Mid-year Outlook 2025: Investing After the Storm

As we close the first half of 2025, you might expect our market outlook to have shifted dramatically given the recent economic and geopolitical upheaval. Yet, surprisingly, our perspective is largely unchanged. With policies on their current path and markets trading at their present levels, our forecast remains fairly steady, despite some adjustments along the way.

We continue to expect a slowdown in the US economy over the course of the year, with risks slightly elevated compared to January but sharply reduced from what they were in early to mid-April.

As for the markets, private markets continue to shine, while municipal bonds have emerged as a standout liquid asset class compared to six months ago.

The US Remains the Economic Epicenter

With the past six months having challenged the notion of “American exceptionalism,” US policy has clearly shaken the markets. By extension, US assets have borne the brunt of the impact. Initially, tariffs sent US assets tumbling and rattled global markets. But as the White House largely reversed course, those same assets rebounded, highlighting America’s central role in this year’s financial drama.

For the past several years, the US economy has been the envy of the developed world, coming out of the pandemic stronger and growing much faster than others. Yet it appeared that period of above-trend growth would finally meet supply-side constraints. Steering the economy back to a longer-run equilibrium without triggering a recession would be a major triumph for economic policymakers—a goal that seemed achievable at the start of the year and still does. But since January, the fundamental economic picture has dimmed slightly, mainly due to the uncertainty introduced by ground-shaking government policies.

Uncertainty has defined the year thus far, as highlighted by our Chief Investment Officer, Alex Chaloff, in his Q1 letter. Measures of economic uncertainty—evident in surveys, the press, and corporate earnings calls—have hit historical highs. The concern is that this elevated uncertainty might lead company management teams and/or consumers to settle into a holding pattern, potentially rippling through the economy and sparking a mild recession.

Our Chief Economist noted after Liberation Day that if tariffs and policy-driven uncertainty persisted for months, the odds of a recession (which had been low) could rise to around 50%. But he humorously suggested forgetting this prediction if policies were quickly reversed. That story, in a nutshell, sums up how we—and other market participants—have navigated policy news and the prevailing economic climate this year.

Thankfully for investors, those policies were paused soon after, mitigating much of the potential economic risk. Yet, some lasting damage and persistent uncertainty linger. Tariff policy remains unpredictable, as we’ve already seen in early July.

Looking at the economic picture today, we’re trying to square three key elements: “hard” economic data, “soft” economic data, and management commentary. The “hard” data—actual dollars, jobs, numbers of units sold, etc.—remains quite strong. If you hadn’t seen the news or the stock market’s performance, the macroeconomic data alone would suggest a healthy economy nearing a stable equilibrium.

Take the monthly non-farms payroll release, perhaps the most important metric at the moment (Display 1). With US consumer spending driven largely by labor income, a steadily growing workforce is vital to the overall economy. That’s what we continue to see in the data, with the three-month moving average typically hovering between 100,000–150,000 jobs added each month over the past two years. But 2025 has seen modest softening, with 782,000 jobs added in the first half compared to 985,000 in the same period last year.

We’re also closely watching weekly jobless claims as a slightly more leading indicator, though the figures can be noisy and seasonal. Right now, jobless claims are hovering near the top of their normal range. Our concern would grow if the four-week rolling average of initial claims rises above 250,000 from their current 236,000.

“Soft” data mostly consists of surveys, which have been notably weak in the past few months. Part of that seems to emanate from ongoing political polarization affecting sentiment and part from policy-induced economic uncertainty. While consumer sentiment data has historically shown limited predictive power, the combination of pervasive uncertainty and the intuitive leap to its potential weight on future growth has raised eyebrows among economists and market participants.

The market’s concern is that negative sentiment could eventually impact economic performance, with weak soft data translating to weak hard data in the coming quarters. But with stocks back at all-time highs, it seems the “wisdom of crowds” has largely dismissed that risk for now.

Further tempering the risks evident in the soft data? Corporate commentary we’ve heard from management teams in Q1 earnings reports. Below are some highlights from our proprietary analyses of company calls:

• “There is broad consensus that uncertainty has increased”
• “Most [consumer discretionary] companies report solid or accelerating growth in Q1”
• “Most companies are not baking a recession into their base case but are operating with increased caution. Many highlight flexible business models, cost controls, and scenario planning”
• “Several are widening guidance ranges or maintaining cautious outlooks”
• “Companies are responding with more conservative or flexible planning and closer monitoring of market signals”
• “Several are proactively monitoring the environment and maintaining operational agility”

Taken together, this suggests that companies have dusted off their recession playbooks, keeping them handy next to the CEO’s desk. Importantly, they are not executing on them, creating a cascading impact which would lead to a recession. But they’re poised to respond quickly, implying that a shock which would have been easily manageable a year ago could have a more severe impact today.

