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Second Half 2025 U.S. Stock Market Outlook

Summary

Resilient but Tested Market: Despite extreme volatility in early 2025 – including a 21% S&P 500 plunge into bear territory on trade war fears – U.S. equities have rebounded to near all-time highs. The market’s resilience is underpinned by a still-growing economy and robust corporate earnings, but valuations are stretched (S&P 500 forward P/E back near 2021 peaks), leaving less room for error. Investors are “riding momentum” yet wary of getting caught offside.

Fed on Hold as Inflation Looms: The Federal Reserve has paused rate hikes at a 4.25–4.50% funds rate, eyeing “meaningful” tariff-driven inflation ahead. Core price gauges still hover just above the 2% target, but new import tariffs – now averaging a punitive ~15% (highest since the 1930s) – are expected to lift inflation to ~3% by year-end and slow 2025 GDP growth to ~1.4%. Fed projections suggest only two quarter-point cuts in 2025, and Chair Powell emphasizes data-dependence amid “foggy” trade policy risks. Markets are pricing ~70% odds of the first cut by September.

Economic Growth Slowing but No Recession (Base Case): Real GDP is forecast around +1.5% in 2025 – a comedown from 2024’s pace as tariffs and past rate hikes bite. Consumer spending showed unexpected weakness in Q2, and business confidence wavers. However, the labor market remains resilient (unemployment ~3.8% now, seen rising toward 4.5% by year-end) and wage growth is moderating, suggesting a potential soft landing. Tariffs could shave ~0.6 percentage points off 2025 growth and add ~0.3 pp to unemployment by Q4, but outright recession is not our base case – more a slow-growth “stagflation-lite” scenario with persistent inflation around 3%.

Sector Leadership in Flux: Leadership has been highly rotational and mercurial – no sector held the top spot for long in H1. Industrials lead year-to-date performance (a surprise outperformer, +≈10% YTD), while Energy lagged despite oil’s spring price spikes. Mega-cap tech (“Mag 7”) lagged during the spring sell-off, but is rallying again as sentiment recovers. Looking ahead, consumer discretionary and financials are poised to outperform on resilient household spending and higher-for-longer rates (a boon for bank net interest margins). Conversely, import-reliant sectors (apparel, retail) face margin pressure from tariffs, and interest-sensitive groups (real estate, utilities near-term) may trail if rates stay elevated. We recommend a neutral weight on Tech – it should participate in any relief rally, but rich valuations and export risks cap its upside. Overweight quality cyclicals (Industrials, Financials, Consumer Disc.) and underweight tariff-vulnerable sectors (Consumer Staples with global supply chains, select Tech hardware, Materials). Diversification remains key amid rapid sector churn.

Key Risks – Geopolitics & Policy: Trade war wildcards dominate: the July 9 expiration of the U.S.–China tariff pause looms, with either a new trade deal or snapback of “reciprocal” tariffs. A partial breakthrough came in late June (China agreed to expedite rare-earth exports to the U.S.), easing supply chain fears in tech/defense. Still, policy uncertainty is “a very foggy time” – any re-escalation of tariffs would jolt markets and inflation. Beyond trade, geopolitical flashpoints persist: the Russia–Ukraine war grinds on (energy and grain markets at risk of disruption), and a Middle East flare-up in June (surprise Israel–Iran conflict) briefly sent oil above $70 before a ceasefire calmed prices. That ceasefire remains fragile, keeping an oil price risk premium. Taiwan tensions are a latent tail-risk – low probability near-term, but high impact. Finally, U.S. domestic politics pose fiscal risks: debates over extending tax cuts (adding to deficits) and potential budget standoffs could rattle credit markets. Volatility is likely to remain elevated given this wall of worry.

Market Internals & Outlook: Market breadth has started to improve after a narrow mega-cap led 2024 – small-caps (Russell 2000) underperformed sharply in early 2025 but may benefit as the rally broadens beyond the top names. Retail investors have eased off the “Magnificent 7,” allowing those stocks room to reassert leadership if fundamentals permit. Sentiment flipped from extreme fear in April to cautious optimism by June, helping fuel the rebound. The CBOE VIX spiked above 50 during the April panic (highest since 2020), but has subsided to ~16–18 recently as equities stabilized. Credit spreads widened during the turmoil but normalized into summer – though high-yield spreads could gap out again if growth fears return. Overall, with the S&P 500 now “flirting with an all-time high”, the bar for further upside in H2 is high. Our base-case assumes a choppy, range-bound market with mid-single-digit upside by December, supported by modest earnings growth and lack of recession, but punctuated by event-driven volatility spikes.

The table below summarizes key market metrics and our outlook:

Index / Macro MetricLevel (Jun 28, 2025)YTD ChangeForward P/EDividend YieldTechnical (200d trend)S&P 500 (large-cap)~6,200 (near record)+4% (approx.)~20× (elevated)1.5%Above 200d MA (bullish momentum)Nasdaq Composite (tech/growth)~20,300 (record high)+2% (approx.)~26× (est.)0.8%Above 200d; regained bull marketDow Jones Industrial Average~44,000 (just below record)+5% (approx.)~18×2.2%Above 200d; lagging slightlyRussell 2000 (small-cap)~2,190 (below ’21 high)+9% (approx.)~15× (disc. to large)1.4%Above 200d; improving breadthU.S. 10-Year Treasury Yield4.3%+50 bps vs Jan––In range; inverted yield curveFed Policy Rate (upper bound)4.50%+0 bps YTD––Peaked; Fed on hold (cuts priced Q4)Inflation (Core PCE)2.1% YoY (Apr)down from 2.3% Jan––Off peak; at risk of rising on tariffsGDP Growth (2025 forecast)1.4–1.6%(vs 2.8% in 2024)––Slowing; below trendUnemployment Rate3.8% (June est.)up from 3.5% Jan––Low, starting to tick upVolatility (VIX)~17–––Below long-term avg; prone to spikes

Sources: Federal Reserve, Bloomberg, Morningstar, Reuters. Valuation metrics as of June 2025.

Index-by-Index Conditions

S&P 500: Broad Market Barometer

The S&P 500, now around 6,200, has essentially round-tripped the rollercoaster of early 2025. It set a record high in February, plunged over 20% on tariff shocks by early April, and then rallied back to record territory by late June. Fundamentally, the index’s valuation is a concern: the forward P/E multiple rebounded to ~21×, near the cycle peak seen in late 2021. With interest rates higher now, earnings must shoulder the load of further market gains, as “there is a bit less juice to squeeze from the multiple-expansion fruit”. Encouragingly, Q1 earnings surprised to the upside, but analysts have not extrapolated that optimism into H2 forecasts. Consensus expects only modest earnings growth for 2025 (low single-digits ex-energy), meaning the E in P/E needs to rise to justify any additional P gains.

From a technical perspective, the S&P has reclaimed its 50- and 200-day moving averages and is showing positive momentum. Market breadth within the index is improving – the gap between the mega-cap tech earnings growth and the rest of the market is narrowing, and a “healthy convergence” is emerging as smaller constituents contribute more to profit gains. This suggests a more sustainable rally. However, the index is near overbought levels (e.g. high RSI), and sentiment, while not euphoric, is considerably less fearful than in the spring. Any negative surprises (e.g. tariff escalation or hawkish Fed turn) could induce a quick pullback. Still, history shows that after a >10% correction like we saw, the S&P 500 tends to recover +10% or more within a year on average. Barring a recession, the path of least resistance skews mildly upward.

Our base case for the S&P 500 is a choppy grind higher to around 6,400–6,500 by year-end (roughly +5%). That assumes no new trade shock and a couple of Fed rate cuts providing a late-year tailwind to valuations. In a bullish scenario (trade deals reduce tariffs, inflation eases to ~2%, Fed cuts earlier), the S&P could break out toward ~7,000+ (low-teens percentage gains). Conversely, a bear case (tariff war reignites or a pronounced growth slowdown) could see the index backslide to ~5,300–5,500 (down ~15%). We assign the highest probability to the base/modest-upside scenario (see Monte Carlo & Scenarios below for detailed distributions).

