Newsletter
Dear Client,
As we pass the midpoint of 2025, the U.S. equity market has been marked by resilience, volatility, and a dizzying array of shifting narratives. While the S&P 500 gained 6.2% for the first half of 2025, this does not paint the full picture of the exceptional volatility witnessed throughout the year. The path to new all-time highs in the S&P has been anything but easy, with the index suffering its most turbulent period since the pandemic.
The year started off strong, but quickly reversed in February when DeepSeek (a Chinese generative AI platform) claimed it could run large language models more efficiently than its U.S. counterparts. This triggered an AI-driven sell-off. Then, on April 2nd, just as markets were starting to claw back, the Trump administration announced its long-awaited reciprocal tariffs which sent stocks tumbling, wiping out more than $6 trillion in market capitalization. However, stocks reversed course on April 9th when President Trump announced a 90-day pause to the reciprocal tariffs which sent the S&P 500 screaming higher, ultimately posting ~10% gain in the single session, one of the largest in history.
Fixed income markets were not spared from volatility either. Long-term U.S. Treasury yields briefly rose on concerns about U.S. debt sustainability and deficit spending, culminating in a Moody’s downgrade of the U.S. sovereign credit rating. While the spike in long-dated yields in May has reversed, the trend towards a steeper U.S. yield curve has continued, with 5s/30s making new cycle highs. With financing needs as high as they are, the long end is likely to get only limited relief unless there is a more credible attempt at structural fiscal restraint, or we see significantly more economic weakness. High yield spreads widened in April on growth concerns, but narrowed later in the quarter as economic sentiment improved.
President Trump’s new tariff regime has marked a seismic shift in U.S. trade policy. Currently, the average effective tariff rate is more than 15%. That is the highest rate in the last ninety years and, if kept, will have a substantial impact on the U.S. and global economies. Tariff hikes are characteristically stagflationary shocks. They increase the likelihood of an economic slowdown and put upward pressure on prices. Economic data have mirrored the volatility in the markets and trade policy. Soft indicators (confidence surveys) have fluctuated concurrently with headlines of on-again, off-again tariffs, while hard data (inflation and unemployment) have shown more resilience. This divergence has added to uncertainty and continues to complicate the economic outlook.
On the demand side, the corporate and consumer response to the administration’s reciprocal tariff strategy has been clear-cut. For companies, capex plans have shifted, new orders have fallen, inventories have been front-loaded before tariffs took effect, and firms started revising down earnings expectations. For households, consumer confidence has dropped to record lows. Unpredictable trade polices have created a business environment where companies have had to delay investment and reevaluate supply chains.
The Federal Reserve remains backed into a corner. Fed Chair Jerome Powell has been candid about the challenges facing policymakers. It is likely that Powell will take a conservative approach to easing policy to safeguard against unanchored inflation. This week’s tariff deadline and geopolitical headlines may cause hiccups, but more of the focus is likely on the next few months of inflation and employment data, and how interpretations of the Fed rate path shift in response. Equity markets have seemingly shrugged off much of the weakness seen in some of the recent economic data prints. Markets are trying to resurrect the “goldilocks” narrative, where data weakness brings forward Fed support. Markets may end up disappointed, however, if the Fed ends up staying higher for longer out of fear that cutting rates despite rising inflation could jeopardize its credibility. This is especially noteworthy given that President Trump has been publicly emphatic in urging the Fed to reduce policy rates.
The One Big Beautiful Bill Act, which President Trump signed into law on July 4th, will define the course of the U.S. budget. It is projected that the impact of the bill will be stimulative in the short run (via tax cuts), but could keep further upward pressure on rates and, therefore, the cost of servicing the U.S. debt in the long run. This is due to the fact that it is estimated to add roughly $5 trillion to the national debt over the next decade. The fiscal deficit continues to be a major issue. The impending mountain of debt issuance over the coming years will likely keep a floor under yields until there is a more credible attempt at structural fiscal restraint.
The U.S. economy and risk assets face a host of challenges in the second half of the year. Given the potential for a stagflationary backdrop for the balance of 2025, this sets a high hurdle for stocks to continue to extend gains. The sharp market sell-off in April, and consequent V-shaped recovery, however, highlight the opportunity costs for investors in wholesale portfolio de-risking at peak market uncertainty and fear. We expect further volatility in the remainder of the year. We continue to favor businesses with strong free cash flow generation and the highest quality segments of fixed income, notably, agency mortgage bonds, short U.S. Treasuries, and munis. As always, we thank you for your continued trust.
Regards,
Edge Wealth Management
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