Tariffs, Geopolitics and Market Rally
The second quarter of 2025 showcased both the resilience of financial markets and their sensitivity to policy uncertainty. From the White House's tariff announcements in April to escalating tensions between Israel and Iran in June, investors faced many challenges. Yet, the stock market went on to stage one of the fastest rebounds in history and finished the quarter at new all-time highs.
Overall, it was a strong quarter for stocks, while bonds also delivered positive outcomes. For long-term investors, these events are a reminder that while headlines can drive short-term swings, maintaining perspective and staying focused on fundamental trends remains the key to achieving financial goals.
Key Market and Economic Drivers in Q2
The S&P 500 and the Nasdaq both ended the quarter at record highs, gaining 10.6% and 17.7% over the three months, respectively. The Dow Jones Industrial Average rose 5.0% and ended the quarter just 2% below its record level.
The Bloomberg U.S. Aggregate Bond Index gained 1.2% in the second quarter. The 10-year Treasury yield ended the quarter at 4.2% after reaching as high as 4.6% in May.
Developed market international stocks (MSCI EAFE) rose 10.6% and emerging market stocks (MSCI EM) increased 11.0% in the quarter.
Gold rallied to a new record level of $3,431 per ounce, before settling at $3,308 to end the quarter.
Bitcoin reached a high of $111,092 in May and hovered around $107,000 at the end of June.
The U.S. Dollar Index continued to fall over the quarter, ending the quarter at 96.88. It started the year at 108.49.
The Consumer Price Index rose 2.4% year-over-year in May, while core inflation, which excludes food and energy, came in at 2.8%.
The University of Michigan Consumer Sentiment Index improved in May to 60.7, its first increase in six months. Consumers expect an inflation rate of 5.0% over the next year, down from 6.6% in the previous survey.
At its June meeting, the Federal Reserve kept rates unchanged within a range of 4.25 to 4.5%.
Taken together, we saw an environment that rewarded those who focused on their asset allocations and maintained a broader perspective. It's important to keep these lessons in mind amid heightened uncertainty as we enter the second half of the year.
Markets are resilient as we begin the second half of the year
Despite significant volatility, the stock market recovered quickly once the worst-case scenarios for tariffs and geopolitical tensions did not materialize. The quarter began with heightened uncertainty following the announcement of new tariffs on April 2, which were more far-reaching than many investors had anticipated. However, as the administration engaged in negotiations and reached preliminary trade agreements with several partners, market sentiment improved. The Middle East conflict created a similar outcome, although markets were broadly resilient and went on to new highs after the ceasefire between Israel and Iran was announced.
Investors have become accustomed to market swings over the past several years, as the accompanying chart highlights.
Looking forward, markets will likely be sensitive to the next phase of trade agreements. The 90-day pauses for most countries will end in July, and the reported deal with China has not yet fully materialized. The administration has shown that its objective is to reach new deals, just as it did in 2018 and 2019. Regardless of the exact outcomes, the average level of tariffs on imported goods has risen significantly this year which could still impact consumer inflation and corporate profit margins.
The economy appears healthy
Perhaps the most important bright spot over the past several years has been the resilience of the U.S. economy. What has surprised investors the most is the strength of the labor market even as inflation has fallen back toward more historically normal levels. Most inflation measures are at or below 3%.
The latest GDP report did show that the economy shrank by 0.2% during the first three months of the year. However, the details also show that this was largely due to trade as companies stockpiled imported goods ahead of potential tariffs. Consumer spending, which represents the largest component of economic growth, continued to grow steadily, supporting the overall economy. Without the trade disruptions, GDP growth would likely have been positive.
One area of concern that will likely resurface in the second half of the year is the growing national debt due to persistent government spending and deficits. This prompted Moody’s to downgrade the U.S. debt in May, following similar actions from other ratings agencies including Standard & Poor’s in 2011 and Fitch in 2023. This will be at the forefront once more as Congress has just passed the next budget bill (the One Big Beautiful Bill), including provisions from the extension of the Tax Cuts and Jobs Act.
Geopolitical risks are dominating headlines today
Geopolitical risks have intensified, particularly with the escalation of the Israel-Iran conflict which now involves the U.S. military. This naturally creates worries for some investors since these headlines are unlike the normal business and economic news flow. Fortunately, history provides important perspectives on how markets typically respond to geopolitical events.
Markets have generally recovered from geopolitical shocks over time, often within months of the initial disruption. Even significant events such as wars had limited long-term impact on well-diversified portfolios. This is not to minimize the human and societal costs of these conflicts, but to serve as a reminder that making dramatic portfolio changes based on geopolitics is rarely productive.
Instead, what mattered more during these historical periods were the market and economic trends. For example, the Gulf War took place during a long 1990s bull market driven by information technology. In contrast, the war in Afghanistan began after the dot-com bust, and continued across multiple economic cycles.
The immediate market concern around the Iran conflict centers around oil supply disruptions. In this instance, the Strait of Hormuz to Iran’s south is a critical waterway through which over one-fifth of global oil is transported. Any disruption to oil production or critical supply paths could result in a jump in oil prices, fueling inflation.
Despite this, oil prices have stayed within a narrow range as the conflict has escalated. The price of Brent crude is only back to where it was as recently as January. So, while the situation is still evolving, it’s important to stay balanced when considering the impact of geopolitics.
The Fed holds rates steady, holds out for more data
When it comes to monetary policy, the Federal Reserve held interest rates steady at 4.25% to 4.5% throughout the quarter, reflecting a measured approach to monetary policy in an evolving economic environment. Fed Chair Jerome Powell emphasized the Fed’s focus on price stability even as other factors complicate the economic outlook.
Specifically, the Fed's updated economic projections reveal the challenges policymakers face. Officials now expect inflation to reach 3% in 2025 before moderating to 2.1% by 2027, marking an upward revision from earlier forecasts. They also expect real GDP growth to slow this year to 1.4%, a downgrade from a 1.7% projection in March. These adjustments reflect concerns that tariffs could spur inflation and slow growth.
Asset classes beyond U.S. stocks have performed well
The biggest challenge with the market rebound is that U.S. stock market valuations are once again on the expensive side. That said, the elevated valuation environment has created opportunities in other areas of the market. International stocks, small-cap companies, and value-oriented sectors often trade at more attractive multiples, providing potential sources of opportunity for patient investors. Bond markets also offer compelling opportunities, with yields remaining above long-term averages across most fixed income sectors.
One of the most significant developments of 2025 has been the strong performance of international stocks, with developed and emerging markets experiencing double-digit gains, based on the MSCI EAFE and MSCI EM indices. This has partly been driven by a weakening U.S. dollar. When the dollar falls, assets denominated in foreign currencies become more valuable.
This serves as a reminder for the second half of the year that market leadership rotates over time. Maintaining exposure to different regions can both enhance portfolio outcomes and potentially help to reduce risk through diversification. While past performance doesn't guarantee future results, the current environment highlights why investors often benefit from patient, long-term approaches that capture opportunities across global markets.
This historical perspective reinforces the importance of staying committed to well-constructed portfolios despite short-term concerns. This will only be more important as new developments test markets in the months to come.
The bottom line? The first half of 2025 underscores the need to stay focused on the long run. Investors who maintain discipline and focus on long-term principles are well-positioned to navigate the second half of the year and achieve their financial goals.