Nasdaq: Tech Growth in an AI World

The Nasdaq Composite has just notched a fresh record above 20,000, officially emerging from its spring bear market and “confirming a bull market” again. This tech-heavy index was whipped by tariff news – its trough in April was over 20% below the peak – as investors fled high-valuation tech shares amid trade and rate fears. Mega-cap techs (Apple, Microsoft, NVIDIA, etc.) had led much of the 2023–24 gains, so they bore the brunt of profit-taking in early 2025. Now, however, many of those giants are participating in the rebound. In fact, the “Magnificent 7” are looking to reassert dominance in H2 as their relative earnings prospects stabilize. One positive sign: retail investors significantly pulled back on buying those mega-cap names earlier this year – a contrarian signal that big tech might have room to rally as positioning is no longer crowded.

Fundamentally, the Nasdaq’s valuation remains rich. The forward P/E for the Nasdaq 100 is estimated around 28–30×, and the broader composite has many unprofitable growth companies. Yet the growth outlook for tech is improving: secular drivers like cloud, AI, and software spending remain robust. There is also an influx of interest in generative AI investments – supporting the semiconductor and software names – which could drive upside surprises to earnings in 2025. The caveat is that export restrictions and “brand nationalism” could limit some tech revenue abroad. Indeed, U.S. tech firms face boycotts in some regions as retaliation for American tariffs. So far, these appear limited and short-lived, but it’s a risk for companies like Apple, NVIDIA, and others reliant on China’s market.

Technically, the Nasdaq is in a strong uptrend, well above key moving averages. However, it is also the most stretched versus long-term trend and could correct sharply if yields spike (tech stocks remain sensitive to interest rates). The stock/bond correlation has recently flipped negative – if inflation fears pick up, rising 10-year yields could again pressure Nasdaq disproportionately. We maintain a neutral weight on tech: the sector offers high growth and has shown it can weather growth scares, but valuation and geopolitical risks (export controls, Taiwan) keep us from overweighting. In H2, we expect the Nasdaq to perform in line with or slightly ahead of the S&P (perhaps +5–8%), with higher volatility. Upside could be +15% if AI-driven enthusiasm and a trade truce fuel another melt-up, while downside could be -20% if macro turns south (given its higher beta).

Dow Jones: Blue-Chips and Value Plays

The Dow Jones Industrial Average (DJIA) – now ~44,000 – remains a couple percent below its record high from late 2024. This blue-chip index, comprised of 30 large industrial, financial, and consumer companies, held up better than the tech indexes during the spring turmoil (it never fell into a bear market). However, it also lagged in the subsequent rally. Year-to-date, the Dow is up roughly 5%, trailing the S&P slightly. The Dow’s relative resilience stems from its weighting in value-oriented names and dividend payers (e.g. banks, energy, healthcare) that saw defensive inflows when high-PE tech sold off. But those same “old economy” sectors haven’t bounced as exuberantly in the relief rally.

Fundamentally, the Dow’s valuation (~18× forward earnings) is more reasonable than the S&P’s, and its dividend yield (2.2%) provides some cushion in volatile periods. Many Dow companies stand to benefit from tariff policies in a limited way – e.g. domestic-focused manufacturers might see a competitive boost from tariffs on foreign rivals, and some multinationals (Boeing, Caterpillar) could gain from any infrastructure or defense spending uptick. On the other hand, Dow components like Nike and Walmart face higher import costs (apparel tariffs raising shoe prices ~33% short-term). Margins could be pinched in consumer goods until supply chains adapt or trade tensions ease.

Technically, the Dow is in a steady uptrend but without the momentum of the broader market. Its advance has been narrower – a few stocks (e.g. Nike after a strong revenue forecast, Salesforce with tech strength) have led gains, while others lag. Notably, the Dow’s composition means it missed out on some of the tech resurgence (it has less tech exposure). We expect the Dow to grind higher in H2 but likely underperform the S&P if growth concerns remain moderate (because growth stocks may lead in a benign scenario). In a more risk-off climate (our bear case), the Dow’s defensive tilt could help it outperform on the downside. Thus, for asset allocation, the Dow (or value stocks) serve as a stabilizer. Outlook: base-case Dow to ~$45,000 (3–4% gain), bull case ~48,000 (+10%), bear case ~40,000 (-10%). We lean slightly overweight select Dow/value names, especially quality companies with strong balance sheets and pricing power that can weather inflation.

Russell 2000: Small-Cap Reawakening?

Small-cap U.S. stocks (Russell 2000 index) have started to show signs of life after a difficult start to 2025. The Russell 2000 sits near 2,190, up about 9% year-to-date but still ~10% below its all-time high from 2021. Small-caps were “particularly hard hit” in early 2025’s sell-off – the index plunged into bear market territory faster than large caps, as investors perceived smaller companies to be more economically sensitive and financially fragile in a high-rate environment. Indeed, many small-caps carry higher debt loads and felt the squeeze of rising credit costs and tightening lending after the 2024 Fed hikes.

Now, however, the outlook is improving. Paradoxically, small-caps may be more insulated from trade turmoil than large multinationals – about 80% of Russell 2000 revenues are generated domestically, so these companies face less direct exposure to tariffs and foreign slowdowns. The U.S. economy, while cooling, is still growing, which benefits local-oriented businesses. Moreover, market internals suggest a broadening rally: historical patterns show that when leadership shifts away from concentrated large-cap growth, small-caps often outperform as market breadth improves. We appear to be at such a juncture – the top 10 stocks’ share of the S&P has begun to slip from record highs, a positive sign for the “rest” of the market.

Valuations for small-caps are attractive relative to big-caps. The Russell 2000 forward P/E (~15–16×) is at a sizable discount to the S&P 500’s ~20+×. Even accounting for many unprofitable microcaps, the valuation case and higher expected earnings growth in 2025 (small-cap earnings are projected to rebound more strongly than large-caps next year) have drawn interest from contrarian investors. Quality will be key, however – we favor small-cap firms with solid balance sheets and consistent profitability to navigate any economic bumps.

In H2 2025, small-caps could shine if the economic outlook stabilizes. We saw a preview in Q2: as fear subsided, the Russell outpaced the S&P during certain rebound phases, and broadened participation suggests the worst may be over for small stocks. Our base-case is for the Russell 2000 to post mid to high-single-digit gains in H2, perhaps ending ~2,350–2,400 (+8% to +10%). That assumes no recession and easing credit conditions. In a bull scenario of stronger-than-expected growth or upside trade resolution, small-caps could rally 20%+ (they have more leverage to economic upside after underperforming so long). In a bear scenario, small-caps would likely fall harder again (they are high-beta), possibly giving back 15–20%. Given the attractive risk/reward, we suggest a moderate overweight to small-caps within a diversified equity portfolio – for the first time in a while, they offer compelling value and could “benefit from declining market concentration” as leadership broadens.

Macro Drivers: Policy, Economy, and Earnings

Federal Reserve, Rates and Inflation Trajectory

Monetary policy enters H2 at a critical juncture. The Fed’s aggressive tightening cycle of 2022–24 successfully tamed the post-pandemic inflation surge, with core PCE inflation easing to ~2.1% as of April. However, the late-breaking tariff shock threatens to “rekindle” inflation in the coming months. Fed Chair Jerome Powell has made clear that if not for the trade turmoil, rate cuts might be warranted by now – but with a “cost shock coming” from tariffs, the Fed is in wait-and-see mode.

At its June meeting, the Fed held rates steady at 4.25–4.50% and “penciled in” only two quarter-point rate cuts by the end of 2025. In other words, policy will remain relatively tight for longer. The Fed’s latest forecasts reflect a stagflation-lite scenario: 2025 year-end inflation ~3.0% (vs 2% goal) and GDP growth ~1.4%, with unemployment rising to ~4.5%. This baseline assumes tariffs add some inflation and drag on growth. Powell emphasized the uncertainty, noting policymakers hold these rate path projections “with little conviction” given the “foggy” outlook on trade policy. Translation: The Fed is prepared to adjust if conditions change – if inflation accelerates more than expected, cuts could be delayed (or another hike isn’t off the table), whereas a sharper growth slump could prompt earlier easing.

