The second quarter continued to brace elevated volatility, even as the period ended with stocks nearing all-time highs. Stoked by the Trump administration’s rampant policy overhaul and dismantling of federal agencies, the first half of 2025 was capped with looming tariff uncertainty. While the immediate effects of the tariffs have yet come into play, weakening indicators as well as the long-term risks of the administration’s increasing isolationism, protectionism, and budget brutality make for an extraordinarily cloudy outlook. Read more in Trillium’s Q2 2025 Economic and Market Outlook.
The president’s protectionist impulses drove market volatility during the second quarter. As Trump signaled upcoming tariffs, the S&P 500 peaked on February 19. By April 8, six days after his “Liberation Day” reciprocal tariff announcement, the index had fallen 18.7%, with price-to-earnings ratios dropping from 26.6 times to 18.6 times, while volatility reached 2020 and Great Financial Crisis levels. Bond and foreign exchange markets also showed signs of stress, leading Trump to maintain a 10% tariff on all trading partners, but suspend the proposed reciprocal tariffs for 90 days.
As traders and investors gained confidence in the TACO trade (Trump Always Chickens Out), equity markets recovered and reached new highs by quarter end. However, bond and foreign exchange markets evinced deeper concerns: Growth expectations embedded in the 10-year Treasury yield dropped by just over 0.25% during the quarter, indicating that investors believe the effect of the tariffs will reduce long-term economic growth. The US Dollar Index fell –10.7% for the year to date, dropping –7.0% during the quarter. With new tariffs planned for August 1, 2025 and only the UK, China, and Vietnam announcing deal frameworks, effective tariff rates have risen from 4% as of year-end 2024 to an estimated 15%, potentially reaching 30% if reciprocal tariffs are restored.
Congress narrowly passed the “One Big Beautiful Bill” on July 3. Due to muddled baseline measurements, the 10-year debt impact appears as either a $0.5T reduction, achieved by dismantling the pro-environment IRA, or a $3.25T increase. The difference is that using the current policy as a baseline obscures the effect of making permanent the tax cuts enacted in the first Trump administration. The bill is modestly expansionary through October 2029 but contractionary thereafter, including a provision for $600B in new business tax cuts covering full, immediate expensing for capital equipment, while extending corporate and personal tax cuts and slashing domestic discretionary spending.
A better name for the legislation would be the One Big Brutal Bill. The now-permanent tax cuts largely benefit businesses and the wealthy, using small and time-limited cuts to taxes on tips, overtime, and social security as political cover. These limited benefits are overwhelmed by the effect of cuts to health insurance, nutrition assistance, and other federal aid, so that the entire package favors the wealthy. Yale Budget Lab analysis of tariffs in place as of June 1 and the bill as of June 16 (very close to final passage) reveals the combined distributional impact: the lowest income decile (under $40,000) is projected to lose 6.6% (-$2,620 per household), while the highest decile ($517,100 average) would gain 1.5% (+$7,800 per household). The net effect is negative for the bottom 80% of households (below $171,000).
Specific tradeoffs to achieve the budget targets set for reconciliation reveal its brutality: Border and Immigration funding increases $132B (including $45B for detention and $47B for the border wall) while nutrition programs are cut by $186B. Medicaid cuts of $992B and ACA premium support cuts of $147B collectively eliminate healthcare coverage for nearly 12 million people. Defense spending increases $150B, funded by $153B in assorted cuts including $73B from terminating Green New Deal and green technology subsidies.
Over the long term, increased isolationism, protectionism, and economic brutality are likely to contribute to higher geopolitical, economic, and social instability, and move the U.S. back toward the Hobbesian state of “nasty, brutish, and short” lives. However, equity markets operate in the short-term, with several drivers allowing a near-term optimistic read on corporate profits. The administration’s deregulation agenda cuts short-term corporate costs while permitting increased externalities such as air and water pollution. Deregulation also rolls back safety and labor protections, and relaxed financial regulations allow higher leverage ratios, increasing risk. And, however brutal the economic policy toward the poor and middle class, the corporate tax changes support profit rates. Equity markets have taken notice, pricing out almost all of the risk for tariffs scheduled to begin on August 1.
