Mid Year Economic and Investment Outlook: Slow Grind
By: Brian Seay, CFA
Welcome to our mid-year outlook on the economy and investment markets. Investing has been a wild ride to no-where this year. The year started strong, then we saw the big drop after liberation day, only to watch the market regain all of its losses within a few weeks. Returns have been generated from other assets, like gold and bonds.
In the podcast episode, I take a look and some of the biggest questions facing investors: What impact will tariffs have on inflation and the economy? Is a recession on the horizon? What impact will the One Big Beautiful Bill have on the economy? I also share our outlook for the stock market, interest rates and other investment assets as we navigate the remainder of the year.
What’s Happened In Markets So Far this Year?
Hello and welcome to our mid-year outlook on the economy and investment markets. If we haven’t met, my name is Brian Seay, and I’m glad you’re joining us, there is a lot to get to. We will talk about tariffs, the conflict in the middle east, whether or not we see a recession brewing, the “big beautiful tax bill” and of course stocks and other investment assets.
If you’re joining via the podcast, there are lots of charts in this episode, so consider watching the recording on YouTube so that you can see the charts. Alright – let’s dive into the economy and markets as we move into the second half of 2025.
Let’s start with what’s happened so far this year. On the chart you can see that gold remains the top asset class for the year, up more than 23%. It’s followed by Internation stocks markets returning north of 17%. Bonds have returned 2.6% so far this year and the S&P 500 is bringing up the rear, up just 2.25% for the year so far. This is why diversification is so important and why its key to go beyond owning just tech stocks or the even the stock market index in a long-term portfolio.
But, as we always do, it’s important not to get lost in short-term thinking when you have long-term investment goals. The next chart shows long-term historical average returns for the various asset classes. The S&P 500 remains the best performing long-term asset class, with returns annualizing 9.8% each year. Golf, after a decade of almost no returns, has had a big run the last few years and is growing 8% annually. Bonds are up 4% each year, and despite all the headlines around inflation, inflation is up 2.5% on an annualized basis over the last few decades.
When we zoom in and look at the past decade, The S&P 500 has returned more than 13% each year on average, Gold is now averaging more than10%, Real Estate has averaged 6% and Bonds are actually the laggard averaging only 1.6%.
So as we talk about our outlook for the economy, geopolitical events, politics and markets, keep in mind that we had all kinds of major events over the past few decades. You would be a very happy investor today if you invested at the peak of markets before the global financial crisis, right before Covid, or right before any number of bad news cycles over the last few decades. Managing risk and diversification is very important, but so is making sure that your starting point is a portfolio than will accomplish you long-term goals. So think about your investment portfolio and other assets - and whether you feel comfortable regardless of the environment – good or bad - going forward. If you have concerns, then it’s probably time to seek out professional advice.
At the beginning of the year, I made the case that returns would be harder to generate than 2023 and 2024. That’s been true so far, with the exception perhaps of Gold. Geopolitical events have only made the environment more cloudy, so let’s start a look at where the U.S. economy stands today and then we can dive into the impact of tariffs, geopolitical events and the potential for a recession. Once we have a good feel for the environment, then we will move to a discussion of specific investment assets like stocks, bonds and real estate.
Will We have a Recession? Economic Outlook…
Real GDP is how we measure whether the economy is growing larger or contracting smaller. Real GDP in the 1st quarter of last year was growing 2.1% a year, down from about 2.5% in Q4 of 2024. You see the covid recession in 2020, the a big spike in GDP growth, the red line. That came with a big spike in inflation, the green line, and then the Fed raised interest rates to cool off the economy. Growth and inflation have come down meaningfully from their post-covid highs because those high Fed interest rates have put the brakes on the economy. You can see that the Fed Funds rate – the green line – remains well above growth and inflation.
We expected Q1 GDP to be negative, and it was. But that was largely due to a big spike in imports ahead of the implementation of tariffs. Remember imports actually subtract from GDP. I would expect that to reverse and show GDP to be stronger than it really is for the next couple of quarters as imports have fallen significantly in the second quarter. But a better measure of underlying growth absent the vagaries of GDP accounting is simply looking at consumer spending and domestic business investment. Those categories grew at a 2.5% rate in Q1, which is still solid, frankly higher than I expected to see. So the starting point for the economy is fairly strong.
We’ve heard from company after company in Q1 that consumers were more price sensitive, they were being more choosy on things like travel and name brand products. There was a lot of discussion about pull forward spending for things like cars earlier this year. Retail sales so far have held in there, up 3% over last year, but the last 2 months have been noticeably weaker in some of those categories like cars that experienced pull-forward demand in the first quarter. We’re starting to see the payback.