For markets, the policy stance implies a cap on exuberance but also a backstop. High rates (the 2-year yield ~4.8%) provide competition for equities and keep valuation expansion in check – one reason we aren’t seeing P/E multiples run far higher even after the rally. On the other hand, the Fed on hold, with possible cuts on the horizon, removes the pressure of ever-tightening financial conditions. Indeed, futures price in about a 75% chance of one 25 bp cut by the September FOMC and roughly two cuts by year-end. Our view is the Fed likely delivers one cut in Q4 (probably December) assuming inflation peaks around ~3% and the job market softens somewhat. If the tariff pass-through is more benign (e.g. companies absorb costs or shift sourcing), inflation could surprise lower, opening the door for an earlier cut in September (a bullish case for equities and bonds). Conversely, if inflation flares toward 4% by autumn (tariffs plus, say, an oil price spike), the Fed might forgo any 2025 cuts – a downside risk for markets.

Bottom line: monetary policy is not in easing mode yet, but the “end of tightening” removes a key headwind. The trajectory of inflation in H2 (watch core PCE and CPI) will determine if the Fed becomes a friend to markets again by cutting, or stays restrictive. We expect the Fed to tread cautiously and keep messaging data dependence. For investors, this means interest rate volatility (and thus equity volatility) may stay elevated around CPI and Fed meetings. Also, the inverted yield curve (3m–10y deeply negative) signals the bond market’s growth concerns; any steepening via falling short rates would be a positive signal that Fed policy is finally easing. We will be closely watching Fed communication for hints of shifts in H2.

Economic Outlook: Growth Downshift, Labor Market, and GDP

The U.S. economy heads into late 2025 on a slower footing but still displaying remarkable resilience in avoiding recession thus far. After an estimated ~2.8% real GDP growth in 2024, consensus expects growth to slow to ~1.5% in 2025. The first half likely averaged only around 1% growth (Q2 was choppy with some inventory drawdowns and tariff-related caution). Recession fears spiked in early 2025 during the market turmoil, but several factors kept the economy above water: a still-healthy jobs market, resilient consumer spending (especially among higher-income households), and a rebound in business investment in Q1 as firms rushed orders ahead of tariff hikes.

Looking ahead, key supports and drags can be identified:

Consumer & Labor: The U.S. consumer, which is ~70% of GDP, has moderated but not cracked. Real consumer spending was actually positive in Q1 and early Q2, though May saw a slight contraction in income and outlays. With unemployment still historically low (~3.7–3.8%) and wages growing ~4–5%, households have some buffer. However, confidence surveys (e.g. University of Michigan) show sentiment well below late 2024’s post-election highs, reflecting people’s anxiety over prices and uncertainty. We expect job growth to continue slowing – job openings have come off their highs, though April saw a surprise uptick to 7.4 million openings, indicating firms aren’t panicking. Companies appear to be “hoarding labor” until they are very sure of a downturn. Thus, layoffs may remain limited, keeping consumer spending on a modest growth path. Watch for a potential uptick in unemployment to the mid-4% range by year-end (as the Fed projects), which would still be relatively benign historically.

Business Investment & Manufacturing: Manufacturing has been a soft spot – the ISM factory index is in contraction (sub-50) and even the large service sector saw a wobble into contraction in June. Tariffs have gummed up supply chains (suppliers reporting delivery delays on par with COVID disruptions) and dented export order books. We anticipate capital spending to slow in H2 given higher financing costs and uncertainty. However, certain areas like equipment for AI, defense, and infrastructure might stay strong (backed by fiscal programs and secular demand). Also, any clarity on tariffs (even if they remain, just less uncertainty) could unleash some pent-up investment later in the year. For now, we factor in tepid manufacturing output and flat business capex in our base case.

Trade and Inventories: Net exports will likely be a slight drag – tariffs reduce import volume but also provoke retaliation that hits U.S. exports (e.g. China and others have retaliatory tariffs). The OECD projects global growth to slow to 2.9% in 2025, which means external demand for U.S. goods is weaker. One bright spot: a softer U.S. dollar (the dollar index fell after the tariff announcement, reversing prior strength) could aid exports in non-tariffed categories. Inventories contributed positively to Q1 GDP (with pre-tariff stockpiling) but may swing negative if firms run down stock due to uncertain demand. This is a volatile component to watch quarter to quarter.

Government & Fiscal: Government spending is providing a modest tailwind, particularly via infrastructure outlays and defense (the latter likely to rise given geopolitical tensions). However, the fiscal picture has its risks: the extension of the 2017 tax cuts (currently debated in Congress) could widen the deficit, which bond markets have not ignored – April’s jump in long-term yields was partly on deficit worries. A fight over government funding or the debt ceiling (which could emerge in 2025 or 2026) would introduce downside risk. For now, fiscal policy is somewhat expansionary but may turn into a concern for investors if debt issues come to the forefront (potentially pressuring credit spreads and Treasury yields up).

In summary, we expect U.S. GDP growth around 1–2% (annualized) in H2, resulting in about 1.5% for the full year. This assumes consumer spending grows at a modest 1–2% pace, unemployment edges up but stays <5%, and inflation around 3% keeps real incomes roughly flat. It’s a slow-growth environment, but not a recession – essentially a continuation of the “expansion fatigue” seen pre-pandemic, albeit with higher inflation. Notably, recession odds, while lower than in the tumult of April, are not zero. Should the trade war worsen significantly (tariffs fully snap back, more aggressive retaliations), a mild recession could unfold in 2026. But if a trade truce or clear framework emerges, confidence and growth could actually surprise to the upside next year. Thus, the economy is at an inflection point, highly contingent on policy developments in the near term.

Corporate Earnings and Market Fundamentals

Corporate earnings are the lifeblood of this market recovery. After a surprisingly strong Q1 (S&P 500 earnings grew ~5% YoY, beating estimates), there is cautious optimism for the rest of 2025. However, many companies have been reluctant to issue upbeat guidance given tariff-related cost uncertainty. Margins face cross-currents: on one hand, input cost inflation had been easing pre-tariffs (lower energy prices YoY, normalized supply chains), but on the other, tariffs are effectively a tax on inputs, especially in sectors like retail, machinery, and autos. Companies will try to pass these costs onto consumers – but with consumer inflation expectations fairly contained and spending slowing, pricing power may be limited. Thus, we could see some margin compression in H2, particularly in consumer goods and industrials. The Budget Lab analysis suggests consumer prices might rise ~1.3–1.5% due to tariffs in the short run; if firms succeed in passing that on, revenues could inflate nominally but volume may drop, testing profitability.

By sectors:

Technology: Big tech earnings are expected to resume growth after a flat 2024. Cloud spending, digital ads, and AI-related demand are tailwinds. Export-oriented semiconductor firms could see some revenue hit from China restrictions, but the rare-earth deal in June ensures critical inputs remain available, averting a worst-case supply crunch for now. Overall, tech EPS could grow high-single digits in 2025, supporting the Nasdaq.

Financials: Banks and insurers benefit from higher interest income (banks) and yields (for investing insurance float). Credit quality is so far stable, though we watch small business loan defaults if the economy weakens. The yield curve inversion hurts bank margins to a degree, but many banks have managed through with pricing power on loans. Financials could deliver mid-single-digit earnings growth.

Energy: Energy sector earnings are the big wildcard – oil prices have whipsawed from $80s down to $60s and briefly up on the Iran conflict. Current oil at ~$70 is below last year’s levels, so energy sector EPS will likely be down in 2025 unless prices rebound. We note Goldman Sachs projects Brent oil could average ~$95 in Q4 2025 if Middle East risks persist (and $80 if not). Our base case assumes oil averages $75–80, enough for energy firms to remain highly profitable but with lower YoY earnings.

