Reports

Fiscal policy uncertainty, which drove the decline in stocks this spring (S&P Global), receded during Q3 and helped lift stock valuation multiples.  Job growth slowed materially, but outright job losses remained subdued, and consumer spending was stronger than expected.  Inflation picked up somewhat, but the Federal Reserve placed greater emphasis on the weakening labor market data than the increase in inflation, which it believes is being driven by transitory upward pressure from tariffs.  As a result, monetary policy easing resumed in September, and bond yields declined materially across the curve as investors priced in additional rate cuts ahead.  Meanwhile, investment in artificial intelligence continued to exceed expectations, fueling excitement about a prolonged period of rapid growth.  Against this backdrop, stocks continued their steep ascent from the April low, and while AI-related stocks continued to do well, the best performers were highly volatile, low quality, small capitalization, and cyclical stocks.

Unprecedented. The second quarter began with reciprocal tariff announcements that alarmed investors and sent stocks into free-fall. By April 9, the S&P 500 had declined 20% from its February high. Remarkably, just 89 days after the reciprocal tariff press conference, the stock market had climbed more than 28% from its intraday low on April 9 and closed the quarter at an all-time high. Based on market data dating back to 1900, it was the fastest recovery to a new record high following a decline of 20% or more from the prior peak (The Wall Street Journal).

In this mid-year investment update, we reflect on a highly eventful first half of 2025 and share our current outlook for the remainder of the year.

In our outlook for 2025, we wrote about the following factors that we thought would impact investment returns this year: Artificial Intelligence Investments and Commercialization of AI Applications, Labor Market Conditions, Inflation, and Fiscal and Monetary Policy. We provide our latest thoughts on each of these topics in this update, after a quarter characterized by a lot of market-moving news and a corresponding increase in stock market volatility.

Our outlook for 2025 is based on the following factors that we believe are most likely to impact investment returns: Artificial Intelligence Investments and Commercialization of AI Applications, Labor Market Conditions, Inflation, and Fiscal and Monetary Policy.

The outcome of the Federal Reserve’s aggressive inflation-fighting campaign launched in 2022 is coming into sharper view. Inflation has declined from a peak of over 9% in mid-2022 to 2.5%, unemployment has increased by just a small percentage and remains near the low end of its range over the last 50 years, and theU.S. economy has continued to grow. When the Fed began its inflation fight back in 2022, few economists thought such an outcome was possible, but restoration of inflation back to about 2%, low unemployment and continued good economic growth is now very much the consensus forecast.

In our 2024 outlook that we distributed in January, we wrote about what we thought would be the most important factors hat would impact investments in 2024, including: (1) Will inflation continue to fall as expected towards theFed’s 2% target?(2) Will there be a recession?At the halfway point of 2024, we update our inflation and economic outlook based on new information and assumptions.

In our Winter 2024 outlook, we wrote about what we thought would be the most important factors that would impact investments in 2024, including:
(1) Will inflation continue to fall as expected towards the
Fed’s 2% target?
(2) Will there be a recession?
In January, a large majority of investors believed that the Fed would successfully bring inflation down from a very high level to near its 2% target by the end of 2024 while avoiding a recession. In this update, we analyze recent inflation and economic data and provide our opinions as to how it changes the outlook.

As we start 2024, we make the following observations about what we believe are the most important uncertainties that will impact investments in 2024. (1) Will inflation continue to fall as expected towards the Fed’s 2% target? (2) Will there be a recession? (3) Will artificial intelligence adequately deliver on its promise in 2024?Notably, investors’ opinion on the first question is resoundingly “yes.” Investors’ opinion on the second question has shifted during the last several months and there is now a strong consensus opinion that the answer is “no.” Based on the performance of technology stocks in 2023 and high relative valuations, it seems clear that investors expect a lot from artificial intelligence in 2024. Read along as we explore these questions in more detail.

As we turn the calendar to the closing months of 2023, we look back and consider how the year has unfolded compared to expectations at the beginning of the year. A year ago, the consensus opinion was that economic conditions would be poor in the first half of the year, likely including a recession, and the economy would recover in the second part of the year. Most investors expected a weak first half for stocks, with a rebound later in 2023. Contrary to the consensus belief, the economy proved far more resilient than expected through September, driving equity returns far above expectations in the first half of 2023 as investors’ calls for a 2023 recession went silent by mid-summer.

The phrase “if it is not one thing, it is another” implies that when dealing with financial markets and the economy, there is often a continuous cycle of challenges or issues. It suggests that as one problem is addressed, another one arises. This statement reflects the dynamic and ever-changing nature of financial markets and the economy.