The Carson Investment Team was proud to release our Midyear Outlook 2025: Uncharted Waters last week. Few would have thought at the April 8 lows, with the S&P 500 down nearly 20%, that markets would make such a furious comeback. Yet here we sit in early July with the S&P 500 at a total return of 7.2% year to date as of July 11, well on pace for our full year Outlook 2025 target of 12–15%. If you look just at the end point, it looks like a perfectly ordinary year for markets in an economic expansion so far, but we know it’s been anything but. Still, while the volatility was unusual it’s important to keep in mind that something regularly comes along that sets markets on edge and a 10% decline at some point during a year is not the exception—it’s the norm.
While the potential for “animal spirits” we talked about in our Outlook 2025 hasn’t really manifested, the market rebound certainly highlighted the kind of environment we thought we might see, and animal spirits or no, our views led us to be one of the few strategists not to revise our forecasts near the market lows. Since then, stocks have indeed come back to a place we would view as on target for this point in the year.
Our theme for our Midyear Outlook is “uncharted waters.” While the future is always uncharted, we are in a period where the president of the United States has chosen to try to wield the power of his office to reshape the US economy, and by extension the global economy. We really haven’t seen anything similar since Franklin Roosevelt’s presidency, granted with very different goals. The policy initiatives have increased uncertainty around trade, inflation, the labor market, and monetary policy, to highlight some key areas that markets care about. But underneath the surface, forces outside of policy—the small decisions that consumers, business, and entrepreneurs make every day—are still a source of stability. Our economy may not be meeting its full potential, but while we monitor what’s happening with policy the economy is muddling through just fine for now and some policy tailwinds we anticipated have started coming into play.
Our fundamental takeaways for the second half of the year:
- The economy is slowing but we see no evidence of a recession on the horizon and expect growth to be strong enough to continue to support profit growth and stock gains.
- We are maintaining our target of a 12–15% total return for the S&P 500 Index in 2025.
- We continue to recommend being overweight equities but are no longer at our maximum overweight.
- Inflation uncertainty and a slower path for Fed rate cuts will limit some of bonds’ benefit as a diversifier, but we still think the Bloomberg Aggregate Bond Index can end the year with a 4–7% total return.
- While bonds remain an important diversifier, we recommend including other forms of diversification for both stocks and bonds, including some exposure to international stocks, low volatility stocks, gold, and managed futures (a trend-following strategy across different asset types, including commodities).
Economy – Slowing but Not Recessionary
The two main risks we saw for the economy in our Outlook 2025, uncertainty around tariff policy and higher-for-longer interest rates, have been bigger challenges than expected so far this year. Both the timing and scope of tariff policies have been far more aggressive than during the first Trump administration. During his first administration, the president also made fiscal policy his top priority, achieved primarily through the Tax Cuts and Jobs Act. Tariffs came later and the policy was also more focused. The emphasis was on China, squarely targeting unfair trade practices, and those tariffs were largely kept in place by the Biden administration. There are some deep divisions between Democrats and Republicans, but tariffs on China were a place where the first Trump administration had actually won a bipartisan consensus. Then there was a reworking of the North American Free Trade Agreement (NAFTA), which had aged and needed an update. But we did receive some hints of what was coming in Trump’s second term with various broad sectoral tariffs (including solar panels, washing machines, steel, and aluminum).
During his second administration, the president has prioritized enacting sweeping trade policy that harken back to the Smoot Hawley tariffs enacted at the start of the Great Depression. Smoot Hawley may have had the right intention—protect American businesses during a period of economic decline. But instead of being a cure for the decline it in fact contributed to it, and may have even been a symptom of the decline itself, capturing a moment when the US no longer believed it could compete on a level playing field.
Policy uncertainty has created inflation uncertainty, and that has roiled the outlook for the Federal Reserve and interest rates. Fed Chair Jerome Powell has mentioned not only tariffs but also immigration, fiscal policy, and regulatory policy as clouding the outlook for inflation. This has intensified what we viewed as the second major risk, a slowdown in the path of rate cuts, which continues to weigh on more cyclical areas of the economy, especially housing. We continue to believe the Fed should be cutting more aggressively, but also agree that policy uncertainty has made balancing the Fed’s dual mandate of low and stable inflation and full employment more difficult.
At the same time, the US economy still has some important sources of strength and there are also policy tailwinds. President Trump signed the “One Big Beautiful Bill” into law on July 4. This should provide a boost to the economy and profits, but it is not likely to have as a robust effect as the Tax Cuts and Jobs Act. Another source of strength for the economy is consumer balance sheets remain quite healthy.
