Last quarter at a glance

The second quarter of 2025 witnessed one of the most dramatic market reversals in recent memory, as equity markets staged a remarkable recovery from the depths of the "Liberation Day" tariff shock to reach new all-time highs. After President Trump's April 2nd tariff announcement triggered a severe selloff that brought the S&P 500 within striking distance of bear market territory—falling 19% from February highs—the subsequent announcement of a 90-day tariff pause on April 9th marked a decisive turning point that unleashed a powerful rally through quarter-end.¹ The market's resilience was underscored by the stark disconnect between deteriorating sentiment surveys and robust hard economic data, as corporate earnings continued to outperform expectations despite widespread downgrades, driven largely by the AI investment boom. While consumer and CEO confidence remained well below pre-tariff levels, both began recovering by June as trade negotiations progressed and policy uncertainty diminished, validating the market's bet that the volatility would prove short-lived and that underlying economic fundamentals would ultimately prevail over trade policy fears.

• Market Performance: All Stock markets experienced a dramatic turnaround in Q2 2025, with the S&P 500 and NASDAQ reaching all-time highs by the end of the quarter after entering bear market territory following the April 2nd tariff announcement.²
• Trade Policy Developments: The magnitude and breadth of the new tariff regime introduced on April 2 surprised investors, causing a sharp sell off in equity markets. A 90-day pause in implementation of those tariffs was announced on April 9th and further reduction in trade tensions with Europe and China soothed investors' worries and sparked a broad rally in equity markets.
• Economic Data: Inflation came in a little higher than expected in May although the impacts from tariffs are expected to begin showing up in the coming months.³ Employment growth has slowed but remains solid.⁴ Consumer spending has held up despite the housing market showing signs of stress with rising for-sale inventories, mortgage rates near 7%, and weak spring selling season traffic.⁵ Economic data shows a disconnect between soft indicators (confidence surveys) that fluctuate with tariff news and hard data (employment, inflation) that have demonstrated more resilience.
• Federal Reserve: The Fed left interest rates unchanged at its May and June meetings as Chair Powell pointed to continued solid economic growth and still above target inflation.⁶ Some signs of a split have emerged between hawkish and dovish Fed camps, with some officials suggesting rate cuts could begin as soon as July if data cooperates.⁷
• Fiscal Policy: The "One Big Beautiful Bill Act" working its way through Congress, features significant tax cuts and spending cuts that the Congressional Budget Office estimates will add roughly $3.3 trillion to the national debt over the next decade.⁸ Rising federal debt levels caused gyrations in the treasury bond market and pushed the US dollar down sharply.
• Geopolitical Risks: The Israel-Iran conflict that erupted in mid-June created a spike in oil prices, stoking stagflation concerns. US military strikes against Iranian nuclear development sites were met with limited Iranian retaliation against US regional assets, leading to a ceasefire agreement between Iran and Israel that eased tensions and dropped oil prices to early June levels by the end of the quarter.
• AI and Technology Sector: AI-related companies posted continued strong orders and are accounting for an increasing share of US GDP growth, with data center infrastructure, hardware, and power investments driving exceptional performance.⁹

Stocks stage a massive rally

Equity markets staged a remarkable turnaround in Q2 2025, with the S&P 500 delivering 10.94% returns for the quarter and reaching a new record high.¹⁰ This represented a swift recovery from April lows when markets had approached bear market territory following the initial tariff shock. Still, markets remained highly sensitive to trade headlines throughout the quarter, with the US-China trade framework announcement and rare earth export agreements providing significant tailwinds, while Trump's termination of Canadian trade talks at the end of the quarter caused a pullback, only to be walked back during the same day.

• Growth-oriented indices significantly outpaced value counterparts, with S&P 500 Growth delivering 18.94% in Q2 versus just 3% for S&P 500 Value.¹¹
• The NASDAQ 17.96% quarterly gain highlighted the technology sector's leadership role in the recovery.¹²
• Small-cap stocks posted solid returns for the quarter, but continued to lag large cap stocks significantly, with the S&P 600 posting just 4.90% for Q2 and still showing negative returns year-to-date (-4.46%).¹³
• International markets continued to show strong performance with International Small Cap up 16.86% for Q2 and Emerging Markets andInternational Developed Markets each gaining over 12%.¹⁴
• The quarter reinforced a "barbell" market where AI-exposed growth sectors massively outperformed while traditional defensive plays and cyclical sectors lagged. The 30+ percentage point spread between top (Technology 23.71%) and bottom (Energy -8.56%) in a single quarter is remarkable.¹⁵
  
  • Information Technology dominated Q2 returns with Communication Services not far behind at 18.49%. Both sectors benefited massively from AI-related investment.
  • Real Estate (-0.07%) struggled with the challenging rate environment and housing market stress signals.
  • Health Care (-7.18%) and Energy (-7.56%) were the quarter's biggest losers. Energy's decline is particularly notable given the Iran conflict's oil price spikes, suggesting structural headwinds outweighed geopolitical premiums. Health Care's weakness reflects a less defensive investor posture as well as potential regulatory uncertainties.

