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Q2 2025: Teflon Markets

Q2 2025: Teflon Markets

Jul 9, 2025 | Market Commentary

Trade-war tensions gripped the globe in Q2 2025, yet markets shrugged them off, correctly wagering on diplomacy winning out. The White House temporarily shelved announced tariff hikes and recession fears calmed, then, major indices surged: the S&P 500, MSCI EAFE, and MSCI World each climbed between 11 – 12%, respectively. Volatility remained tame despite bookend shocks like the April 2 “Liberation Day” tariff bombshell and the June 24 Israel-Iran ceasefire. Ensuing market resiliency illustrated the power of strong consumer demand and high liquidity in the face of geopolitical uncertainty: by quarter-end the S&P stood 24% above its early April low. For now, headlines alone cannot disrupt the foundation of a strong underlying economy.

The rebound may only be masking mounting structural strains. Washington hopes to rewrite global trade rules without interrupting the foreign capital that has bankrolled

U.S. deficits for decades. The nation’s net international investment position has swung from a $7 trillion deficit in 2018 to nearly $18 trillion today, as erratic policies chill demand for dollar holdings. The tariff collections are now propping up the federal budget; reversing them would require either fresh taxes or deeper borrowing. As of now, tariff collections are running $60B ahead of 2024; should capital inflows fall short of the current account deficit, pressure could surface through higher yields, a weaker dollar, or slower growth.

For now, investors are accepting the contradiction: Wall Street is booming even as America’s external ledger frays. Liquidity, not headlines, remains the bulls’ friend. But one rogue policy tweet could unleash chaos, reminding us all to stay alert.

ECONOMIC CONDITIONS:

U.S. – Resilient Amid Mixed Signals

Q2 2025 real GDP growth is currently estimated at 2.6% (seasonally adjusted annual rate) by the Federal Reserve Bank of Atlanta’s GDPNow model.

Defying labor market projections, more jobs were added and the unemployment rate ticked down.

Housing starts dropped to a five-year low in Q2 and new home construction fell 4.6 percent year over year.21 Sales of existing homes fell by 6.3 percent, and the market had a little over half a million unsold new homes in May, equal to 9.8 months of supply at the latest sales pace.23

International: Showing Strength

Global shares gained overall after sharp falls experienced at the start of Q2 when President Trump unveiled new “Liberation Day” trade tariffs. Equity markets subsequently recovered amid the temporary suspension of most tariffs while trade talks took place, with a deadline of 9 July for most countries. For now, rather than immediately impose the new tariffs, the administration appears to be in negotiations with several countries as part of an ongoing process.

Many Japanese companies released full-year results and provided guidance for fiscal 2025. Although earnings forecasts were cautious, shareholder returns through dividend increases and buybacks rose significantly, reflecting ongoing corporate governance reforms and efforts to enhance return on equity – key factors supporting the market’s performance during the period.

EQUITIES: Welcome Advances

U.S. EQUITIES: U.S. shares advanced in Q2 supported by generally robust corporate earnings the quarter prior. Investor appetite for select “Magnificent 7” ignited interest in the information technology and communication services sectors. Stocks with exposure to artificial intelligence staged a strong recovery after some weakness earlier in the year.

DEVELOPED INTERNATIONAL EQUITIES: Eurozone shares also made strong gains with industrials and real estate sectors leading the advance. Within industrials, defense stocks generally continued their good performance amid an agreement at the NATO summit for countries to lift defense spending.

Emerging market (EM) equities were just ahead of their developed market peers in Q2, helped by weakness in the U.S. dollar. Both the EM and World indices delivered double-digit returns in U.S. dollar terms.

FIXED INCOME: Rising Yields

U.S. FIXED INCOME: U.S. policy set the tone this quarter. Trump’s early April “Liberation Day” surprise—10% tariffs on all imports, higher levies for deficit partners—initially rattled markets, but a 90-day negotiation pause soothed recession worries. Attention then pivoted to debt sustainability after Congress passed the “Big Beautiful” reconciliation bill. Moody’s downgraded U.S. debt to Aa1, and Treasury yields spiked, pressuring other high-deficit nations.

DEVELOPED INTERNATIONAL FIXED INCOME: Over the quarter, yield curves across all major government bond markets steepened (i.e. yields moved comparatively higher in longer dated bonds). Japanese and Canadian government bond markets were the laggards, with the Bank of Canada expressing uncertainty around U.S. tariff policy. Weak growth and easing inflation pressures prompted a comparatively positive market reaction in the Australian rates market.

QUARTERLY FOCUS: Sustainability?

A rare tandem decline in U.S. stocks and the dollar dominated early Q2 2025, but by quarter-end the narrative had flipped: the S&P 500 clawed back its losses even as the greenback slid to a three-year low, down more than 10% year-to-date. That divergence is critical for equity allocators. A weakening dollar historically boosts non-U.S. shares, because local-currency revenues translate into more dollars and foreign earnings become relatively more valuable. Today, that currency tailwind is bolstered by an important macro shift: since April, the dollar’s long-standing link to Treasury yields has broken down, making persistent current-account deficits—not rate differentials—the primary driver of FX. As long as capital inflows fall even slightly short of the roughly $1 trillion U.S. external gap, further dollar softness is likely, strengthening the case for international assets.