Consumer Discretionary: This sector (autos, retail, leisure) should see decent earnings growth if consumers keep spending. Lower commodity input costs (gasoline was lower YoY for much of H1) gave some relief, but tariffs on goods like apparel are biting (as noted, apparel and footwear costs jumping >15% long-term from tariffs). Luxury and high-end retailers seem resilient (wealthier consumers still spending), whereas low-end retail is more challenged. The autos subsector faces both higher input costs (steel tariffs) and higher financing costs for consumers – not a great combo, so we are cautious there.

Healthcare and Staples: Generally defensive, with steady if unspectacular growth. Drugmakers face political risk (drug price negotiations) but otherwise have stable outlooks. Tariffs don’t directly hit much here except certain medical supplies. We expect low-to-mid-single-digit EPS growth for these sectors.

Industrials & Materials: Industrials had strong earnings momentum early in 2025 (aided by pre-tariff order rushes and robust aerospace/defense demand). Tariffs on steel/aluminum (now 50% on many imports) raise input costs for machinery and construction firms, potentially squeezing margins unless they can raise prices on customers (which, for government or infrastructure projects, might be feasible with contract adjustments). Materials (chemicals, metals) face a slower global economy and direct tariff impacts (e.g. chemicals to China). We expect flat to slightly down earnings for Materials, and modest growth for Industrials (with defense spending a bright spot).

Overall S&P 500 earnings are on track to grow perhaps ~5% in 2025 (ex-energy, closer to 8%). That is enough to support the mid-single-digit market return we forecast, given the starting valuations. The risk to earnings is if the economy slows more than expected or if companies find they cannot pass through tariff costs (leading to a hit on margins). Conversely, if a comprehensive trade deal is struck (removing some tariffs by late 2025) or if the dollar stays weaker, we could see an upside surprise to earnings via improved profit margins and export volumes.

Importantly, the market’s breadth of earnings is improving: last year, a handful of tech giants drove an outsize share of S&P profits, but now earnings growth is “broadening out” beyond the Mag 7. For example, small-cap earnings in Q1 actually grew nearly 10% year-on-year (and ex-Energy, +22%!), signaling that many smaller firms are recovering profitability as the pandemic disruptions fade. This breadth is a healthy sign; it means the market is less vulnerable to a disappointment from any single big company.

In sum, fundamentals for equities are mixed but mostly supportive: moderate earnings growth, high but not extreme valuations (especially relative to bonds at ~4.3% yields, the equity risk premium is about average), and shareholder payouts (dividends + buybacks) continuing strong. Corporate balance sheets have weakened a bit (debt is higher, interest costs up), but large firms termed out debt at low rates, so imminent stress is limited. Smaller firms are more exposed to refinancing, which bears watching in 2026–27, but not an H2 2025 story yet.

Sector Rotation and Market Internals

One hallmark of 2025’s market has been rapid sector rotations. Analysts dubbed it a “sector quilt” of leadership – with different sectors swapping the top performance spot every couple of weeks. In the first half, Industrials quietly outperformed all other sectors (a year-to-date leader despite only briefly topping the charts in any short interval). This strength came from areas like aerospace/defense (geopolitical demand) and industrial automation firms seeing solid orders. Energy, in contrast, delivered one of the worst YTD returns by June, despite oil price volatility – reflecting concerns about global demand and the fact that energy stocks had run up in prior years.

Financials and Consumer Discretionary are two sectors we have a positive bias on for H2. As noted in the summary, consumer discretionary (retail, travel, autos) should benefit from continued consumer spending – particularly households in higher income brackets, who remain in good shape and are spending on experiences and goods post-pandemic. This sector also was beaten down during tariff scares (e.g. apparel retailers fell hard), so valuations are attractive. Any relief on the trade front (or creative rerouting of supply chains to avoid tariffs) could lead to sharp rebounds in retail/apparel names. Financials (banks, insurance) are set to gain from the “higher for longer” rate environment – banks earn more on loans, and credit losses so far remain low. They also tend to perform well in the late-cycle phase of an expansion until the economy rolls over. With our base case avoiding recession in 2025, financials’ cyclical risk is moderate.

We are more cautious on sectors like Utilities and Real Estate in the near term, as they face interest rate headwinds (their dividend yields have competition from bonds now, and they are often used as bond proxies). That said, a notable long-term theme is emerging for utilities: the demand for electricity is set to rise with the AI and tech boom (data centers, crypto, etc.), potentially benefiting well-positioned utilities down the road. In fact, “utilities stand to benefit from heightened demand for energy to fuel innovation in generative AI”. This is a longer-term tailwind that could make the traditionally defensive utility sector a stealth play on tech growth. But for H2, we think utilities will lag unless interest rates fall significantly.

Technology and Communication Services (which includes Internet, media, telecom) have been so central to market moves that it’s hard to call them simply “sectors.” Within Tech, we favor semiconductors and software over hardware in H2. Semiconductors (despite being caught in U.S.–China crossfire) have strong global demand (AI chips, automotive chips). The rare-earth export agreement in June should alleviate one supply bottleneck for chip production. If Taiwan geopolitical risk remains low, we expect chip stocks to do well on secular growth. Big hardware (smartphones, PCs) is more challenged, with saturation and Chinese competition (plus potential consumer boycotts of U.S. brands abroad). Communications is a mixed bag: streaming and entertainment face a slower advertising market, but select media and telecom stocks have high dividend yields that might attract investors if volatility rises.

Materials and Energy are the most directly commodity-driven sectors. For Materials, tariffs on imported metals (steel/aluminum) actually help U.S. steel producers (they enjoy price support domestically), but hurt manufacturers who consume steel (as discussed). Chemicals companies face higher input costs for any imported inputs and slower global demand. Precious metals miners might perform well if gold prices climb (gold often rises with geopolitical risk and if real yields fall). We have a neutral stance on Materials – not expensive, but lacking a catalyst unless global growth surprises positively. Energy stocks will follow oil and gas prices. Given the murky oil outlook (tension between OPEC+ managing supply vs demand worries in a slower economy), we are neutral on Energy in base case. Notably, if there is any escalation in the Middle East (Iran conflict reignites or other supply disruption), energy would spike and energy stocks would be big beneficiaries – so a case for holding some energy as a hedge. But lacking that, policy trends (the administration’s less fossil-friendly stance) and potential windfall taxes in Europe keep some lid on the sector.

Market breadth deserves a deeper look. Earlier in 2025, breadth was extremely narrow – at one point, just a handful of mega-caps kept the S&P 500’s decline from being worse. The Ned Davis “Crowd Sentiment” poll hit extreme pessimism in April, which paradoxically helped establish a bottom as contrarians stepped in. Since then, breadth has improved: roughly 60% of S&P stocks are back above their 200-day moving average (up from <30% in April’s depths). We’re also seeing small-caps and mid-caps outpace large-caps in some rallies, indicating broader participation. A “carnival of the animal spirits” is tentatively returning – sentiment rebounded from extreme fear to a level historically associated with strong market gains as long as it stays short of euphoria. Indeed, that poll is now in the optimal zone (neither too euphoric nor pessimistic) that has been supportive for stocks in the past.

Volatility measures confirm the changing mood: the VIX’s round-trip from 52 in April to the mid-teens now signals that panic has given way to complacency. We caution that volatility could spike again – perhaps not to 50 unless another shock of similar magnitude – but into the 20s on any negative headlines. The skew in options (demand for puts vs calls) remains higher than pre-2020 norms, suggesting investors are still buying downside protection (a positive, as it means less outright complacency).

Credit spreads (corporate bond yield premiums) widened significantly during the April turmoil as liquidity dried up, but the Fed’s calming words and the tariff pause helped spreads retrace. High-yield (junk bond) spreads in mid-June are only mildly above year-end levels. As long as credit markets function and companies can refinance debt, equities usually avoid deep trouble. We monitor credit as an early warning – if high-yield spreads blow out past, say, 600 bps over Treasuries (currently ~400 bps), it could signal stress that might presage equity downside.

In conclusion on sectors and internals: we advocate a balanced, quality-oriented allocation. Prefer sectors with pricing power, domestic focus, and solid balance sheets (industrials, financials, select consumer and healthcare) and be cautious on those reliant on global trade flows or ultralow rates. The rapid rotations mean being nimble – extremes can correct quickly (for instance, if tech runs too hot, rotate some profits into laggards like small-caps or financials, and vice versa if panic returns).