Credit market volatility continues

Fixed income markets reflected a flight to quality combined with geographic diversification, where investors sought the safety of bonds but preferred international exposure over purely domestic holdings, likely due to concerns about US fiscal sustainability and the unprecedented debt-to-GDP levels. Investors demanded premium returns for taking on different risks - rewarding international diversification most, followed by credit risk, with "risk-free" Treasuries offering the lowest returns.²⁰

• Global Developed Bonds led the pack with strong 4.52% Q2 returns, suggesting investors sought international diversification as US trade policy uncertainty and fiscal concerns mounted.
• US High Yield Bonds delivered solid 3.53% returns, as investors' “risk on” posture embraced taking on higher credit risks.
• US Treasury Bonds posted modest 0.85% gains despite the volatile quarter, consistent with markets pricing in limited Fed easing and the "higher for longer" environment.
• Municipal Bonds were the quarter's only loser at -0.12%, likely reflecting concerns about state and local fiscal conditions amid economic uncertainty and potential federal spending cuts.

Solid results in private markets^21,22

• Private credit funds continued to deliver solid performance in Q1, both for direct lending and other private credit categories. With strong asset flow into the category, concerns are that competition will erode returns and investors have been emphasizing well-collateralised, senior-positioned debt with robust borrowers, as weaker entities face increasing stress.
• Private real estate funds continued to show some signs of recovery with valuations and transaction volumes improving. 2025 is expected to be a strong vintage year for deployment, though sentiment remains fragile. Investors have favored operational real estate with inflation-linked cashflows.
• Private equity returns ended the year on a strong note, although results vary across managers. There continues to be uncertainty for the category as distributions of invested capital have slowed as managers and owners await better exit opportunities which has led to a growing importance for secondary market investments and continuation funds. Investor focus has also been on small and mid-sized buyout opportunities which can offer lower competition, better pricing, less reliance on leverage, and greater resilience in times of volatility.

Rebounding Soft and Hard

A “V” Shaped Recovery in Equities

This quarter will likely be remembered as a textbook example of market resilience, where initial panic gave way to a powerful recovery driven by easing of trade policy concerns, sector rotation, and the underlying strength of AI-driven growth stories. The chart below illustrates the dramatic rebound in the second quarter of 2025 following significant volatility in the first quarter. The recovery was particularly pronounced after April 9th, when a 90-day pause in tariffs was announced, marking a clear inflection point for market sentiment. From April 2nd through April 8th, markets had declined sharply amid concerns over "Liberation Day" tariff announcements, with the S&P 500 falling over 11% during this brief period. However, the subsequent tariff pause triggered a powerful rally that carried through the remainder of Q2.²³ From April 9th to the end of the quarter, the S&P 500 rallied over 21% while small-cap stocks (S&P 600) jumped almost 17%.²⁴ International developed markets (MSCI EAFE) and emerging markets also participated in the recovery, rising over 21% from April lows.²⁵ This rebound demonstrates how quickly markets can pivot when policy uncertainty is reduced, with the tariff pause effectively removing a key overhang that had been weighing on investor confidence earlier in the quarter.

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Rebounding Consumer and Business Sentiment

Consumer sentiment has exhibited extreme volatility throughout 2025, closely tracking the dramatic shifts in trade policy and economic uncertainty. After experiencing a post-election bounce in December 2024, consumer confidence began a steep decline that persisted through the first quarter, falling for five consecutive months through May. This deterioration coincided with mounting concerns over President Trump's tariff regime. The University of Michigan data shows that consumer sentiment fell to levels last seen during COVID, with Americans expressing deep anxiety about the economic outlook.²⁶

The tariff shock created a particularly challenging environment for consumer psychology, as the uncertainty around trade policies translated directly into reduced spending appetite. Corporate surveys showed contractions in new orders, while consumers delayed major purchases amid fears of higher prices and economic disruption. The disconnect between "soft" survey data and "hard" economic indicators became pronounced during this period, with sentiment surveys reflecting far more pessimism than actual employment and inflation data would suggest. A record-high share of consumers reported believing that business conditions were worsening, while job loss fears reached levels typically associated with recession periods.

However, consumer sentiment began showing signs of recovery in late spring, with June marking the first meaningful improvement of the year. The University of Michigan sentiment index, shown in the chart below, surged 16% from May, representing a broad-based improvement across expectations for personal finances, inflation expectations and business conditions. This rebound coincided with progress in trade negotiations and the announcement of tariff pauses, suggesting that policy clarity was a key driver of the shifts in consumer psychology. Despite this improvement, sentiment remained approximately 18% below the December 2024 post-election levels, indicating that while the worst fears had subsided, consumers remained cautious about the economic outlook and continued to harbor concerns about the potential long-term impact of tariffs on their purchasing power.

