Jun 26, 2025 Our Mid-Year Outlook | Late-Cycle, Not Last Call: Staying Invested When the Headlines Scream
It’s now mid-2025, and investors have been through a whirlwind of economic news and market swings. Let’s take a step back to make sense of what’s happening and discuss how to stay positioned. By grounding ourselves in the facts and maintaining a long-term perspective, we can better navigate whatever comes next.
Economic Backdrop: Cooling Inflation, Slowing Growth – But No Recession (Yet)
After the post-pandemic surge and the inflation scare of 2022, things are calming down. Prices are still rising, but not as fast as before. In fact, the latest Consumer Price Index reading showed a 2.3% annual inflation rate – much lower than the 8%+ we saw at the peak. This is close to the Federal Reserve’s 2% goal, which is good news for consumers and investors. It means your dollar isn’t losing value as quickly and the cost of goods isn’t running away. Inflation slowed for several reasons: energy prices, which had spiked last year, have come down, supply chain kinks have eased, and higher interest rates are slowing demand.
We often hear the word “recession” thrown around. As of now, the U.S. economy is not in a recession – far from it. Growth has slowed compared to the rapid rebound of 2021, but we’re still seeing resilience. The job market, for example, remains strong. Unemployment is around 4.2%, which historically is quite low. Companies are hiring, and we haven’t seen the big wave of layoffs some feared (beyond some tech sector adjustments last year). Consumers are still spending, albeit a bit more carefully, and businesses are still investing (especially in areas like technology and automation).
However, it’s fair to say the economy has “downshifted” to a slower gear. High interest rates have made big purchases (like homes or cars) more expensive, which cools demand. Earlier this year, there was a curveball: the U.S. implemented a series of tariffs (import taxes) on many products, and trading partners retaliated with their own tariffs. This created uncertainty for businesses that rely on global trade – one week we heard news of higher costs on steel or electronics, the next week a temporary truce was announced. All that policy back-and-forth made companies a bit hesitant. Think of it like driving with stop-and-go traffic: it’s hard to accelerate confidently when you don’t know if another red light is coming.
The encouraging news is that by May, some of those trade tensions eased. The U.S. and China struck a surprise mini-deal that paused further tariff hikes. Investors collectively sighed in relief, and we saw stock markets rally on hopes that the worst of the trade war might be behind us (more on market reactions shortly). Still, uncertainty hasn’t vanished – new tariff threats could emerge, and the global economy (especially Europe and China) is a bit shaky. Europe’s growth, for instance, has been dampened by high energy costs and soft export demand. China, a key engine of growth, has been struggling with a real estate slump and the hit from trade restrictions; its usually high-flying economy is growing at one of the slowest paces in decades.
In summary, the economic backdrop is slower but steady. We often call it “late-cycle”: growth is positive but decelerating, and inflation, while much improved, isn’t completely back to perfect levels yet. Most importantly, the foundation – jobs, consumer spending, corporate profits – is solid enough that a deep recession seems unlikely in the near term. We’re more in a soft patch than a hard downturn. For investors, this environment means we should neither be overly pessimistic (as if a crash is imminent) nor complacent. It’s a time for selective confidence – keep an eye on the road, but don’t abandon the journey.
Interest Rates and the Fed: At a Turning Point
If 2022–2023 was about rates going up, 2025 is about rates leveling off – and possibly heading down. The Federal Reserve raised interest rates quickly over the past two years to fight inflation. Those rate hikes made everything from mortgages to business loans pricier. The goal was to cool off an overheated economy, and as we saw, it worked to bring inflation down. Now, with inflation more under control, the Fed has stopped raising rates. We’re sitting at about a 4.5% short-term interest rate (that’s the federal funds rate), and the Fed’s message is essentially “We’ll wait and see.” They want a few more months of data to be sure inflation is behaving and the job market isn’t weakening too fast.
Many investors are already looking ahead to the next move: rate cuts. There’s a growing expectation that by later this year or early next year, the Fed might start gently reducing rates. If inflation is low and growth is slow, cutting rates a bit can give the economy a boost – like adding a little fuel to keep the engine running. It’s not assured (the Fed has said it’s not in a rush to cut), but markets have priced in a decent chance of a quarter-point cut by the end of 2025.