Below is our sector risk/reward snapshot for H2 2025:

Overweight: Industrials (defense and infrastructure tailwinds), Financials (rate benefit, value), Consumer Discretionary (pent-up demand, especially in travel/leisure and high-end retail).

Market Weight: Technology (long-term growth intact, but export/tariff risks), Health Care (stable earnings, some political risk), Communication Services (mixed outlook).

Underweight: Consumer Staples (margin pressure from tariffs on food/imports, limited growth), Utilities (short-term rate headwind, though long-term positive secular demand), Materials (global slowdown risk), Energy (range-bound oil prices expected; maintain some exposure as geopolitical hedge).

Geopolitical and External Risks

Several geopolitical wildcards hang over the market in the second half:

Trade War & China Relations: The U.S.–China trade conflict is front and center. After imposing sweeping tariffs on virtually all imports (10% base, with punitive rates up to 245% on China) in April, the Trump administration paused further escalations for 90 days (through July 9). As that deadline nears, negotiations are ongoing. Positively, an agreement was struck to allow critical Chinese rare earth mineral exports to the U.S., avoiding an embargo that could cripple tech manufacturing. This hints at compromise. However, tensions remain high – China’s economy has slowed and its leaders bristle at what they see as economic provocation. The risk is a collapse in talks leading to full tariff implementation on both sides. That would likely roil markets: we could see another risk-off wave with spikes in volatility, drops in cyclicals, and possibly a Fed policy rethink (they might turn more dovish to offset the shock). Conversely, a U.S.–China trade deal removing some tariffs would be a huge upside surprise – it would alleviate cost pressures and boost corporate confidence. While a comprehensive deal is unlikely so soon, even partial deals (like the rare earths) or extending the tariff pause would be taken positively by markets. Beyond tariffs, export controls on tech (U.S. limiting chip exports, etc.) and China’s responses (like its own sanctions or Taiwan posturing) are key flashpoints. So far, those have stayed manageable.

Taiwan and East Asia: The Taiwan Strait remains a latent risk that the market currently prices as low probability. Any severe escalation – such as military exercises that go awry or more aggressive rhetoric – could quickly inject fear, given Taiwan’s central role in global semiconductor supply. The status quo has held, and with the U.S. and China already locked in an economic spat, neither side seems eager to open another front. We will monitor for any surprises (e.g. a high-profile arms sale or political provocation that angers Beijing). This is a classic tail risk – not expected to occur in H2, but if it did, the impact on risk assets would be severe (safe havens like gold would jump, equities would tumble, especially tech hardware names).

Ukraine War and Europe: The war in Ukraine grinds on with no clear end in sight. Markets have become somewhat desensitized, but a few risk vectors exist. First, any major escalation (e.g. a new offensive that triggers greater NATO involvement or a Russian move to cut off Ukrainian grain exports) could affect commodity prices. Europe’s economy has been strained by high energy costs, though thankfully a warm winter and alternative gas supplies stabilized things. For H2, a risk is that if Ukraine’s counteroffensive falters, the conflict could stalemate into attrition, dampening European investor sentiment and potentially leading to renewed energy supply threats in winter 2025. The U.S. stock market might not react strongly unless energy markets are disrupted – for instance, if Russia further curtails oil output or geopolitical events drive oil back toward $100, that would feed U.S. inflation (bad for stocks). So far, Brent oil around $70–80 suggests a relatively contained situation. We maintain vigilance; the VIX could spike if any NATO-Russia direct incidents occur (e.g. accident or miscalculation).

Middle East Volatility: In June, an unexpected conflict flared when Israel conducted strikes on Iranian nuclear facilities, and Iran retaliated against U.S. assets in the region. This jolted oil prices up to 5-month highs (Brent briefly > $75). A ceasefire was brokered quickly, but it was “on shaky ground,” with accusations of violations even hours after announcement. President Trump’s involvement – he signaled that China could keep buying Iranian oil to help calm markets – showed the geopolitical tightrope being walked. The ceasefire has since reduced the risk premium, sending oil down ~6% in late June. But the situation bears watching: if Israel-Iran hostilities reignite, there’s risk to the Strait of Hormuz (through which ~20% of global oil flows). A serious disruption could spike oil into the $90+ range, worsening inflation and hurting global growth. Markets would react by selling off equities (especially transport and consumer sectors) and rotating into energy stocks and safe havens. For now, baseline is a tenuous peace. We will also track other Middle East issues, such as OPEC+ policy (e.g. any surprise output cuts) and Iran’s nuclear talks (which could influence whether sanctions on Iranian oil stay or go).

U.S. Domestic Politics: The U.S. political landscape in 2025 features a new administration with an assertive protectionist trade stance (as evidenced by tariffs) and a Congress split on fiscal priorities. While the next presidential election is 2028, policy shifts now are meaningful. Key areas: Fiscal policy – a bill to extend 2017 tax cuts is in discussion. If passed in full, it would add significantly to deficits (Yale estimates $2.3 trillion in tariff revenue over a decade, but that’s outweighed by potential tax cut costs). Bond markets might balk, pushing yields up, which is a risk for equities (especially high-valuation stocks). Regulation – sectors like Big Tech could face antitrust actions or new rules (the administration hasn’t focused here yet, being preoccupied with trade, but it’s possible). Election cycle – though 2025 is off-year, we’ll have early indications of how the public views the trade war and economy, potentially influencing midterm campaigning in 2026. Political brinksmanship (budget resolutions, potential government shutdown threats in October when the fiscal year ends) could also cause short bouts of market volatility, as we’ve seen in past debt ceiling episodes (though a debt ceiling crisis was averted in 2024).

In summary, geopolitical risk is elevated on multiple fronts. We have seen that the market can climb a wall of worry – so far in 2025, despite war and conflict, indices are up. But that can reverse quickly. We recommend portfolio hedges where appropriate: e.g. gold or Treasury bonds to hedge geopolitical shocks, some energy exposure as an inflation hedge, and perhaps defensive equity positions (healthcare, utilities) as a buffer. The Risk Profile below summarizes major risks and their potential market impact.

Commodities and Inflation: Oil, Chips, and Metals

Commodity markets in 2025 have been buffeted by both geopolitical and macro forces, and their direction will feed back into equities via inflation and sector impacts:

Oil & Energy Commodities: Oil started 2025 in a moderate range ($70s), fell into the $60s amid global growth worries and as U.S. SPR (Strategic Reserve) releases and strong Russian exports kept supply ample, then spiked into the $80s on the early-June Iran conflict, and subsequently plunged back to mid-$60s after the ceasefire. This volatility demonstrates the binary nature of oil right now: supply shocks vs. demand concerns. Our base view is that absent new conflicts, oil will gravitate around $70–80. OPEC+ has shown willingness to adjust output to defend prices (they don’t want a crash), but they also face limits as higher prices encourage U.S. shale output. For equities, moderate oil is a sweet spot – it keeps consumer inflation down (good for spending and Fed) while allowing energy companies to profit. If oil breaks $90 due to a renewed Middle East crisis or supply cut, expect inflation expectations to rise and pressure on Fed to stay hawkish, a negative for most stocks (but a positive for energy producers, oil service firms, and commodity-exporting countries). Conversely, if oil slides below $60 (for instance, if global recession odds spike or a Iran nuclear deal brings more supply), it would help cooling inflation and boost consumer-oriented sectors (transports, retailers). Natural gas has been less in focus after the mild winter, but it could come back if next winter is cold or European demand spikes – not a big factor for H2 (should mostly stay moderate, benefiting chemical companies and utilities with lower feedstock costs).