Valuations amplify the opportunity. Even assuming American profit margins hold, U.S. equities trade at a hefty premium: bringing all developed markets back in line with their share of global earnings would imply a 20% pullback in U.S. prices and roughly a 30% advance for Europe and other developed regions. Investors have been slow to rotate, partly because regulation and sluggish non-U.S. data have kept enthusiasm muted, but every incremental piece of good news abroad can spark a powerful re-rating.

Europe is already benefiting from euro strength versus both the dollar and the renminbi, while an accommodative European Central Bank injects fresh liquidity. Japan is normalizing policy only gingerly, and Switzerland’s near-zero rates underscore the room most ex-U.S. central banks still have to support growth if needed. Meanwhile, many multinationals—American and otherwise—are adopting “multi-local” strategies, shifting production nearer to customers to sidestep tariffs. That operational agility means investors don’t need to fear trade frictions torpedoing overseas earnings.

In short, the macro stars are aligning: a structurally weaker dollar, cheaper valuations, supportive policy backdrops, and adaptable corporate models all tilt the risk-reward balance toward international equities. The window for reallocating before markets fully price in this regime shift may not stay open for long.

DPWM OUTLOOK: Opportunity Knocks

With tariff negotiations continuing past the 9 July deadline and Washington’s fiscal path now under scrutiny after Moody’s downgrade, policy uncertainty is likely to keep volatility elevated through the summer. That backdrop reinforces one core truth: a thoughtfully diversified portfolio—anchored by alternatives—remains the best defense and offense. DPWM continues to recommend trimming outsized positions in richly-priced U.S. large-cap technology and consumer discretionary names. Domestic defensive sectors – healthcare, energy and select utilities — offer steadier earnings and attractive dividend support. The bigger valuation gap, however, now sits overseas. European financials, industrials and energy companies stand to benefit from a weaker dollar, recovering demand and accommodative ECB policy, while many Asian exporters enjoy currency-related tailwinds. Emerging markets tied to commodity production—Brazil, Mexico, parts of Southeast Asia—look compelling as U.S. Treasury yields drift lower; we remain cautious on tariff-exposed markets such as Taiwan and India.

Core high-quality U.S. Treasuries still provide ballast against equity drawdowns. Investment-grade corporate spreads have widened modestly, offering better risk-adjusted income, whereas high-yield valuations appear less forgiving given slower global growth. We favor a barbell of short-maturity IG credit and intermediate Treasuries to balance carry and liquidity. Sectors insulated from tariff risk, i.e. semiconductors, pharmaceuticals and critical-mineral producers, should outperform. Gold and other precious metals can hedge both volatility and any rekindling of inflation pressures linked to a weaker dollar. Infrastructure assets tied to digital networks and renewable energy, plus defensive real estate (data centers, healthcare facilities), provide inflation-linked cash flows with low equity correlation. Private credit and market-neutral absolute-return strategies remain valuable shock absorbers in choppy markets.

While policy fog persists, opportunities abound: lower international valuations, supportive central-bank liquidity abroad, and multi-local supply-chain realignments all create fertile ground for disciplined buyers. At DPWM we are staying flexible, rebalancing portfolios methodically and keeping dry powder ready to deploy if short-term dislocations surface. As always, we are here for you to answer any questions and discuss your portfolio strategies.

 

 

 

 

CITATIONS:
1. WSJ.com, June 30, 2025
2. WSJ.com, April 4, 2025
3. WSJ.com, April 9, 2025
4. CNBC.com, April 22, 2025
5. CNBC.com, May 12, 2025
6. CNBC.com, May 13, 2025
7. Finance.Yahoo.com, May 30, 2025
8. MarketWatch.com, June 5, 2025
9. CNBC.com, June 24, 2025
10. WSJ.com, June 6, 2025
11. CNBC.com, June 12, 2025
12. WSJ.com, June 27, 2025
13. Sectorspdrs.com, June 30, 2025
14. GDPNow.com, June 17, 2025
15. MSCI, June 30, 2025
16. WSJ.com, June 30, 2025
17. BEA.gov, June 26, 2025
18. WSJ.com, June 6, 2025
19. CNBC.com, June 17, 2025
20. FederalReserve.gov, June 17, 2025
21. MarketWatch.com, June 18, 2025
22. National Association of Realtors (nar.realtor), June 23, 2025
23. Realtor.com, June 25, 2025
24. CNBC.com, June 11, 2025
25. KPMG.com, June 26, 2025
26. WSJ.com, June 18, 2025
27. WSJ.com, June 24, 2025
28. IDFA.org, June 2025
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