One major support for the economy over the last few years has been spending from high-end consumers. The values of 401ks, investment accounts, homes and even businesses have increased and consumer tend to spend more when they “feel rich.” The market decline after “liberation day” wiped out about $5 Trillion in equity value, but that has now almost all returned in a few short weeks. So those assets are still available to support spending from high-end consumers. So the outlook for spending is ok, but not great.
When we look at business activity measures, both the service and goods ISM measures are now below 50, which means activity is declining. For several years goods activity has been falling but service sector things like travel and personal care held up the economy. Now they are both moving the wrong direction.
The labor market is undoubtedly weaker than this time last year. We continue to see the payrolls numbers moving lower, meaning few jobs are being created. But, there are fewer people looking for jobs. Some of that has to do with reduced immigration, some of it is likely U.S. citizens leaving the labor market because jobs are hard to find. New claims for unemployment insurance are up, but only very slightly since the beginning of the year. It is becoming very difficult for the unemployed to find a new job, rates of job finding are at new lows. Over time, the grind of a small number of layoffs and very few open jobs will raise the unemployment rate, but without a sudden shock, it’s a slow grind, not something that causes an imminent recession. You can see from our chart on the right hand side of the page that because the labor force is getting smaller, the U.S. is continuing to produce enough jobs to satisfy demand, we just keep hanging around the black line.
In order for job losses to be more severe, we need layoffs to rise materially. We are seeing layoffs tick up, but again, at a very slow pace compared to history. Again, more evidence of a slow grind down, very similar to where we started the year.
We also hear a lot about the consumer being “tapped out,” after-all, prices are much higher than a few years ago and consumers have increased their credit card balances. Can they keep going? You can see on the chart the oft cited “record levels” of consumer debt. Keep in mind, the economy gets larger every year, so almost all forms of debt reach new highs every economic cycle. What matters is debt – or debt payments – relative to consumer income. You can see that consumer debt to income – this is credit card payments and the like – that has moved higher from the lows we saw during Covid. But we are really just back to the levels we saw pre-Covid and no where near the debt service levels we saw before the financial crisis in 2008. The same is true with mortgage payments. So this seems more like an equilibrium that can continue than a major risk for the economy at the moment. You may also hear about consumers being “taped out” because prices are higher and they just can’t continue to afford to spend. The reality is that wages, especially for blue collar workers, have kept up with inflation over the last 5 years. You can see inflation, as measured by CPI in the red line, is up a cumulative 25% since Covid, but average hourly earnings has more than kept pace and the employment cost index is only slightly below inflation. So I don’t think that consumers are simply going to “run out of steam” without a shock to the economy.
On its own, this feels like an economy that will continue to slow under the pressure of high rates, but in my view, slowing means moving from 2.5% growth to perhaps 1% growth, not falling off into a recession. In order to a recession, we would need to see layoffs move higher and jobless consumers to significantly curtail their spending. So what could cause that?
Tariff War Outlook:
Well, as outlined on “Liberation Day,” tariffs would have caused prices to rise materially and a subsequent drop in consumption and likely layoffs. Consumer just couldn’t afford goods at those prices. However, President Trump walked back the most severe Tariffs and more deals seem to be forthcoming. Let’s look at a few facts around trade to get a baseline. The U.S. exported about $3.19 Trillion in goods and services in 2024 and we imported about $4.1 Trillion, leaving about a $900 Billion dollar trade deficit. So trade generally is important, and many of the items the U.S. exports don’t come from factories, they are services. The other thing to keep in mind is that because we do import more than we export, foreign countries have U.S. dollars from those transactions. They invest those dollars back into the U.S., there is currently more than $30 Trillion of foreign capital invested in the U.S., Half of that is in the stock market, the remainder is in various types of bonds, only about $6 Trillion dollars are in U.S. treasuries. Every year we run a trade deficit, foreign holdings of U.S. securities increases. So the reverse would happen if we stopped trading, U.S. asset prices would go down, and not by a little. There are 4 potential outcomes from tariffs:
1) Raise revenue (tariffs are an import tax after all)
2) Protect U.S. industry from foreign competition, encourages “investment in U.S. manufacturing”
3) Protect “strategic” industries (pharma, metals etc.)
4) Use as leverage in negotiations to reduce global trade barriers (mutually exclusive to other goals)
Some of these are mutually exclusive, you can’t both negotiate and raise revenue. Its one or the other. Lastly, despite all the discussion, U.S. trade is important to China but it is not the end all be all that it was a decade ago. The Chinese have diversified their export base. They don’t want a significant hit to their GDP growth, but as we have seen, the U.S. position is not strong enough that the Chinese will come to the negotiating table and give the U.S. everything it demands. A more likely outcome with China is an offramp that gives each country a little bit of what they want and doesn’t do significant damage to either economy.