Following a disappointing first quarter and a bumpy start to the second quarter due to “Liberation Day” tariffs, U.S. equity markets roared back after Trump’s 90-day pause on reciprocal tariffs. The S&P 500 returned +10.9% (+6.2% YTD). Larger caps outperformed with Russell 1000 at +11.1% vs. Russell 2000 at +8.5%. Growth dominated value: Russell 3000 Growth returned +17.6% vs. Value at +3.8% (YTD: Growth 5.8%, Value 5.5%). International markets advanced with MSCI ACWI ex-USA at +12.2%. Within the S&P 500, Information Technology led sectors at +23.7%, followed by Communication Services at +18.5%, while Energy (-8.6%) and Healthcare (-7.2%) lagged.
In fixed income, credit spreads remained tight and Treasury yields were fairly stable. The Bloomberg US Aggregate Bond index rose +1.2%, the Bloomberg US Intermediate Government/ Credit Index rose +1.7%, and the Bloomberg Municipal Intermediate 1-10 Year Index rose +1.0%.
Despite the strong rally, S&P 500 valuation was almost unchanged at 20.0 times expected earnings for the next 12 months (vs. 20.2 times in Q1) and is now 1.5 standard deviations above its 30-year average of 17.0 times. The 12-month forward earnings yield of 4.5% is 2.6 percentage points above the 10-year Treasury Inflation Protected Securities (TIPS) yield of 1.9%, indicating a modest expected return advantage for equities over bonds. However, the cyclically adjusted price-to-earnings (CAPE) ratio, which references 10 years of inflation adjusted earnings, is more extended, at 37.6 times, or 1.49 standard deviations above its 30-year average of 28.3 times. Valuations are quite elevated given stagflation risks from threatened tariff increases in August. Reported first quarter earnings were somewhat better than expected, but as we expected, many companies pulled guidance citing an extraordinarily cloudy outlook.
With the budget bill now signed, tariff uncertainty looms large. While Trump’s IEEPA authority faces court challenges (with a hearing scheduled for July 31), there are other, less sweeping laws and provisions that Trump can use in its place. On July 7, Trump announced 25% tariffs for five countries, including Japan and South Korea, and 40% tariffs on Laos and Myanmar; additional tariffs are expected to follow. Markets are not discounting higher tariffs at this point despite levels not seen since World War II. We do not have clear insight into the feed-through into consumer demand or into capital goods costs. On a longer-term basis, continued strengthening of ex-U.S. global trade relationships may limit U.S. markets in the future.
We have not yet seen a substantial effect on consumer prices, but anticipate increasing flowthrough. Soft indicators such as sentiment, new orders, and job creation in goodsproducing sectors have weakened. However, the budget bill’s expansionary effects via the retroactive business equipment deduction precede most of the contractionary effects such as cuts in nutrition assistance and Medicaid, which are delayed until after the next election. We therefore do not expect the economy to fall into recession in 2025.
We recognize the longer-term risks to the environment and civil society from current policies, but acknowledge that the U.S. economy has proven to be quite resilient in the long term to shocks. We are therefore maintaining a neutral allocation to equities across risk tolerance levels. Market pain often indiscriminately hits all stocks, including those for quality companies that are well run and have strong balance sheets that offer considerable resilience, offering opportunities to establish or increase positions in wellpositioned companies. We continue to assess holdings across sectors to judiciously sift for good values and balance risk and reward across multiple dimensions.
We continue to seek quality in our holdings, especially in an increasingly uncertain economic environment. As businesses ponder where to source inputs and where to locate production, companies with strong balance sheets, demonstrated profitability, and steadier revenue flows will have more flexibility in making those decisions. Our cautious positioning is now providing some protection in deeply unsettled markets.
As a baseline for individual portfolio decisions, we continue to slightly favor stocks over bonds as a strategic allocation, even as we face considerable economic and political uncertainty. We recognize that stocks may have considerable additional risk over the immediate horizon, and that bonds frequently provide a diversification benefit to portfolio construction. Nonetheless, over investment horizons longer than ten years, stocks provide substantial protection against rising prices that bonds do not and therefore merit a place in an investors’ strategic asset allocation.