Bottom line, the economy is now later cycle but later cycle does not have an expiration date and can last a long time. Policy uncertainty and just normal later cycle dynamics have pushed us off the path of near 3% GDP growth we experienced the last two years, likely to something more like 1–2%. When Trump first came into office in 2017 the economy had just gone through a slowdown and that created something of a springboard for supply-side policy to boost growth. This time, the opposite was the case: the president came in following a period of fairly robust growth, and yet policy has been higher risk with the foregrounding of an aggressive tariff policy. This effect should now be partially offset by deficit-financed fiscal stimulus, deregulation, and eventually further rate easing. We are also likely to see a small but meaningful added boost from continued artificial intelligence infrastructure buildout. We believe these forces collectively will be enough to sustain the expansion, boost corporate profits, and support stock prices.
Stocks Right on Track
The story of the first half of 2025 was the volatility and weakness we saw in March and April, with the S&P 500 down nearly 19% from the February 19 peak until the lows on April 8. No, we didn’t expect to see that much weakness this year, but we also didn’t expect liberation day to be so aggressive. Neither did markets, with a two-day decline following liberation day of near 10%. The market’s verdict on the impact of the proposed tariffs was clear. From a market perspective, this simply was not good policy. Even if it was only negotiating tactic, it’s the kind of tactic that might be quite effective when running a small private business but less effective when leading the world’s largest economies. Downstream effects when running a private business are someone else’s problem, but when leading a large economy they become your problem. The president seems to have adjusted and markets responded accordingly, but we may see the president’s stance get more aggressive now that markets have recovered, and then possibly looser again if markets were to decline, and that kind of instability has a cost.
But when it comes to stocks, the main point is to remember the destination because the path may continue to be bumpy. The bottom line is that earnings growth is the fundamental driver of stock prices over time. Even if tariffs are a drag, corporate America will look for ways to limit the impact. One of the reasons we sometimes downplay the impact of policy is that while policy matters, and sometimes it matters a lot, businesses are generally skilled at navigating different policy environments. That holds for both Republican and Democratic administrations.
Another theme in our Midyear Outlook is not fearing recent market strength. To the contrary, if you follow market history you should embrace it. Of course, history doesn’t drive markets, events do, but history does provide insight on how markets typically respond to events. It won’t be the same every time but similar patterns come up again and again. Knowing history is also a great check on emotions.
Here’s one telling piece of market history from the Midyear Outlook. A near bear market (~19%) that reverses is historically bullish six months and a year out. The sample is small but the reversal makes sense. Near bear markets often mean a serious scare where the concern that soured markets didn’t have follow-through. (Note that with a low on April 8, the first six months runs all the way through October.) The next six months aren’t as strong but still see gains on average. But that’s something we’ll look at as we approach the end of the year and start thinking about our Outlook 2026.
Bonds May Be OK but Beware Higher Correlations
Higher starting yields are giving bonds a larger cushion than they’ve had in a long time. In our Outlook 2025, we thought high starting yields and the possibility of a modest decline in yields over the year would put the Bloomberg Aggregate Bond Index (“Agg”) in a position to return 4–7%. If the Fed cuts rates, that would be enough to give the Agg an advantage over Treasury bills over the year. Well, we got the modest decline in yields but not the rate cuts so far, but the Agg was still able to eke out an advantage, returning 4.0% through June 30 versus 2.1% for the Bloomberg 1–3 Month US Treasury Bill Index. The early year strength, while modest, along with shifting rate cut expectations actually led us to lower the rate sensitivity of our bond holdings in the first half. It’s not a major move, since bonds are still the best defense against a deflationary recession and Agg starting yields remain higher than Treasury bills, but a deflationary recession is not our base case so the bond holding remains a hedge, complemented by other diversifiers.
Here’s the rub. With inflation uncertainty elevated, bond correlations with stocks have increased, which means they’re potentially a less effective diversifier if stocks sell off. In the table below we look at two-year rolling correlations (lower means a better diversifier) and correlations remain quite different from the first 20 years or so of the 2000s.
Our takeaway: Don’t run from bonds, but look for other diversifiers that have provided ballast in different kinds of environments, such as gold and managed futures. We don’t recommend a lot of exposure, but a little can go a long way.
We cover these topics in our Midyear Outlook 2025: Uncharted Waters in greater depth and many more and will continue to provide our thoughts and insights over the second half of the year.
This newsletter was written and produced by CWM, LLC. Content in this material is for general information only and not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly. The views stated in this letter are not necessarily the opinion of any other named entity and should not be construed directly or indirectly as an offer to buy or sell any securities mentioned herein. Due to volatility within the markets mentioned, opinions are subject to change without notice. Information is based on sources believed to be reliable; however, their accuracy or completeness cannot be guaranteed. Past performance does not guarantee future results.
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