Going forward, tariff rates are higher, to be sure, the average Tariff rate moved from about 4% to 17% depending on your exact assumptions. That is significant and it will cause inflation go up by 1 to 1.5% in the second half of the year. But It’s far from the 30% that was originally imposed and again, likely to cause a dull grind lower in the economy, but not likely to be the sole cause of a recession. Now, if tariffs snap back because negotiations with major U.S. trading partners like China go poorly, then perhaps they do get high enough to cause a recession. So there is a real risk there, but as things stand today, it seems like the administration does not want to risk a recession, so they will take the wins they can get without major U.S. economy consequences.
Two things I don’t see as major risks to the economy are a conflict in the Middle East and the Big Beautiful Tax bill currently working its way through congress. Let’s start with the middle east.
What is the Impact of the Iran-Israel Conflict for Investors?
I wrote a note on this last week, so see that for more detail on the Israel – Iran conflict. The U.S. is currently not directly involved, but we all know that can change any moment.
First, as with most conflicts in the Middle East, Iran is a very small part of the global economy and the direct investment implications of conflict are minimal. The death and destruction are very real and saddening, but Iran’s initial response seems rather weak and their ability to wage a long-term war is likely limited. Even a full regime change in Iran is not that impact for global economics.
The most significant indirect risk is an increase in oil prices. Iran only produces about 4% of the world’s daily oil supply, but 25% of the global supply travels through the Strait of Hormuz off its coast. Closing the Strait would likely result in Oil prices over $100 per barrel. The risk of this occurring is driving up oil prices short-term. If necessary, it’s likely that the U.S. and other countries would step in to ensure passage through the Strait, thus the likelihood of an ongoing significant oil price shock is probably limited from here. I expect global market to revert to trading on global economic activity when the conflict subsides.
One Big Beautiful Bill’s Impact on the Economy:
Let’s talk about the tax bill. Before we get into the current legislation, I always like to set the table on U.S. fiscals correctly. Most people get their information on the U.S. fiscal situation from the news, which is usually tilted one way or the other. Two things are true about the U.S. fiscal situation. The first is that we have a spending problem, not a revenue or tax collection problem. U.S. revenue has been very steady around 17% of GDP since the 1940s, and that is where we sit today, you can see that in the green line of the chart. Spending, however, exploded higher during the financial crisis in 2008, then again during Covid and continues to break higher. Spending should be somewhere between 18-20% during good economic times. We don’t have to have a completely balanced budget, but we should be closer than not during good economic times so that we can spend to stimulate the economy when things go south. So you can argue that we should raise tax revenue to a higher level than its ever been – that’s a political argument. You can argue that we should have even more spending – that’s also a political argument – but you can’t argue with the current levels of either relative to the size of the economy and history.
Second, the annual discussion of who pays and does not pay their “fair share” is undoubtedly coming later this summer. So let’s look at the tax data. These charts show U.S. households by income quintile, you can see in the bottom row the dividing lines between the 5 groups. On the left, the lowest 4 quintiles all have a higher share of income than they pay in taxes. The only group that shoulders a greater burden of the taxes than their share of income is the richest 20% of Americans. They pay 81% of the taxes and only earn 55% of the income. You might ask how is possible to have a negative share of taxes or negative tax rate, that’s because this takes into account refundable credits and deductions, so you can get back more from the government in income taxes than you pay. That happens in the lowest quintile. You can also see on the right that the average tax rate for the highest earners is higher than all the other groups. No the secretary does not pay a higher tax rate on average than her boss. You can make a political argument that the riches quintile should pay an even higher rate – or an even higher share of the taxes. That’s a logical argument. You can make an argument that the tax burden should be more evenly shouldered across income groups. One thing you can’t say is that the top earners don’t “pay their fair share”, because objectively they are the only group that pays more than their fair share of the taxes in the U.S.
Alright – so now that we have a starting point – lets talk about the tax bill. I’m not going to cover every proposal in the bill, but what matters from an economic standpoint is the overall impact on Government spending and taxes. Does the government spend more money in 2026 after the bill is passed than it did this year? Does the government collect more or less in taxes than it does this year. The best consolidated view of that is the deficit. We are currently projected to run a Federal Deficit of about $1.9 Trillion in 2025. The Big Beautiful Bill does reduce spending levels. That’s what the administration claims, and it is true. According to the CBO, spending goes down by about $175 Billion a year. Now, on the revenue side, in 2026, the proposed tax cuts will reduce revenue by $557 Billion, followed by $571 Billion in 2027. Over the next decade, taxes are reduced between $3.5 and $4 Trillion dollars. That means in 2026 and 2027, the deficit will increase by $542 Billion in 2026 and another $522 Billion in 2027. In total, the deficit increases by $2.6 Trillion over the next decade.