As the Trump administration engenders policy chaos and uncertainty, guts environmental protections, turbocharges deportation actions and internment camps, and increases the authoritarian posture of the government, we believe it is critical to identify and invest in companies that manage ESG risks. These companies will be positioned to benefit from the continued importance of diversity, climate change, and workplace satisfaction to company financial performance. These issues remain strategically significant, and wise leaders will remain committed to managing the associated risks.
The president’s protectionist impulses drove market volatility during the second quarter. As Trump signaled upcoming tariffs, the S&P 500 peaked on February 19. By April 8, six days after his “Liberation Day” reciprocal tariff announcement, the index had fallen 18.7%, with price-to-earnings ratios dropping from 26.6 times to 18.6 times, while volatility reached 2020 and Great Financial Crisis levels. Bond and foreign exchange markets also showed signs of stress, leading Trump to maintain a 10% tariff on all trading partners, but suspend the proposed reciprocal tariffs for 90 days.
As traders and investors gained confidence in the TACO trade (Trump Always Chickens Out), equity markets recovered and reached new highs by quarter end. However, bond and foreign exchange markets evinced deeper concerns: Growth expectations embedded in the 10-year Treasury yield dropped by just over 0.25% during the quarter, indicating that investors believe the effect of the tariffs will reduce long-term economic growth. The US Dollar Index fell –10.7% for the year to date, dropping –7.0% during the quarter. With new tariffs planned for August 1, 2025 and only the UK, China, and Vietnam announcing deal frameworks, effective tariff rates have risen from 4% as of year-end 2024 to an estimated 15%, potentially reaching 30% if reciprocal tariffs are restored.
Congress narrowly passed the “One Big Beautiful Bill” on July 3. Due to muddled baseline measurements, the 10-year debt impact appears as either a $0.5T reduction, achieved by dismantling the pro-environment IRA, or a $3.25T increase. The difference is that using the current policy as a baseline obscures the effect of making permanent the tax cuts enacted in the first Trump administration. The bill is modestly expansionary through October 2029 but contractionary thereafter, including a provision for $600B in new business tax cuts covering full, immediate expensing for capital equipment, while extending corporate and personal tax cuts and slashing domestic discretionary spending.
A better name for the legislation would be the One Big Brutal Bill. The now-permanent tax cuts largely benefit businesses and the wealthy, using small and time-limited cuts to taxes on tips, overtime, and social security as political cover. These limited benefits are overwhelmed by the effect of cuts to health insurance, nutrition assistance, and other federal aid, so that the entire package favors the wealthy. Yale Budget Lab analysis of tariffs in place as of June 1 and the bill as of June 16 (very close to final passage) reveals the combined distributional impact: the lowest income decile (under $40,000) is projected to lose 6.6% (-$2,620 per household), while the highest decile ($517,100 average) would gain 1.5% (+$7,800 per household). The net effect is negative for the bottom 80% of households (below $171,000).
Specific tradeoffs to achieve the budget targets set for reconciliation reveal its brutality: Border and Immigration funding increases $132B (including $45B for detention and $47B for the border wall) while nutrition programs are cut by $186B. Medicaid cuts of $992B and ACA premium support cuts of $147B collectively eliminate healthcare coverage for nearly 12 million people. Defense spending increases $150B, funded by $153B in assorted cuts including $73B from terminating Green New Deal and green technology subsidies.
Over the long term, increased isolationism, protectionism, and economic brutality are likely to contribute to higher geopolitical, economic, and social instability, and move the U.S. back toward the Hobbesian state of “nasty, brutish, and short” lives. However, equity markets operate in the short-term, with several drivers allowing a near-term optimistic read on corporate profits. The administration’s deregulation agenda cuts short-term corporate costs while permitting increased externalities such as air and water pollution. Deregulation also rolls back safety and labor protections, and relaxed financial regulations allow higher leverage ratios, increasing risk. And, however brutal the economic policy toward the poor and middle class, the corporate tax changes support profit rates. Equity markets have taken notice, pricing out almost all of the risk for tariffs scheduled to begin on August 1.
Following a disappointing first quarter and a bumpy start to the second quarter due to “Liberation Day” tariffs, U.S. equity markets roared back after Trump’s 90-day pause on reciprocal tariffs. The S&P 500 returned +10.9% (+6.2% YTD). Larger caps outperformed with Russell 1000 at +11.1% vs. Russell 2000 at +8.5%. Growth dominated value: Russell 3000 Growth returned +17.6% vs. Value at +3.8% (YTD: Growth 5.8%, Value 5.5%). International markets advanced with MSCI ACWI ex-USA at +12.2%. Within the S&P 500, Information Technology led sectors at +23.7%, followed by Communication Services at +18.5%, while Energy (-8.6%) and Healthcare (-7.2%) lagged.