Overall, in the battle between resilience and fragility, our base case is that resilience will largely prevail.

US Policies Cascade Across Continents

Outside the US, the global economy is also grappling with the effects of US economic and foreign policy, particularly in Europe. European policymakers have historically run tighter budgets than in the US. Now, Germany and other European allies are laying the groundwork for more expansionary fiscal policy, with an enormous increase in planned defense spending.

While European growth had been languishing and recession risks remain high, this new fiscal impetus—coupled with inflation reaching the ECB’s target—positions the region for a potentially higher growth trajectory from here.

China continues to experience a slowdown as it deflates its property bubble and reorients its economy, a trend expected to persist long term. What’s more, the country is now wrestling with a new trade offensive from the White House, further clouding its outlook.

Japan, meanwhile, is charting its own course. After a decade of fighting deflation, the country has finally generated inflation, prompting its central bank to raise rates while other major central banks are cutting. This alters the balance of opportunities for Japanese capital, which has traditionally been invested abroad due to low domestic interest rates and growth. Now, with improved rates and growth prospects, Japan may become more attractive relative to other developed markets, potentially redirecting capital flows that have historically favored the US or other regions.

The outlook for emerging-market economies remains more mixed, with tariffs adding substantial uncertainty that varies by country and region.

Round-Tripping the Markets

Fixed Income

Typically, we start our asset allocation discussions with the bond markets, given their lower-risk nature and foundational role in setting the bar for other assets. Yet this time, we have another reason to focus on bonds first. We’ve previously mentioned the “Trump put,” usually in the context of policy reversals triggered by hefty stock market declines. In 2025, however, we’ve learned that bonds, not stocks, are the catalysts for policy walk-backs (Display 2).

 

Twice so far this year, we’ve come close to what we’ve termed a “mini-crisis” (or as the press has started calling it, a “Liz Truss moment”). These incidents have prompted major Trump policy reversals—first in March, when trade tensions with Canada and Mexico eased, and second in April, when the global Liberation Day tariffs were paused. Intriguingly, while we initially thought such moments might arise from misgivings over the nation’s debt trajectory, it’s actually been tariffs and foreign policy that have pushed us to the brink in these instances.

Concerns about the US government’s future actions and its role in the global order have led foreign investors—historically reliable purchasers of US assets—to reconsider their positions. While these investors haven’t sold assets, they have stepped back from their buying activity. As a result, we’ve seen a rare confluence in US markets, typically seen during emerging-market crises:

• A weakening currency, specifically the dollar 
• Rising bond yields as bidders pull back from Treasuries
• Falling stock prices as buyers pause and reevaluate US corporate holdings

Much as we’re grateful for the policy reversals that averted a sharp spike in the odds of recession, we’re similarly thankful for the way backpedaling has reduced the risk of a mini-crisis in the bond markets. But while that risk has been skirted so far this year, it remains a notable concern, especially for foreign holders of treasuries. Tariff-driven uncertainty has created fragility in corporate and consumer actions—as well as among bond buyers.

Now, fixed-income investors must brace themselves for potential volatility in the price of their holdings. In the current environment, a brief drop might be needed to force a policy reversal and improve fundamentals. At the same time, selling due to that short-term news may leave investors vulnerable to a sharp rebound as the fundamental picture stabilizes, much as we’ve seen this year.

Beyond the risk of shocks, we continue to expect a downward trend in interest rates from here, especially for shorter maturities. The slowing economy, the Fed’s current outlook, and the potential actions they might need to take if the economy slows more than expected all point to a cyclical bias toward lower rates.

Meanwhile, credit quality remains relatively high, whether for municipal or taxable bonds and investment-grade or high-yield borrowers. While the compensation for credit risk is relatively low on a historical basis, it seems fair given the strong fundamentals.

Due to technical supply and demand factors, the municipal bond market has slightly lagged other asset classes year-to-date. That sets up relatively high risk-adjusted returns from here (Display 3). For instance, the Bloomberg Municipal Bond index currently has a 3.9% yield-to-worst— which measures the lowest possible yield an investor will receive if the bond is called or paid off early before its maturity date. For investors in high income tax brackets, that puts medium-term expected returns in the same ballpark as stocks. We don’t expect that to last.