Semiconductors & Rare Materials: The mention of semiconductors as commodities is apt in the sense of their critical supply nature. Memory chips, for example, trade somewhat like a commodity with boom-bust cycles. Currently, the chip sector is in an upswing thanks to AI demand (GPUs, high-end chips are scarce). Tariffs have not directly hit semiconductors heavily (the U.S. targeted finished electronics more than chips), but export controls on cutting-edge chips to China are effectively a supply constraint for companies like NVIDIA – so far it hasn’t dented financials because global demand elsewhere is huge and Chinese firms find workarounds. However, going forward, any expansion of tech restrictions could shuffle winners/losers in the sector. Rare earth metals (like Neodymium, vital for electronics and EV motors) became a focal point – China had threatened restrictions, which would have made those inputs costly or unavailable. The June 11 US-China deal forestalled that, China ended export limits on rare earths in exchange for presumably no new U.S. tariffs then. This is crucial: it ensures U.S. high-tech manufacturers (from chips to fighter jets) get the materials they need. It’s a relief for companies like Apple, Tesla, defense contractors – one less supply risk. Prices of certain rare earths might even fall with assured supply, slightly easing costs.

Industrial Metals (Steel, Aluminum, etc.): The administration doubled tariffs on steel and aluminum imports to 50% in June. This has a nuanced effect. Domestic steel producers benefit – U.S. steel prices gained a “critical price support” from prior tariffs and now even more. U.S. Steel, Nucor, etc., could see improved margins and volume (to the extent imports drop out). On the flip side, manufacturers using steel/aluminum (autos, aerospace, appliances) face higher input costs. The Boston Consulting Group estimated doubling these tariffs could raise total tariff costs to $50B (some of which is borne by end consumers and some by companies). Automakers, for instance, are in a tough spot: steel tariffs raise the cost to build cars by hundreds of dollars, at a time when rising interest rates are already crimping auto sales. We might see car companies trim profit outlooks or try more cost-cutting. For aircraft makers like Boeing, aluminum costs more, but they can often pass costs in pricing to airlines given duopoly market. For construction, higher steel prices mean higher building costs, which could dampen some private projects – bad for construction firms and real estate development.

Precious Metals (Gold, Silver): Gold has quietly performed well as a safe-haven with all the uncertainty. It’s around $1,950/oz, up year-to-date. If real yields (nominal minus inflation) stay low or fall (say inflation rises but Fed doesn’t hike), gold could break $2,000. We mention this because gold-mining stocks would benefit, and also because gold’s rise usually coincides with lower confidence in currencies and higher risk aversion. In a scenario of escalating geopolitical tension, we’d expect gold to spike – a sign that fear trade is on (and likely bad for equities). Silver, being part industrial, would depend on manufacturing health as well as precious metal trends.

Agricultural Commodities: Not a primary focus for equity sectors except indirectly (consumer food companies, retailers). Food commodity prices have been mixed – grain prices are below 2022 highs but could jump if Black Sea tensions cut off Ukrainian exports. A notable risk: food inflation re-accelerating would hurt consumer sentiment and spending power, which in turn hits retail/restaurant stocks. Currently, food inflation has moderated to mid-single digits from double digits last year, a positive trend. We assume no crisis, so ag prices remain range-bound in H2.

Crypto and Other: Crypto assets (Bitcoin etc.) saw a resurgence in early 2025 after lagging – partly due to the narrative of an alternative in times of fiscal profligacy (tariffs/trade war = weaker dollar?). This is a minor market factor, but a big crypto rally can sometimes correlate with speculative fervor that spills into tech stocks.

In summary, commodities present both inflationary risks and sector opportunities. Our base case assumes commodity price pressures are manageable – oil roughly stable, metals up modestly due to tariffs but not runaway, and no major new supply shocks. This supports the view that inflation, while elevated, won’t explode, allowing the Fed to gently ease later. However, the myriad geopolitical hotspots mean investors should be prepared for sudden commodity-driven shocks. Using options or hedges for energy risk, and keeping an eye on key commodity price levels (like $80 oil, $2000 gold, $4.50 copper) as barometers, is prudent.

Monte Carlo Simulation: Market Return Distribution

To quantitatively gauge the range of potential market outcomes, we employ the Vulcan-mk5 Monte Carlo engine to simulate thousands of possible returns for major indices over H2 2025. This model integrates current volatility levels, correlations, and macro uncertainty to generate a probabilistic distribution of index returns by year-end.

Monte Carlo simulation of 6-month total return distributions (July–Dec 2025) for major U.S. equity indices.

The chart above shows the simulated return distribution for each index (S&P 500, Nasdaq, Dow, Russell 2000). Key observations:

The S&P 500 median simulated return is around +1–2% for H2, with a relatively symmetric spread. There is roughly a 5% probability (left tail) of the S&P ending down >17% by December (a significant sell-off scenario), and a 5% chance (right tail) of it rallying >25% (an exuberant melt-up). The central 90% of outcomes ranges from about -17% to +25%. This wide range reflects elevated uncertainty – a reflection of the volatile backdrop. The distribution skews slightly to the upside (mean ~+2.3%), consistent with our base-case slight bullish tilt.

The Nasdaq Composite has a wider dispersion – its volatility is higher. The median outcome is around +1%, but the 5th percentile downside is ~-24% (a severe tech slump) and 95th percentile upside ~+35%. In other words, tech could swing dramatically, more so than the broad market, depending on how macro and earnings scenarios play out. Investors in Nasdaq-100 or growth stocks should be prepared for this volatility; position sizing and risk management are key.

The Dow Jones Industrial Average shows a tighter distribution. With many stable blue-chips, its 90% range was approximately -15% to +20%, and a median around +1–1.5%. The Dow’s lower volatility means it’s less likely to have extreme moves – a reflection of its composition (value and dividend stocks). In a downside scenario, we’d expect the Dow to fall less than the Nasdaq (as seen in simulations), which aligns with historical beta differences.

The Russell 2000 small-cap index has the broadest range of outcomes in percentage terms. The simulation suggests ~5% chance of a 35%+ surge (small-caps often jump the most in a bullish inflection) and ~5% chance of a -25% or worse drop (they also could crater most if recession fears spike). The median outcome is around +1.5–2%, slightly higher than S&P’s, reflecting the modest small-cap risk premium (and perhaps the model pricing in that small-caps are starting from lower valuations).

These simulations underscore that while our base case is modestly positive, there is considerable uncertainty. The overlap of the distributions also indicates that outcome rankings are not set in stone – e.g. while on average we expect Nasdaq to outperform if things go well (hence its higher upside tail), there are plenty of scenarios (the left side of its distribution) where it underperforms or even delivers negative returns.

Investment implication: The probability of a negative H2 outcome is certainly non-trivial – roughly 35–40% of Monte Carlo trials showed the S&P 500 down for the second half (implying a full-year 2025 could still end red if a shock occurs). Conversely, there’s roughly a 60–65% chance of a flat or positive H2. This argues for a balanced approach: maintain equity exposure to capture upside, but use hedges (options, sector diversification) and avoid over-leverage, because tail risks (trade war escalation, etc.) are very real.

Scenario Analysis: Bull, Base, and Bear Cases

To complement the probabilistic Monte Carlo, we outline three qualitative scenarios for now through year-end 2025 – Bull, Base, and Bear – along with their drivers and market implications. The Vulcan-mk5 Bayesian scenario model produces a fan chart of index trajectories under these scenarios, as shown below.

Bayesian scenario projections for major indices through Dec 2025. Solid line = Base case, Dashed = Bull, Dotted = Bear.

Base Case (55% probability): “Slower Growth, No Recession” – Trade tensions linger but do not drastically worsen. The U.S. extends the tariff pause with China beyond July or only implements limited additional tariffs. Inflation blips up to ~3% by early fall then stabilizes. The Fed executes one rate cut by December as inflation shows signs of easing and growth is sluggish. GDP continues to grow at ~1% in H2. Under this scenario, equities grind higher modestly. The S&P 500 (blue line) would “re-examine” its highs but only exceed them slightly, ending the year around 6,450. We’d see some range-bound trading – perhaps a mild pullback in late summer as the market digests mixed data, then a year-end rally on Fed cut hopes. The Dow (orange line) similarly trends up slowly to ~45,300. Nasdaq (green line) outperforms slightly as easing rate expectations give growth stocks a late boost – finishing around 21,700. The Russell 2000 (red line) does okay, reaching ~2,360 as domestic economic resilience offsets earlier small-cap pessimism. Volatility in this scenario runs moderate (VIX mostly in teens). This “muddle-through” outcome aligns with historical mid-cycle slowdowns where earnings grow a bit and valuations hold steady.

