Domestic Equity Market Commentary – 2Q 2025

After a difficult start to April following the “Liberation Day” market meltdown, equities rebounded strongly the last 11 weeks of the quarter. The rally was driven by easing trade tensions, a generally favorable economic outlook, strong corporate earnings, cooler inflation readings, reemerging optimism on AI-related spending, and deescalating Middle East tensions. The S&P 500 Index advanced 10.9% for the quarter, closing at a record high and more than erasing the first quarter’s decline to finish up 6.2% for the first half. Information Technology was up in the mid-teens, with particular strength in AI-related software and semiconductors. Other high growth and economically-sensitive sectors were also strong, including Communication Services, Industrials, and Consumer Discretionary. The Magnificent 7 names—oversized weightings in most of these sectors—contributed over half of the quarter’s gains. Energy stocks were weak, following the price of oil down as Iran’s tepid response to Israeli and US bombing calmed fears of supply disruption. Health Care was quite weak on ongoing policy uncertainty, while defensive sectors, Real Estate and Consumer Staples, also lagged.

The Russell 2000 Index gained 8.5% in the quarter. However, this was not quite sufficient to erase the nearly double-digit first-quarter decline, ending the first half with a loss of -1.8%. Sector winners and losers were similar to large caps, with particular strength in Information Technology, which returned over 20%, and weakness among defensive sectors, which posted modest losses. Style factors greatly favored higher risk attributes such as small size, high beta, low ROE, and non-earners, as the quarter’s retail-driven stock buying favored momentum-oriented names over quality.

Fueled by strong performance from the Magnificent 7, large-cap Growth significantly outpaced Value in the second quarter, posting a 14-percentage-point advantage that wiped out Value’s first-quarter lead. Among small-caps, Growth also outperformed, beating Value by seven points and reclaiming a three-percentage-point lead through the first half.

While the market feels more constructive, we would expect continued volatility until investors can better gauge the impact of Trump policy initiatives and the outlook for the economy and inflation. On the positive side, the outlook for the US economy in 2025 has improved, with earnings reports generally solid, and estimates for the year holding up better than expected. The labor market remains sound, with unemployment still low and a slight cooling in job creation that could benefit wage inflation expectations. The ISM Services survey, representing the majority of US employment, is back in expansion territory. While tariff uncertainty is still high, Trump has walked back the most onerous tariff proposals, although it remains to be seen if he is willing to further postpone these reciprocal tariffs. AI-spending levels, one driver of overall capital spending, remain strong despite last quarter’s concern about newly introduced Chinese AI competition. Inflation continues to drift down, although it remains stubbornly above the Fed’s 2% target. And while the timing of Fed rate cuts has been pushed out, despite tremendous pressure being placed on the Fed Chair by the President, expectations remain for two cuts before year-end. Corporate balance sheets remain healthy, providing ample firepower for share buybacks, dividends, and acquisitions. Personal balance sheets also remain strong, no doubt helped by record stock market levels, providing a continued tailwind for spending and investment.

Yet, there are risks that bear watching. Trump policy uncertainty has impacted business and consumer sentiment, suggesting spending levels could slow. We have started to see some signs of this with weakness in private employment surveys and in the Personal Consumption Expenditures reports. Home sales remain weak, as higher prices combined with higher mortgage rates have made homes unaffordable to many. Inflationary fears, and their potential impact on interest rates, remain elevated given the high spending levels and inherent fiscal deficits included in the budget bill that has recently been signed into law.

As always, we remain diligent in finding companies positioned for long-term success. While this charge has been tested in market environments such as this where aggressive momentum buying of riskier companies is done with little regard to valuation, we remain confident our strategy of focusing on companies with leading market positions, strong financial characteristics, and experienced management teams selling at reasonable valuation levels will pay off in the long term.