In fixed income, credit spreads remained tight and Treasury yields were fairly stable. The Bloomberg US Aggregate Bond index rose +1.2%, the Bloomberg US Intermediate Government/ Credit Index rose +1.7%, and the Bloomberg Municipal Intermediate 1-10 Year Index rose +1.0%.
Despite the strong rally, S&P 500 valuation was almost unchanged at 20.0 times expected earnings for the next 12 months (vs. 20.2 times in Q1) and is now 1.5 standard deviations above its 30-year average of 17.0 times. The 12-month forward earnings yield of 4.5% is 2.6 percentage points above the 10-year Treasury Inflation Protected Securities (TIPS) yield of 1.9%, indicating a modest expected return advantage for equities over bonds. However, the cyclically adjusted price-to-earnings (CAPE) ratio, which references 10 years of inflation adjusted earnings, is more extended, at 37.6 times, or 1.49 standard deviations above its 30-year average of 28.3 times. Valuations are quite elevated given stagflation risks from threatened tariff increases in August. Reported first quarter earnings were somewhat better than expected, but as we expected, many companies pulled guidance citing an extraordinarily cloudy outlook.
With the budget bill now signed, tariff uncertainty looms large. While Trump’s IEEPA authority faces court challenges (with a hearing scheduled for July 31), there are other, less sweeping laws and provisions that Trump can use in its place. On July 7, Trump announced 25% tariffs for five countries, including Japan and South Korea, and 40% tariffs on Laos and Myanmar; additional tariffs are expected to follow. Markets are not discounting higher tariffs at this point despite levels not seen since World War II. We do not have clear insight into the feed-through into consumer demand or into capital goods costs. On a longer-term basis, continued strengthening of ex-U.S. global trade relationships may limit U.S. markets in the future.
We have not yet seen a substantial effect on consumer prices, but anticipate increasing flowthrough. Soft indicators such as sentiment, new orders, and job creation in goodsproducing sectors have weakened. However, the budget bill’s expansionary effects via the retroactive business equipment deduction precede most of the contractionary effects such as cuts in nutrition assistance and Medicaid, which are delayed until after the next election. We therefore do not expect the economy to fall into recession in 2025.
We recognize the longer-term risks to the environment and civil society from current policies, but acknowledge that the U.S. economy has proven to be quite resilient in the long term to shocks. We are therefore maintaining a neutral allocation to equities across risk tolerance levels. Market pain often indiscriminately hits all stocks, including those for quality companies that are well run and have strong balance sheets that offer considerable resilience, offering opportunities to establish or increase positions in wellpositioned companies. We continue to assess holdings across sectors to judiciously sift for good values and balance risk and reward across multiple dimensions.
We continue to seek quality in our holdings, especially in an increasingly uncertain economic environment. As businesses ponder where to source inputs and where to locate production, companies with strong balance sheets, demonstrated profitability, and steadier revenue flows will have more flexibility in making those decisions. Our cautious positioning is now providing some protection in deeply unsettled markets.
As a baseline for individual portfolio decisions, we continue to slightly favor stocks over bonds as a strategic allocation, even as we face considerable economic and political uncertainty. We recognize that stocks may have considerable additional risk over the immediate horizon, and that bonds frequently provide a diversification benefit to portfolio construction. Nonetheless, over investment horizons longer than ten years, stocks provide substantial protection against rising prices that bonds do not and therefore merit a place in an investors’ strategic asset allocation.
As the Trump administration engenders policy chaos and uncertainty, guts environmental protections, turbocharges deportation actions and internment camps, and increases the authoritarian posture of the government, we believe it is critical to identify and invest in companies that manage ESG risks. These companies will be positioned to benefit from the continued importance of diversity, climate change, and workplace satisfaction to company financial performance. These issues remain strategically significant, and wise leaders will remain committed to managing the associated risks.
Learn how Trillium’s impactful investment strategies transform investor capital into a catalyst for change.
