The market’s performance in the second quarter of the year was surprisingly good with gains of 17.8% in the Nasdaq Composite, 10.6% in the S&P 500, 5.0% in the Dow Jones Industrial Average, and 8.1% in the Russell 2000 index. However, these percentages do not accurately reflect the volatility seen in equities over the last three months. Volatility – to change rapidly or unpredictably but often used by strategists in place of indicating a weak or bear market — was indeed a very accurate description of the second quarter.
The S&P 500 index reached a high of 6144.15 on February 19, 2025 before falling to a low of 4982.77 on April 8, 2025. This was a 19% decline on a closing basis and more than a 20% decline on an intra-day basis. A 20% decline, or more, typically defines a bear market. The Nasdaq Composite was even more volatile in the same period, dropping nearly 24% between February and April on a closing basis and over 25% on an intra-day basis. Yet by the end of the quarter, the S&P 500 and the Nasdaq Composite were at new record highs, with gains from their April lows of 24.5% and 33%, respectively.
Tariff and DOGE Tizzy
The catalyst for April’s swoon in the equity market was tariff policy, or more precisely the breadth and level of tariffs proposed by President Trump. The April 2, 2025, “Liberation Day,” announcement did take us, and the world, by surprise. However, the media failed to understand the purpose of President Trump’s proposed tariff policy or the newly installed Department of Government Efficiency (DOGE). Economists began forecasting high inflation, massive job cuts, and a US recession in the wake of these policies and consumer sentiment soured.
As we noted in April’s quarterly strategy report, we think these recession forecasts totally ignored the objectives of President Trump’s trade policy and DOGE, and the likely positive impact tariffs and DOGE could have on the US economy, the trade balance, GDP, and budget deficit. From a simple perspective, it is not surprising that the stock market fell early in April, but it is also not surprising that equities recovered their losses and more. By the end of the second quarter equity indices were at all-time highs.
Technical Vigor
The underlying strength of the rally from the April lows has been impressive. Typically, the popular indices will rally to new highs, and it takes several days or several weeks, for volume and breadth indicators to confirm these highs with positive breadth and volume signals. However, 2025 was different. The 25-day up/down volume oscillator rose to and remained in overbought territory for 9 of eleven consecutive days in May and reached a high of 5.10 on May 16. This May reading was the highest since August 18, 2022, when the market was rebounding from the 2022 low. Strong overbought readings are bullish in this indicator since it confirms that robust buying is driving stocks higher. The NYSE cumulative advance/decline line made a string of new highs in June, the latest on June 30, 2025, a sign that the rally from the April lows was solid and broadly based. In short, stocks were indicating that the popular indices would soon be making new highs. On April 2, 2025, the survey from the Association of American Investors showed 61.9% of investors were bearish, a new high for this cycle and a very favorable reading. The 8-week bull/bear is currently neutral but was positive for 17 consecutive weeks from mid-February through June. All in all, these indicators have been confirming an ongoing bull market.
Awaiting Fundamentals
Most economists have relented on their forecasts for a 2025 recession, and economic releases have been good, but somewhat mixed. Total retail & food services sales rose 3.3% YOY in May, down from the 5%+ levels seen in prior months yet showing respectable growth. Housing has been relatively glum for over six months, but many housing surveys are now rebounding from their April lows. May’s employment report showed 139,000 new jobs despite the fact that federal government headcounts declined by 22,000 in the month. Wage growth has been steady at 3.9% YOY and is beating the level of inflation.
Total personal income grew 4.5% YOY in May and real personal disposable income grew 1.7% YOY. This is a small growth rate in real income; nonetheless, it is far better than the negative monthly growth rates seen from January 2021 through December 2022. Inflation benchmarks remain low and stable despite the fact that tariffs are in place. The Federal Reserve’s favorite index, the personal consumption expenditure index, showed prices rising 2.3% YOY in May, up only slightly from 2.2% in April. Headline CPI was 2.38% YOY in May, relatively unchanged from the 2.33% YOY in April. Both inflation indices are down substantially from the
7.25% to 9.1% recorded in June 2022. Energy represents 6.4% of the CPI, and with WTI crude oil currently under $65 a barrel, down from $80 a barrel in January, headline inflation is apt to trend lower in months ahead.
The underlying foundation of any bull market is earnings growth, and while first quarter earnings results were better than expected, the impact of tariffs is more likely to be defined by results reported in second quarter. Second quarter reporting season will begin in earnest in mid-July; however, earnings forecasts for 2026 and 2027 have been creeping higher in recent weeks. This is a good omen. If there is one area of concern it would be equity valuation which remains stretched. The 12-month forward S&P 500 earnings PE is currently 21 times and well above the long-term average of 17.9 times. This is why earnings releases and CEO forecasts will be a defining factor for equities in the second half of the year.
All in all, we have been expecting the stock market to rally to new highs in the second half of the year. Part of our optimism is based upon the passage of the Big Beautiful Bill which we expect will boost GDP as a result of retroactive tax cuts and corporate investment deductions. If this is correct, corporate earnings should also beat expectations and support a solid equity performance in the second half of 2025.
Gail Dudack
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