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Business sentiment has followed a remarkably similar trajectory to consumer confidence, experiencing severe volatility that closely mirrored the trade policy uncertainty of 2025. Corporate confidence declined sharply in lockstep with consumer outlook as fluctuating trade policies created an unpredictable business environment. The April 2nd "Liberation Day" tariff announcement triggered a particularly dramatic collapse in CEO confidence, with the Chief Executive CEO Confidence Index recording a steep 28% one-month decline that month.²⁸ This represented one of the most severe drops in business sentiment on record, as companies faced the prospect of massive disruptions to their supply chains and cost structures.

The corporate response to this uncertainty was swift and pronounced. Companies began delaying investment decisions and fundamentally reevaluating their supply chain strategies, leading to contractions in new orders and sharp reversals in US corporate capital expenditure plans. The unpredictable nature of trade policy made long-term strategic planning extremely difficult, with many executives adopting a wait-and-see approach rather than committing to major investments. This corporate caution manifested in survey data showing widespread pessimism about business conditions, with recession expectations spiking to 62% among CEOs in April.²⁹

However, like consumer sentiment, business confidence began recovering as trade negotiations progressed and policy clarity emerged. By June, CEO sentiment had improved, with the confidence index rising to 5.8 out of 10, representing a 17% recovery from April's lows.³⁰ More significantly, recession expectations among CEOs plummeted from 62% in April to just 28% by June.³¹ This dramatic shift was supported by executives' recognition that underlying economic fundamentals remained solid—69% reported that consumer demand was the same or higher than the previous year. The growing optimism was largely predicated on the belief that trade-related uncertainty would prove short-lived, with 51% of CEOs expecting conditions to continue improving as trade negotiations settled. By June, 42% of executives were forecasting growth by year-end, up from just 27% in May, suggesting that business sentiment had shifted from crisis mode to cautious optimism.

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Corporate Earnings Forecasts Still Reflect Concerns

The corporate earnings environment in 2025 has presented a complex picture of underlying resilience amid growing external pressures from trade policy uncertainty. Q1 2025 delivered exceptionally strong results, with 78% of companies beating earnings expectations—well above the historical average—and actual earnings growth reaching 14.0% year-over-year, nearly double the 8% growth that markets had initially priced in at the start of the quarter.³³ This outperformance was driven primarily by strong revenue growth, demonstrating that the underlying business fundamentals remained robust despite mounting concerns about tariff impacts.³⁴

However, the earnings outlook has weakened as companies and analysts grapple with the implications of the new tariff regime. Forward-looking estimates for Q2 2025 have been subject to substantial downward revisions, with expected year-over-year earnings growth falling from 9.4% at the end of March to just 5.0% as of mid-year.³⁵ This represents a dramatic 47% reduction in growth expectations over a three-month period, reflecting analysts' attempts to incorporate the potential drag from higher input costs, supply chain disruptions, and reduced corporate investment. If the 5.0% growth rate materializes, it would mark the lowest earnings growth since Q4 2023, though it would still represent the eighth consecutive quarter of positive year-over-year growth for the S&P 500.³⁶

The sectoral distribution of earnings expectations reveals the uneven impact of trade policy changes across the economy.³⁷ Six of eleven sectors are still projected to report year-over-year growth, with Communication Services and Information Technology leading the way, largely driven by the continued AI investment boom. The "Magnificent Seven" technology companies, which represent 31.4% of the S&P 500, have shown little indication of scaling back their AI-related capital expenditures despite the broader uncertainty. This concentration has provided a stabilizing force for overall index earnings. Conversely, five sectors are expected to report earnings declines, with the Energy sector leading the downturn. The earnings environment may remain challenging as companies work through the impacts of the new trade policy regime.

Looking Ahead: Navigating the Path Forward

The Q2 2025 "Resilient Rally" ultimately demonstrated the market's remarkable ability to adapt and recover from severe policy shocks, but it also highlighted the ongoing challenges that investors must navigate in the quarters ahead. As the 90-day tariff pause expires in July and the "One Big Beautiful Bill" works its way through the Congress, policy uncertainty remains elevated, suggesting continued volatility as markets digest the final contours of the Trump administration's economic agenda. The stark performance divergence between AI-driven growth sectors and traditional cyclicals underscores the importance of sector selection, while the disconnect between deteriorating sentiment surveys and resilient hard data suggests that investors should focus on fundamentals rather than headlines. Key risks to monitor include the sustainability of AI capital expenditure trends, the potential for foreign investors to reduce their appetite for US assets amid fiscal concerns, and whether the economic soft landing can be maintained as tariff-related cost pressures begin to materialize in earnest. While the quarter validated the strategy of focusing on companies with strong cash flow generation and defensive characteristics, the market's preference for growth over value and the outperformance of international markets suggest that diversification and flexibility will be crucial as investors position for a period where policy implementation may prove more challenging than policy announcements.