Bull Case (20% probability): “Trade Peace and Soft Landing” – One might call it a Goldilocks scenario. Here, the U.S. and China strike a meaningful trade deal by autumn (for example, removing a portion of tariffs or at least providing a multi-year suspension). Global supply chains rejoice; business confidence jumps. Meanwhile, inflation, though temporarily boosted by tariffs, is contained below 3% as companies find alternative sourcing and the strong dollar earlier in the year helps. The Fed starts cutting by September and signals a faster pace of easing into 2026. No recession in sight – in fact growth reaccelerates to ~2+%. In this scenario, equities surge. The S&P 500 would likely enter a “regrowth” phase of a new bull market. We could see it climb toward 7,100 or higher by year-end (roughly +15% from mid-year). The Nasdaq might explode upward (big tech loves lower rates and China market reopening) – possibly +20% to around 24,000+. Cyclical and small-cap stocks would thrive; the Russell 2000 could rally 25% (toward ~2,740). The Dow would hit record highs as well, maybe ~48,400 (+10%). Such a rally would broaden across sectors (finally rewarding laggards like materials, and boosting internationals). Volatility would likely fall to very low levels (VIX < 12) as the “fog of uncertainty lifts” and a “powerful relief rally” takes hold. This bull case, while plausible, requires quite a few things to go right – hence we assign it a 20% chance.

Bear Case (25% probability): “Tariff Shock and Stagflation Scare” – This scenario sees the trade war reignite in full. July brings the imposition of the threatened “reciprocal tariffs” across the board (e.g. tariffs jump to 25–30%+ on broad categories) after talks fail. China and other nations retaliate in kind. The global economy buckles: U.S. businesses face spiking costs, supply shortages (perhaps China halts rare earth exports briefly until a deal on that was reached – hypothetically if that deal fell apart). Inflation shoots up to 4%+ by late fall due to tariffs. The Fed, rather than cutting, is caught in a bind – Powell may delay cuts or even hint at hikes if inflation expectations de-anchor. Meanwhile, higher prices cut into consumer spending; Q4 GDP turns negative. Essentially a stagflation scenario emerges (low growth, high inflation). Equities would likely sell off sharply in this case. The S&P 500 could swiftly retest the April lows (~5,000) and possibly finish the year around 5,300 (down ~15% second-half). The decline might happen in a matter of weeks (as it did in April) then markets could stagnate or drift lower with continued volatility. The Nasdaq would be hit harder (perhaps -20% or worse, ending under 16,500) given its global exposure and sensitivity to rates. The Dow might fare a bit better but still drop around 10–12% to ~39,600. Small-caps could plunge early (they dropped fastest in April’s rout) and, though somewhat insulated from exports, would suffer from domestic recession fears – Russell 2000 might fall ~20% to ~1,750. The VIX would likely spike back into the 30s or 40s on such an episode, credit spreads would widen, and we might even see policy responses (perhaps the Fed eventually cutting despite inflation, or White House considering tariff rollbacks under market pressure). In this bear scenario, defensive assets (Treasurys, gold) would be about the only winners, while equities broadly sink.

Our base case remains closest to the first scenario – slower growth, range-bound market with modest upside – as we believe the most extreme outcomes (trade collapse or full resolution) will be avoided or delayed. We assign roughly 55% odds to base, 20% bull, 25% bear. These probabilities can change with incoming data: for instance, a clear cooling in inflation or major progress in trade talks would increase the bull odds, whereas any indication of talks breaking down or inflation spiking unexpectedly would up the bear odds.

Investors should monitor key catalysts: July 9 trade deadline, Fed meetings (late July, September, November), inflation reports, and any geopolitical flashpoint news. Staying agile and hedged is advisable given the non-negligible tail risks.

Risk Profile and Allocation Implications

Considering the analysis above, we present a Risk Profile summary and our recommended sector weightings for asset allocation through year-end.

Risk Profile – Key Downside Risks and Mitigants:

Risk FactorLikelihoodMarket Impact (if realized)Mitigants / MonitoringTrade War Re-escalation (U.S.–China tariffs fully implemented, global retaliation)Medium-High (by late Q3)High Negative: Renewed sell-off in equities (S&P could drop 10-20%), cyclical sectors hit hardest; safe havens surge. Inflation spike >4% forces Fed hawkish.Ongoing negotiations; 90-day pause till July 9 – watch for extensions or deals. Rare earths deal signals some compromise. Fed likely to turn dovish if markets tumble, providing some backstop.Inflation Surge / Fed Misstep (Tariff-driven inflation stays high into Q4, Fed delays cuts or hikes rates)MediumNegative: Valuations compress (P/E multiples down), rate-sensitive growth stocks fall. Bond yields jump; could induce stagflation vibe with both stocks & bonds down.Current core inflation ~2-3%; Fed “on hold” but vigilant. Mitigant: strong disinflationary forces ex-tariffs (e.g. housing cooling, supply chains normal). Fed would likely tolerate some inflation overshoot unless expectations unanchor.Recession / Growth Shock (GDP contracts, jobless jumps >5%)Low (in 2025)High Negative: Broad market decline (>20% bear); credit spreads widen sharply; small-caps and banks most vulnerable.Leading indicators mixed – yield curve inverted, but no consumer collapse yet. Households have cushion (excess savings). Watch ISM, jobless claims. Fiscal/monetary response would come quickly if a true downturn unfolds (policy support).Geopolitical Crisis (e.g. Major Middle East war, Taiwan conflict, or escalation in Ukraine involving NATO)Low (tail risk)Severe in short-term: Sudden risk-off: VIX could spike to 40+, S&P could fall 10%+ in days depending on severity. Oil prices likely soar if Middle East, hurting consumers. Taiwan conflict would especially tank tech.Diversification: gold, oil, defense stocks hedge some of this. Diplomacy signals to watch: Iran-Israel ceasefire holding? Taiwan status quo maintained? The fact that multiple hotspots would have to erupt simultaneously for systemic risk provides some comfort.Fiscal & Credit Concerns (US deficit surge, credit rating issues, or liquidity crunch)Low-MedModerate Negative: If bond market revolts (yields spike on deficit fears), could pressure equity valuations. A credit event (e.g. major default) could tighten financial conditions.Thus far, demand for Treasuries remains; no debt ceiling crises imminent. U.S. still seen as safe haven. Credit spreads are reasonable; corporate earnings supporting debt service. Fed could ease liquidity if needed (they have tools).Overvaluation / Sentiment swing (market overshoots and corrects even without new bad news)MediumModerate: A healthy correction (-10 to -15%) could occur if sentiment turns euphoric then disappoints. Perhaps triggered by profit-taking or technical factors.Valuations are high but not dot-com extreme. Earnings are coming through to support prices. Investor sentiment, while improved, is not at “extreme optimism” yet – implies room before irrational exuberance. Use of options indicates some caution remains.

Table: Major risks through Dec 2025, with our assessment of probability and potential market effects. In our view, trade policy remains the top risk factor.

On the upside, we should note there are positive risks too – e.g., a significant productivity boost from technology (AI) improving earnings, or a peace deal in Ukraine reducing commodity prices – which could lead to better-than-expected outcomes. These are harder to quantify but worth keeping in mind (the bull scenario captures many of these).

Asset Allocation & Sector Strategy: Based on the above analysis, our recommendations for the second half of 2025 are as follows:

Equities vs. Bonds: We maintain a slight overweight to equities in a multi-asset portfolio, but not a maximum overweight. Equities still offer a path to growth and a roughly 5% earnings yield vs. a 4.3% 10-year yield – a modest equity risk premium that is about average. Given our base case of no recession and low earnings growth, stocks should edge higher. However, carry a healthy allocation to bonds as well: high-quality bonds yield ~4–5% now, providing income and likely appreciation if any risk-off event pushes yields down. In essence, use bonds and possibly gold (or other hedges) to buffer equity volatility. Within equities, favor U.S. over international developed in the near term – Europe and China have more growth uncertainty (though longer-term, non-U.S. markets are historically cheap, but perhaps will remain so until trade issues resolve). Emerging markets are tricky – if a trade deal happens, EM (esp. China) could rally hard (a bull-case play), but our base view is to be cautious on EM due to dollar strength and geopolitical risk.