For everyday folks and investors, stable-or-falling rates can mean few things. Borrowing costs might come down – mortgage rates could dip, making home-buying slightly more affordable than it was last year. Businesses might find it a tad easier to finance projects. Importantly for portfolios, bond investments have become attractive again. After a rough period where bond prices fell, we can finally earn solid interest. Yields on many bonds are the highest in ~15 years, which is great for income-focused investors.
However, a word of caution: higher yields today do not guarantee higher bond prices tomorrow. Bonds had such a good run of price gains during decades of falling rates that many forgot they can decline. 2022 (with both stocks and bonds down). Now that yields are reasonably high, bonds have regained their role as a cushion – if the stock market hits turbulence, bonds paying 5% provide some stability and return. We have slightly extended our bond maturities (locking in some of these rates) but we’re not betting the farm on a huge bond rally. If the economy does fine, rates might not fall much; in fact, long-term rates could even drift up a bit if investors demand extra yield to lend money for 10 or 30 years.
In simpler terms, our approach is to enjoy the income that bonds now offer, but not expect big capital gains from them. And keep some “dry powder” – cash or short-term bonds – on hand. Today’s cash yields are nothing to scoff at, and having some cash gives you flexibility to invest in other opportunities if markets pull back.
One more angle on interest rates: mortgages and housing. The rapid rise in rates over the last two years (with 30-year mortgage rates up around 6–7%) put a damper on the housing market. Home sales slowed, and prices even dipped in some overheated markets. If the Fed starts cutting later on, mortgage rates could ease somewhat, potentially stabilizing housing. We aren’t predicting a housing boom – the affordability issues are real – but we also aren’t seeing a 2008-style crash. It’s more of a housing cooldown. Over the next year, if interest rates inch down, we might see pent-up demand (especially from first-time buyers) gradually re-enter the market. For homeowners, that could mean home values start rising modestly again after a flat period.
Overall, the message on interest rates is that the heavy lifting on rate hikes is done. We’re in a holding pattern that is likely to transition to gentle rate cuts. That’s generally positive for both stocks and bonds looking ahead. Just remember that “gentle” is the key word – the Fed isn’t likely to slash rates dramatically unless a serious downturn emerges (which is not what we want, because that would come with other problems). A slow and steady Fed that nurtures the expansion is basically the best case for markets.
Recent Market Trends: Stocks Rebound on Hope, Markets “Not Out of the Woods”
Now, let’s talk about what markets have been doing – because it’s been a tale of two quarters. The year started on a weak note for stocks, but then sentiment flipped. Through the first half, international stocks have been unexpected stars. If you owned an international fund or ETF, you might have noticed it doing better than your U.S. fund. In fact, developed market stocks (think Europe, Japan, etc.) are up double digits this year, whereas U.S. stocks are barely above water. What’s going on? Part of it is catch-up – U.S. markets outperformed for so many years that overseas markets were relatively cheap. When the dollar fell earlier and Europe managed to avoid an energy crisis over the winter, international stocks rallied hard.
However, be careful not to chase past performance. A 17% year-to-date gain in Europe, for example, is impressive, but as mentioned earlier, the economic data out of Europe doesn’t fully justify such euphoria. Their stock valuations have gotten expensive compared to earnings, and some of that rally could fizzle if earnings disappoint. It’s a reminder that sometimes markets overshoot on optimism. The same goes for certain hot sectors: technology in the U.S. has been red-hot, with excitement around artificial intelligence driving big gains in some mega-cap tech stocks. We love the long-term prospects of AI and quality tech firms, but even good companies can become overvalued if investors get too excited all at once.
On the flip side, U.S. equities overall have shown encouraging resilience. By May, the S&P 500 made it back near all-time highs, and it even crossed into positive territory for 2025 thanks to that trade-war truce rally. Corporate earnings have been a pleasant surprise – instead of declining, many companies reported higher sales and profits in Q1 and provided stable guidance for the rest of the year. That confidence from CEOs (not pulling guidance en masse as some feared) gave the market a solid fundamental underpinning. It tells us that businesses, by and large, are handling this high-rate environment and still finding ways to grow, or at least maintain profitability.
