike has been curtailed. Which brings us to current market expectations for two, 25 basis point (a basis point is 0.01% or 1/100th of one percent) cuts this year. Market participants expect to exit 2026 with a Fed Funds rate around 3.00% versus the current rate of 4.25 to 4.50%.

A key storyline during the quarter was Fed independence and future Chair candidates. President Trump has repeatedly expressed his displeasure with Powell as he prods the central bank to lower interest rates. While removing Powell had been discussed, the move has questionable legal merit, and the President appears to have pulled back from seriously considering this option in favor of naming a new Chair early. With Powell’s term as Chair ending in May 2026, an announcement of Powell’s successor as Federal Reserve Chair could hold considerable sway over the market, despite having no ability to influence Fed rate decisions. In this scenario, the ‘shadow Chair’ could communicate freely which could dramatically influence the shape of the yield curve along with other repercussions.

While this idea is possible, it is also worth considering how the Fed sets its Fed Funds rate. This is done via a committee of 12 members. Five of these members are heads of the regional Federal Reserve banks, while the remaining 7 are on the Federal Reserve’s Board of Governors, who the President formally nominates. Assuming Powell leaves after his Chair term expires (which is the precedent), there is only one other Governor term expiring before 2028. Our View: This structure may very well limit the ability of the President to impact monetary policy.

Valuation and Sentiment

Not much has changed on the valuation and sentiment front since our last communication. Equity valuations remain above average and expensive relative to bonds. However, unlike bonds, equity returns are positively impacted by future profit growth. On this front, double-digit earnings growth is still expected for 2026. However, 2025 earnings expectations have declined from the start of the year from the low-teens level to today’s expectation of 9% growth. If this outlook can be delivered, stocks may not be as expensive as they appear.

Investment Outlook and Strategy – Navigating Market Headwinds and Embracing Opportunity

Bull markets are known to “climb a mountain of worries” and this market certainly has faced above average headwinds and levels of uncertainty. As we enter the second half of 2025, investors are confronting a landscape shaped by complex and often contradictory forces. While economic indicators have sent mixed signals, the resilience of financial markets continues to spark both caution and optimism. The following summary presents our thoughts on current headwinds and why common stocks remain an essential long-term growth vehicle.

Bearish Factors:

• Inflation Uncertainty and Tight Monetary Policy – Despite central bank efforts, concerns over the impact of tariffs and trade policies on inflation, particularly services, have prompted ongoing rate vigilance from the Fed. This has led to higher borrowing costs and some softening in consumer and business spending.
• Geopolitical Uncertainty – Conflicts abroad, especially in energy-rich regions, have stoked volatility in commodity prices and unsettled global trade expectations. In turn, supply chains and corporate margins remain under pressure.
• Corporate Earnings Compression – Elevated input costs, coupled with sluggish consumer demand in certain categories, have led to cautious guidance and margin compression across industries.
• Labor Market Imbalance – While unemployment remains low, tight labor conditions have created wage pressure that is challenging for businesses and complicating policy decisions.

Bullish Factors: 

• Resilience in U.S. Corporate Fundamentals – Balance sheets remain healthy, cash flows are robust, and most large-cap companies have demonstrated adaptability through cost controls, digital transformation, and strategic restructuring.
• Easing Rate Cycle Ahead – Market expectations are beginning to shift toward the potential for rate stabilization━or even modest cuts━in the next 6 to 12 months. While lower rates would support valuations, spur lending activity, and buoy investor sentiment, rate declines could be the result of an economic slowdown and recession (so let us be careful what we wish for).
• Technology-Led Productivity Gains – Adoption of AI, automation, and cloud infrastructure continues to drive efficiency gains across sectors, opening new revenue streams and transforming business models━the impact is more disinflationary than inflationary.
• Valuation Opportunities – During market pullbacks, many high-quality companies trade at attractive levels relative to long-term earnings potential. These swoons in price present a prime entry point for investors with multi-year investment horizons.

Strategic Takeaways – One Eye Ahead, One Eye Behind

While volatility may persist in the near term, disciplined investors who stay the course may be well rewarded. We continue to view stocks as providing attractive potential returns on a risk-adjusted basis, though we see increasing signs of risks hidden below the surface that may erupt at any time. We are reminded of the late 1990’s when a hedge fund━Long Term Capital Management━was viewed as having founded a financial methodology that was able to “coin money”. Their methods did indeed rake in large sums until their rake broke and the firm blew-up, shaking global markets and being a major factor in the Asian Currency Crisis (1998).  Our Point: While current markets are stable, there are risks━known and visible as well as unknown and invisible.

While time and space preclude us from writing further on this subject today, in subsequent communications we will address these concerns and share related thoughts on trigger candidates, such as highly leveraged hedge funds, private equity, private credit, stablecoins, and cryptocurrencies. In the interim, we will retain the strategy that has served us well━a neutral investment allocation with a defensive bias.

Tapping Retirement Assets Early – What to Know

For savers short on cash, using a retirement account to help cover expenses can be tempting. While we do not recommend tapping into a retirement plan before the IRS established retirement age of 59½, sometimes it is unavoidable. It could be from a loss of job, medical emergency, or home purchase.

Understanding the Tax Impact of Early Withdrawals

Withdrawals from these accounts prior to the retirement age typically results in a 10% penalty of the amount withdrawn along with having to report the amount as taxable income. If, for example, a 45-year-old saver in the 22% tax bracket withdraws $20,000, he may pay $6,400 in taxes and penalties if taken from a retirement account. Before making early withdrawals, it is important to know the facts and the few exceptions allowed by the IRS.

Different Rules for Different Retirement Accounts

Retirement accounts come with tax advantages, and the government stipulates specific rules for how these funds can be used. There are different account types, and it is important to know the nuances of each type. IRAs are owned by the individual saver directly (IRA stands for Individual Retirement Account), while 401(k)s and similar plans are maintained by employers for the workers and are “qualified” plans if they meet criteria that qualify them for tax benefits.

Exceptions to the Early Withdrawal Penalty

What are Hardship Withdrawals? Early withdrawals from IRAs, SEPs, SIMPLE IRAs, and 401(k)s can avoid the 10% penalty if they are for death, disability, terminal illness, medical expenses that exceed 7.5% of the owner’s adjusted gross income, victims of domestic abuse, birth or adoption expenses and qualified natural disasters.

Hardship Withdrawals from IRAs that avoid the 10% penalty include withdrawals for higher education expenses, first time home buyers, and health insurance premiums while unemployed. 401(k) also allows free withdrawals to those who retire in the year they turn 55 or later. In all these cases, however, federal and if applicable, state income tax is owed at the saver’s current income bracket.

When a 401(k) Loan Might Be a Better Option

A better option, which many 401(k) plans allow, is for the employee to take out a loan. Up to 50% of the vested balance or $50,000, whichever is less, may be taken, and is required to be paid back within 5 years with interest (the interest is payable back to the saver within the 401(k) account). Taxes and penalties are avoided on these loans.

Why Roth IRAs Offer More Flexibility

Withdrawals from Roth IRAs are the most forgiving, assuming the account has been open for at least 5 years. A saver with an account that has been opened for longer than 5 years may withdraw up to the total contribution amount (not the earnings), tax and penalty free. The main drawback is that the withdrawn dollars cannot be put back into the account.

Know Your Options—and Ask for Guidance

While circumstances vary and emergencies can happen, knowing your options can help save thousands of dollars. As CFP’s®, we have tools and resources to help our clients make the proper decisions. As always, please contact us if you have questions or if we may be of assistance in any manner.