 

US Stocks

The US stock market has rebounded to all-time highs, with the forward P/E multiple historically elevated, as it was coming into the year. Stock fundamentals are marginally worse than at that same point. With valuations also modestly cheaper, that means the overall outlook remains virtually the same.

Are US stocks a little expensive relative to history? Yes. But even factoring that in, their prospective returns are likely to outpace other assets, making them reliable candidates for capital appreciation. Plus, much of the elevated valuation comes from the Magnificent 7 stocks. This small clique is generally connected to the long-term AI theme and their management teams have largely executed well in recent years. While a tactical and tax-exempt investor might try to be more opportunistic when it comes to US equities, most of our clients should simply grin and bear it. That’s held true for most of the last decade, during which US stocks have tripled. We find that in general, it’s better to participate in the long-term growth potential than to be overly precise in the short run.

Inside the US market, the picture has changed from where we started the year. While the Magnificent 7 stocks that dominate the market are not a monolith, most of them have historically struck us as having fair expectations and reasonable valuations. We’re a little less sanguine this time around.

For the market overall, the S&P 500 currently trades at around 21x expected 2026 earnings. Stripping out the Magnificent 7 leaves the rest of the constituents trading at around 16.4x, with more moderate earnings expectations.

From a capitalization viewpoint, mid-caps stand out as potentially the most intriguing. Earnings expectations for middle-market companies are in line with our economic base case, though well below those of other parts of the market. At the same time, they trade at only 15.2x 2026 earnings.

In the small-cap space, reward potential requires more selectivity. In particular, we favor trends in the small bank ecosystem—continued economic expansion, improving regulatory and capital requirements, and valuations that support an ongoing wave of acquisitions by larger banks.

International Stocks

Amid the US market tumult, foreign stocks outperformed handily in the first half of the year, with developed international stocks returning 19% in the first half of the year, compared to US large caps’ 6%. While we continue to have faith in long-run US economic growth and stock returns, this underscores why we’ve always emphasized diversification—especially coming into 2025. Predicting market rotations is challenging at best, as today’s laggards often become tomorrow’s leaders. By diversifying, we’re able to benefit from that rotation over time.

Case in point? Our portfolio managers are currently overweight European stocks, though we have been reducing underweights in other regions lately. In emerging markets, we see opportunities in China, Korea, Brazil, and Greece, but we’re being extremely selective in China given the macroeconomic and policy environment there.

Private Markets

Just as when we entered the year, the most compelling opportunities remain on the private side.

Private equity (notably, middle-market private equity, Display 4) continues to enjoy a robust outlook and remains an evergreen building block in investors’ portfolios. Private credit—much like recent years—offers some of the most attractive risk-adjusted returns, whether in direct lending, specialty finance, opportunistic credit, or other sectors. 

 

Real estate—whether on the debt or equity side—also continues to hold appeal. Properties still need refinancing, and a large gap remains between development costs and property prices.

Further Afield

Finally, we’ve fielded an atypical number of questions lately on two other, somewhat related assets: gold and bitcoin. In a more geopolitically volatile world, we’d expect heightened demand for disaster hedges, anchoring their value at a permanently higher level. Gold, in particular, has broken away from its longstanding relationship with US real (after-inflation) yields. It seems to be searching for a new tether.

Likewise, we see investing in bitcoin as a VC-like bet, with those who buy into it hoping it will be treated like gold at some point in the future. That means it could gain perceived value as a disaster hedge, similar to gold’s current role. What’s more, though bitcoin is still considered a “risk-on” asset (unlike gold, the ultimate “risk-off” asset), it didn’t drop as much as expected during the recent geopolitically driven market downturn. That suggests some emerging bidders who are starting to treat it like digital gold. Yet, at the same time, we’d attribute its current all-time highs and the surge in investor interest more to its risk-on nature. In other words, bitcoin isn’t gold yet.

Strange Tides, Indeed

While the pandemic was an unusual investing environment, today’s uncertainty feels even higher. The prescription for that uncertainty? Diversification. When you’re less sure of what will happen, ensure your portfolio can reasonably withstand many environments.

At the same time, the investment picture remains relatively positive, especially when you focus on the long term. The further ahead you look, the better your ability to endure turbulence along the way.

Times like these can spook investors. But we recommend formulating a sound plan and sticking to it. That approach has served investors well for ages, including so far this year, and we expect it will remain wise moving forward.