One noteworthy trend is that market leadership broadened during the recent rally. For a while, a few big tech stocks were dragging indices up single-handedly. Then in May and June, we saw participation widen – midsize and even small-cap U.S. stocks bounced back, and more sectors joined the party. For example, industrial stocks (manufacturing, equipment, etc.) have perked up, and cyclical areas like consumer discretionary (think retail, travel) have done well as recession fears abated. The only sector that really lagged was defensive, slower-growth areas like consumer staples (household product companies). That makes sense – when investors are feeling more upbeat, they rotate into growth and economically sensitive areas, leaving the defensive “steady Eddies” aside for the moment.
Now, despite these positives, we have to acknowledge that markets remain volatile and news-driven. A perfect case is the recent Middle East flare-up between Israel and Iran. When news hit in June that sites in Iran were struck, oil prices jumped and there was a knee-jerk risk-off reaction in some markets. But remarkably, the broader markets mostly shrugged it off within days. Investors saw that the conflict, while serious, was limited in scope and not disrupting actual oil shipments. In fact, by later that week, oil prices had settled back and stock indexes were climbing again. The takeaway? Geopolitical events can cause short-term jitters, but markets tend to focus on the big picture – which, right now, is dominated by inflation, interest rates, and corporate earnings. Unless a conflict materially changes those (for instance, by sending oil to $150 or damaging global trade), markets may treat it as just a temporary headline. We stay vigilant (diversifying into some gold and defense-related stocks as hedges), but we don’t recommend making drastic portfolio changes for every geopolitical headline. It’s usually a recipe for whipsawing your investments.
How to Stay Positioned: Balanced and Opportunistic
Given all that, what should a long-term investor do now? Here are a few suggestions:
Stay Diversified – Don’t Put All Eggs in One Basket: This might sound basic, but 2022–2025 have underscored its importance. In 2022, bonds fell at the same time as stocks – something that hadn’t happened in decades, catching many off guard. Going forward, we expect bonds to regain their diversifying role (if stocks drop, high-quality bonds should hold up better now that they have yield). But beyond stocks and bonds, consider holding some diverse asset types. For example, a bit of real assets exposure – commodities or real estate – can help if inflation flares up unexpectedly. A small gold allocation acts as insurance against tail risks. And alternative strategies (like hedge funds or private market investments, if they’re appropriate for you, consult your advisor) can add another layer of diversification by doing well in different environments. The idea isn’t to guarantee a huge return; it’s to build a portfolio that can weather different storms. If you were 100% in tech stocks, you did great in 2023 but probably felt pain in 2022. If you were 100% in cash, you slept well in downturns but missed the rallies and barely kept up with inflation. A balanced mix ensures you participate in upside but also have buffers in downturns.
Quality Over Hype: When uncertainty is high, lean into quality investments. For stocks, that means companies with strong balance sheets (low debt), consistent earnings, and solid competitive positions. These tend to be the companies that can ride out economic bumps. For instance, large-cap U.S. companies have, on average, lower debt levels now than 20 years ago, which helps with higher interest rates. We’ve been emphasizing quality in our equity holdings – favoring, say, a financially healthy industrial company or a tech leader with huge cash flows, over a highly leveraged or purely speculative bet. The same applies within bonds: we prefer investment-grade bonds or higher-quality high-yield, rather than chasing the absolute highest yielding junk bonds. In choppy waters, quality is your friend.
Don’t Chase Recent Winners Blindly: Momentum is powerful – what’s been going up often continues for a while. But be mindful of valuations and fundamentals. A real example is that European stocks soared ~17% in a short time, making some think they can’t lose by investing in Europe now. But the reality is those stocks are no longer cheap, and Europe’s economy is fragile. The future returns might be much lower than the recent past. As another example, a cutting-edge tech stock that doubled because of AI excitement might indeed be a great company, but if it’s trading at 100 times its earnings, it’s priced for perfection. Any slip and it could tumble. Our approach is to rebalance – trim a bit from the high-flyers and add to laggards that still have good prospects.