Market Cap Bias: As discussed, we see a case for increasing small-cap exposure from underweight toward neutral or even modest overweight. Small-caps have higher risk but potential higher reward if the bull case or just a breadth expansion continues. They are also less exposed to trade war fallout. At the same time, one shouldn’t abandon large-cap quality growth – those mega-cap companies have fortress balance sheets and secular growth that can carry them even through macro storms. So a barbell of some mega-cap growth and some small-cap value can actually work well.

Sector Weighting: We summarize our sector recommendations:

Within sectors, emphasizing quality factors – companies with strong balance sheets, high return on equity, and stable margins – is important in this uncertain environment. Our Vulcan-mk5 model’s factor analysis gives equal weight to Quality and Safety alongside Value, Growth, and Momentum. That resonates now: we want companies that can weather higher input costs (economic moats, pricing power) and those with manageable debt if rates stay higher for longer. High-dividend stocks could also be selectively attractive if one expects eventual Fed easing (they’d gain in relative appeal if yields fall).

Portfolio hedges: As noted, consider a gold or commodity ETF allocation as an inflation/geopolitical hedge (~5% position). Also, one can use option strategies – e.g., buy modest put protection on S&P or Nasdaq when volatility is low, to insure against downside. The cost of hedging has come down with VIX in the teens.

To wrap up, here is a Master Metrics & Allocation Table summarizing our tactical stance:

Asset Class / SectorAllocation Stance (H2 2025)Key RationaleU.S. Equities (Overall)Slight OverweightResilient earnings, moderate upside; maintain core exposure but hedge tail risks.– Large-Cap GrowthMarket Weight (selectively overweight mega-cap tech within)Secular growth leaders (AI, cloud) still driving market, but valuation limits; hold core positions.– Small-Cap ValueOverweight (modestly)Undervalued, domestic-focused, poised to rebound if economy avoids recession. Focus on quality small-caps.International EquitiesNeutral (Dev.), Underweight EM ex-ChinaDeveloped (Europe/Japan) face headwinds (energy, slower growth). EM uncertain; only tactically add if trade outlook improves.Fixed Income (Bonds)Neutral (Duration slight overweight)Hold core bonds for ~4-5% yield and downside protection. Prefer intermediate Treasuries, investment-grade credit. Overweight duration a bit anticipating eventual Fed easing.CashNeutral to slight OverweightCash yields ~5% are attractive; okay to hold a bit of dry powder given volatility. Use for tactical opportunities on dips.CommoditiesNeutral (with tilt to gold)Energy neutral (balance risk vs. reward). Gold overweight as hedge for tail events. Industrial metals neutral (tariff impact mostly known).Sectors:––– TechnologyNeutral (OW semis/software, UW hardware)Long-term winners but monitor export risks; prefer subsectors less tariff-exposed.– FinancialsOverweightBenefiting from rates, value pricing, solid balance sheets; limited tariff impact.– IndustrialsOverweightTailwinds from defense, infrastructure; beneficiaries of reshoring and likely fiscal support.– Consumer DiscretionaryOverweight (selective)Strong consumer niches (travel, leisure, luxury). Avoid tariff-sensitive apparel producers lacking pricing power.– HealthcareMarket WeightSteady earnings, defensive qualities; political risk in drug pricing caps upside.– EnergyMarket Weight (hold via integrated majors)Use as inflation hedge; dividend rich. Expect range-bound oil so neither aggressively buy nor sell.– Consumer StaplesUnderweightTariff pressures on input costs (food import costs, etc.), limited growth, relatively high valuations.– UtilitiesUnderweight (short-term)Rate headwinds; however, keep on radar for long-term AI/electric demand theme.– MaterialsUnderweightGlobal demand soft, China construction down; tariffs disrupt cost structure. Some positives for U.S. steel but not enough to offset sector-wide caution.– Real Estate (REITs)UnderweightHigher interest rates and financing costs weigh on real estate; some segments (data centers) okay but overall cap rates rising = headwind.

This allocation aims to deliver solid participation in any continued equity upside while providing buffers against the key risks identified. It is a nuanced environment – not one for all-in bets, but for balanced, factor-diversified positioning.

Conclusion

As we enter the second half of 2025, the U.S. stock market stands at a crossroads of opportunity and risk. The first half’s wild swings – “uncertainty, whiplash, topsy-turvy” as one analyst described it – may give way either to renewed turbulence or a path toward recovery and regrowth. The fog of uncertainty is beginning to lift on some fronts: we have more clarity on the Fed’s reaction function, and the economy’s resilience has been proven up to now. Yet, crucial questions remain unanswered: Will trade disputes abate or escalate? Will inflation stay benign or roar back? Can corporate America continue to grind out earnings growth under challenging conditions?

Our analysis suggests that the most likely trajectory is a continued, if bumpy, expansion – “slowing but not negative growth,” as the outlook appears to be. In such a scenario, staying invested in equities – with an emphasis on quality and a readiness to “prepare for a potential period of slower growth” – is warranted. At the same time, prudence dictates we “stay as diversified as you can”. The worst days and best days often cluster – attempting to time the market could mean missing the swift rebounds that tend to follow sharp corrections.

For asset allocation decisions through December 2025, we advise a stance that is neither complacently bullish nor overly defensive, but strategically balanced. Embrace equities for their upside potential in a low-yield world, but hedge the downside. Emphasize sectors and assets with inherent resilience – those that can generate profits in a high-inflation or low-growth scenario (e.g. companies with strong moats and essential products). Remain vigilant to the macro signals (policy shifts, economic data) and be ready to pivot if the evidence changes.

In sum, the outlook for H2 2025 can be characterized as cautiously optimistic. The market faces a “confluence of challenges” – from policy uncertainty to geopolitical flashpoints – which keep the bar high for outperformance. Much has to go right (tariffs easing, inflation under control, labor market cooling gently) for a significant bull run to take hold. Those are possibilities, but by no means assured. On the flip side, the U.S. economy’s core strengths (innovation, consumer adaptability, entrepreneurial dynamism) and policy buffers mean that even if things go wrong, a 2020-style collapse is unlikely. We anticipate volatility will continue to create opportunities – pullbacks can be “potential buying opportunities” for long-term investors to add exposure to high-conviction assets, while rallies can be used to rebalance or trim winners.

As always, we will refine our view as new information arrives. For now, a prudent course is to follow the advice to “not abandon markets” due to volatility, but rather navigate them with discipline and awareness. The remainder of 2025 will test investors’ resolve and flexibility – but with the deep research and data-driven approach outlined in this report, we aim to inform your asset allocation decisions so you can stay ahead of the risks and positioned for the opportunities that lie ahead.

Sources:

Bank of America Private Bank CIO Outlook, Midyear 2025

Charles Schwab 2025 Mid-Year Outlook (Liz Ann Sonders), June 2025

U.S. Federal Reserve – FOMC Statement/Projections, June 18, 2025

Reuters, Fed keeps rates steady but sees “meaningful” inflation ahead, June 19, 2025

Reuters, S&P 500, Nasdaq hit record highs amid trade negotiations, June 27, 2025

AllianceBernstein, How US Small-Cap Stocks Can Overcome the Market Stress Test, April 29, 2025

Yale Budget Lab, State of U.S. Tariffs: June 17, 2025

Luckbox Magazine, VIX Reversal – 2025 Market Rebound?, April 30, 2025

Reuters, Oil prices drop 6% as Israel-Iran ceasefire reduces supply risk, June 24, 2025

Morningstar Market Outlook, June 2025 (via Capital Spectator)

Vulcan-MK5 Model Documentation

Source: Second Half 2025 U.S. Stock Market Outlook

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