2025 Mid-year outlook: Volatile but viable

Key takeaways:

• Markets proved resilient in early 2025 despite volatility driven by trade tensions and policy uncertainty, with Q2 gains fueled by solid earnings and economic data.
• With inflation, interest rates, and geopolitical risks still in play, long-term discipline remains essential for navigating a choppy and uncertain market environment.

07/02/2025 – Financial markets experienced notable volatility in the first half of 2025, largely fueled by uncertainty surrounding trade and tariff policies. In April, this turbulence nearly tipped U.S. equities into bear market territory. However, markets rebounded through the second quarter, supported by resilient economic data, steady first-quarter earnings growth, and sustained investor appetite for growth-oriented and technology stocks.

Stocks have regained some footing and now appear to be pricing in a slowdown rather than a full-blown recession. That said, we expect markets to remain range-bound and choppy in the second half of the year, swayed by intermittent growth scares, evolving central bank policies, and the ongoing tug-of-war between valuations and earnings. In our view, both valuations and earnings will remain vulnerable to signs of economic deceleration, making it essential for investors to stay attuned to the pace and direction of growth.

The U.S. economy is likely to face continued headwinds through the remainder of 2025. Elevated prices stemming from tariffs, along with higher interest rates and slowing job growth, are expected to weigh on consumer spending. At the same time, policy uncertainty and persistent geopolitical risks may dampen business investment, as many firms adopt a wait-and-see approach amid unsettled economic conditions.

Financial markets resilient despite uncertainty

The S&P 500^® Index ended the first half of 2025 with a gain of just over 5%. Large-cap stocks significantly outperformed small caps, and growth stocks continued to lead value. While U.S. equities demonstrated resilience, momentum shifted notably toward international markets. The MSCI EAFE^® Index surged more than 18% year-to-date through June 30, strongly outperforming its U.S. counterpart.

In early Q2, concerns about a tariff-driven U.S. recession gained traction among investors. However, credit spreads didn’t fully reflect the level of anxiety seen in equity markets—suggesting that many companies expected to manage the earnings impact of tariffs. Recent data supports this cautiously optimistic view, including resilient—though moderating—labor market conditions, steady aggregate income growth, and solid earnings forecasts. Encouragingly, the inflation outlook also appears less severe than initially feared.

Fixed income markets also showed resilience—not just in the face of trade-related uncertainty, but amid rising concerns over the federal deficit following the passage of the ‘One Big Beautiful Bill’ on taxes and spending. Longer-term interest rates briefly climbed to 4.5% in mid-May before retreating below 4.3%. Looking ahead, we expect long-term rates to remain elevated, reflecting only modest Fed easing, persistent inflation pressures, and ongoing fiscal concerns. The yield on the 10-year Treasury note is likely to stay above 4.0% through year-end and into 2026.

On the short end of the yield curve, subdued inflation readings for April and May fueled speculation about imminent Fed rate cuts. However, the Federal Reserve maintained its “wait-and-see” stance, opting to monitor potential inflationary effects from tariffs before taking action. The Fed is expected to resume rate cuts in September, with a projected total reduction of 75 basis points in the federal funds rate by year-end to help mitigate downside risks to the economy. From there, the central bank may shift into an extended pause, with rates likely to remain steady throughout 2026.

Fed easing on the way to help bolster growth

Nationwide Economics expects economic growth to remain essentially flat in the second half of the year. Still, the expansion is expected to continue, with full-year GDP growth projected around 1.7%—a modest step down from the pace seen in 2023 and 2024. Looking ahead, the stage could be set for stronger growth in 2026 if tariff uncertainty eases and consumers benefit from lower tax burdens, though that outlook remains uncertain for now.

Hiring is expected to remain weak in cyclically sensitive sectors such as manufacturing, retail, and construction through the second half of 2025. These soft spots will likely offset broader job gains, which continue to be supported by steady hiring in education and health care services. As a result, monthly job growth may average 100,000 or fewer—marking a notable slowdown in household income gains. The unemployment rate is projected to drift higher, peaking around 4.5% by late 2025—still low by historical standards.

Consumer inflation is expected to rise over the summer as tariff-related costs begin to filter through to retail prices. Annual Consumer Price Index (CPI) inflation is projected to remain above 3.0% through the rest of 2025 and into 2026, further delaying a return to trend. While housing and services costs may continue to ease, they’re likely to be offset by sharper price increases for many imported goods.

Potential for more volatility calls for a quality focus

In an environment marked by uncertainty, identifying companies with strong fundamentals and solid growth prospects becomes increasingly important. We believe large-cap equities—particularly value stocks—and, eventually, mid-cap equities may present compelling opportunities for investors aiming to balance risk and reward in a year of moderated returns. Historically, the third year of a bull market tends to be the most subdued, with average gains of just 0.50%. Investors should remain vigilant and keep this historical perspective in mind when making allocation decisions.

International equities appear well-positioned to extend their recent outperformance. Over the past decade, the dominance of U.S. stocks—fueled by the narrative of “U.S. exceptionalism”—has led many investors to underweight international exposure. Yet, even after strong gains in the first half of 2025, developed and emerging market indexes remain attractively valued relative to their U.S. counterparts. Expanding one’s investment horizon to include global markets remains a key strategy for managing risk and capturing growth opportunities beyond domestic borders.

As the second half of the year unfolds, earnings guidance will be critical in shaping expectations for corporate margins heading into 2026—especially as companies continue to navigate persistent policy uncertainty out of Washington. While greater clarity was anticipated by this point, it remains elusive, reinforcing the importance of focusing on quality factors when evaluating investment opportunities.

While recession risks have receded, the persistence of slower growth and elevated policy uncertainty is likely to inject periodic volatility and weigh on investor sentiment as the second half of the year progresses. In this environment, we believe the case for quality-oriented stocks remains strong—supported by improving market breadth, encouraging price momentum, moderating economic fundamentals, and elevated valuations. These companies tend to be more resilient amid macroeconomic fluctuations, offering a more stable path forward for investors.