Keep an Eye on the Fed and Inflation Trajectory: These are the macro drivers that affect almost everything. If we see inflation unexpectedly tick back up for a few months, that might delay those hoped-for Fed rate cuts and could hurt both stocks and bonds in the short term (like a mini replay of 2022). Conversely, if inflation keeps surprising to the downside, the Fed might ease sooner and more, which would be a boon especially for interest-rate-sensitive assets like growth stocks and real estate. We’re watching indicators like wage growth, rent inflation, and inflation expectations. At the moment, most signs point to moderating inflation (for example, households’ long-term inflation expectations are fairly well anchored, and commodity prices have been stable). That supports the case for a friendly Fed. But we stay nimble – if the story changes, we’ll adjust accordingly, perhaps by increasing inflation hedges (like more commodities or inflation-linked bonds) if needed.
Prepare for Volatility – Mentally and Tactically: Volatility is not something to fear; it’s something to prepare for. On the mental side, expect that there will be down days (or weeks) in the market and that it’s normal. We’ve had a relatively calm few months with the VIX (volatility index) drifting lower, but we shouldn’t get lulled into thinking it will stay that way permanently. Whether it’s an unexpected piece of economic data or a geopolitical shock, markets can still throw a tantrum. Tactically, this is why we keep some cash and short-term bonds – to seize opportunities that volatility presents. For example, if stocks dropped 10% on some scare that we believe is temporary, having liquidity lets us buy at a discount. It’s like having a shopping list ready for a sale. Earlier in the year, when trade war fears knocked stocks down, those who systematically added to their portfolios (say, via regular 401k contributions or automated investments) ended up buying low and then benefited from the rebound. Sticking to your plan – like continuing those dollar-cost-averaging contributions – is a proven way to take advantage of volatility rather than be harmed by it. In contrast, investors who sold in panic often missed the recovery and hurt their long-term results.
Consider Portfolio Hedges for Extreme Scenarios: While our base case is positive, it’s prudent to have a few hedges for worst-case scenarios. We mentioned gold – it’s an asset that tends to go up when everything else is going wrong (for instance, it held its value when banks were wobbling or war fears spiked). Another hedge can be certain types of stocks: defense contractors (companies making military equipment) often see increased demand when geopolitical tensions rise. In fact, when news of the Israel-Iran conflict broke, shares of aerospace & defense companies jumped, as investors bet on higher military spending. We’re not suggesting to load up on these, but a small exposure can provide a buffer in such events. Similarly, holding some energy stocks can hedge against oil price spikes – if oil zooms up due to a crisis, integrated oil & gas companies’ profits often surge, offsetting some losses you might see in broader equities. These hedges are like insurance – you hope you won’t need them to pay off big, but you’re glad to have them if the unexpected happens.
The market environment today is challenging but not alarming. We have higher interest rates than we’re used to, but they are fighting inflation successfully. We have slower growth, but it’s a controlled slowdown, not a freefall. We have global conflicts and policy drama, but also innovation and adaptation by businesses. Markets have climbed a wall of worry in the past months – showing that when worst-case fears don’t materialize, prices can recover swiftly. The key for investors is to stay focused on their long-term goals and plans. If your goals haven’t changed, a dip in the market shouldn’t cause a change in strategy; if anything, it creates opportunities.
By maintaining a well-thought-out asset allocation, tilting towards quality, and remaining disciplined, you put yourself in the best position to weather the storms and capture the recoveries. And remember, recoveries historically last longer than downturns – over the long run, markets tend to reward patience. As we head into the second half of 2025 and beyond, keep your seatbelt fastened (volatility likely isn’t over), but also keep your eyes on the horizon. The road may be bumpy, but it’s leading us forward.
-The Seventy2 Capital Team
Commentary and Research provided by:
Michael Levitsky, CFA®, CAIA® – Managing Director, Investment Strategy