Calm Waters After a Turbulent Storm

If you only looked at the end-of-quarter numbers, you’d think the second quarter was smooth sailing, with strong equity performance and minimal volatility. But beneath those calm waters, markets experienced a dramatic rollercoaster, rocked by policy shifts, tariff tensions, and rapid investor sentiment swings.

In April, markets plunged as unexpected new U.S. tariffs triggered fears of economic stagnation and supply-chain disruptions, sending the S&P 500 down by approximately 12% in just five days. However, sentiment quickly reversed in May as tariffs were rolled back, and stronger-than-expected corporate earnings helped markets recover and rally.

Key Takeaways

• Despite significant volatility in April, U.S. equities finished the quarter up nearly 11%.

• International markets notably outperformed due to a weaker U.S. dollar.

• Inflation remained persistent, influenced by high shelter costs and tariff pass-through.

• AI-related investment remained a robust and expanding theme.

• The Federal Reserve held rates steady, signaling potential future cuts to support slowing economic growth.

Market Commentary

Bonds provided stable returns, with the Bloomberg U.S. Aggregate Bond Index rising 1.21%. Investor caution around growth and inflation influenced demand for high-quality, longer-duration bonds. High-yield corporate bonds stood out, benefiting from improved market confidence and tighter credit spreads.

U.S. equities surged 10.99% in Q2, led by robust corporate earnings and improving market sentiment after tariff-related concerns eased. Large-cap tech stocks notably excelled, benefiting from continued investments in AI infrastructure. Despite elevated valuations, investors focused on companies with proven earnings power and long-term growth potential.

International developed markets, as measured by the MSCI World ex-U.S. Index, climbed 12.05%. A weaker U.S. dollar and strong European earnings, buoyed by ECB rate cuts, propelled returns. Europe emerged as a standout performer, highlighting renewed investor interest in diversification opportunities outside the U.S.

Emerging markets also benefited significantly, rising 11.99% according to the MSCI Emerging Markets Index. The weaker dollar was a key driver, though country performance varied widely. While China’s returns were modest, markets in India and Brazil were notably stronger. Investors continued to favor larger, value-oriented firms within these regions.

Country-specific returns varied dramatically. European markets broadly led international developed equities, driven by stronger earnings and monetary easing. Emerging markets saw uneven returns, with India and Brazil outperforming due to favorable economic reforms and stable growth prospects, while China lagged amid a slowing economy.

The Why Behind Market Moves

• Policy Shock and Recovery: The quarter demonstrated how quickly markets can respond to unexpected shocks, such as tariffs. Investors initially reacted strongly, but swift policy reversals helped markets regain their footing.

• AI Investment Growth: AI infrastructure spending continued to accelerate, offering tangible growth opportunities across multiple sectors, including beyond mega-cap tech firms.

• Economic Moderation, Not Collapse: While growth indicators softened, resilience in labor markets, continued business investments, and policy support from the Fed suggested moderation rather than an impending recession.

• Global Diversification’s Return: For the first time in several years, international and emerging market equities outperformed U.S. counterparts, reinforcing the value of global diversification.

The Path Forward

• Navigating Tariff Risks: Though tariff-related uncertainties remain, policymakers’ inclination towards negotiation and de-escalation reduces the likelihood of prolonged economic disruption.

• Economic Deceleration, Not Crisis: The U.S. economy appears to be slowing but remains fundamentally resilient, supported by labor income, ongoing AI investments, and solid service-sector performance.

• Shifting Monetary Policy: With labor market pressures easing, the Fed is likely shifting towards rate cuts, potentially supporting equity valuations and broadening market participation.

• Reasonable Valuations: While market valuations remain elevated, they are underpinned by strong corporate fundamentals, particularly in leading sectors like technology and select international markets.

This quarter vividly demonstrated the value of patience and long-term perspective in navigating volatile markets. Investors who remained calm through the turbulence saw their discipline rewarded, underscoring the importance of focusing on underlying fundamentals over short-term headlines.