So from an economic growth perspective, that’s good. The government is spending slightly less money than it did in 2025, but it is collecting far less in taxes, so the net effect should be stimulative for the economy. What this does not account for is the deficit. The cost of that near term economic growth is more debt and deficits long-term. Now, you’ve heard that the CDO is archaic, the way the do math in DC is strange etc. So for this discussion I just took this year’s budget and looked at the impact going forward. No exemptions, things that would have happened, budget glide paths etc. Do we spend less or more, period.
That still leaves out the tariff revenue. Won’t that cover some of the costs of the bill? It is true that if the April 2nd tariffs were left in place, they would raise $1.4 Trillion dollars over the next decade. By the way, that isn’t enough to pay for the bill to start with. But it would raise more than $1 Trillion in Revenue. The reality is that since April, the President has been negotiating rates lower. The reality is that rates that high raise revenue, but they also hurt the economy, so tariffs will raise some revenue, but its more likely to be closer to $500 Billion over a decade, which doesn’t come close to paying for the tax bill.
So, the Big Beautiful Bill is good for the economy short-term, it probably drives more growth than we would have otherwise in 2026 and 2027, but it does little to solve the long-term debt and deficit problem the U.S. faces because the limited spending reductions are more than offset by tax reductions.
For our purposes, I think it’s a slight positive for the economy as we move into 2026.
So short of a snap back in Tariffs, I think its likely that we see the economy continue to slow throughout 2025, but perhaps not fall into a recession. Think 1% growth with 3.5 to 4% inflation as the tariffs take hold in the second half. So given the economic backdrop, let’s look at investment assets. We will start with stocks and then talk about bonds, gold and real estate.
What is our Outlook for the Stock Market?
I start with stocks because equity exposure generally forms the bulk of portfolios aimed at long-term growth. When we think about portfolio construction, the major question is really how much stock exposure should we have? Equities, both public and private, provide the bulk of portfolio growth over the long-term. After that important question is answered, you can fill in the rest with diversifying assets.
Stocks should (and do) track their earnings growth over the long-term. Companies make more money, stock prices go higher. Simple. You can see in the chart the earnings are in green and the S&P 500 price is in red. We started the year with analyst’s expecting 14% earnings growth. As I mentioned in the 2025 Outlook, I thought that was an optimistic outlook, everything had to go right for earnings to grow that much. Obviously now, everything is not going right. What’s funny is that earnings expectations have dropped down to about 7.5% for the year according to Bloomberg, yet the market is higher than it was at the beginning of the year. You can see in the chart, the market continues to grow faster than earnings, causing Price Earnings multiples to go higher, making the U.S. stock market expensive in our view. Corporate growth is currently expected to be only about 4.5% in the second quarter, and given the slow grind we have discussed, I don’t see how profits meaningfully accelerate in the second half of the year.
What has been working in the U.S. is a tilt towards growth, this has been the case for several years as the economy is slowing down, but some companies, think AI and tech here, are still able to growth their businesses despite overall sluggish growth. So in the U.S., sticking with growth in a slowing environment is still the right approach in my view.
Overall, the U.S. stock market is expensive and the earnings outlook isn’t great going forward, so we need to find better opportunities to generate investment growth for the balance of the year.
The good news is that we have lots of other choices. In the stock market, international stocks have by far been the best performer of the year. Both developed markets like Europe and Japan and Emerging markets like China, Brazil and Poland. Yes, even the Chinese stock market is up 17% for the year. Do I think the U.S. is losing its position as the main driver of global economic growth? No. I think the U.S. will continue to be the best place to be long-term. But can international assets outperform U.S. stocks when the U.S. has anemic growth and higher stock valuations? Absolutely, and that’s what we have seen so far this year after surprise fiscal stimulus in Europe. The run up in developed international markets has corrected what was a discount to their long-term valuations, so the stocks aren’t on sale, but they aren’t overvalued like the U.S.
Let’s talk about emerging markets. Growth in the U.S. and much of Europe is anemic, but other areas of the globe still look attractive. India is growing their economy by 7.5% YoY and inflation is down below 3%. China is still projected to grow between 3 and 5% this year depending on the outcome of trade negotiations. When we think about emerging markets, my view continues to be that buying specific countries and assets that are attractive is the way to go vs. owning the entire index. This is one of the few places where active management seems to still pay off. Exports do drive most of the economic growth in the emerging world, so there is a risk that the trade war heats back up, so companies that can win domestically in EM countries are likely a better bet than those that solely rely on exports to the U.S. (or China).
Moving on from stocks, let’s talk about the diversification part of portfolios. Perhaps never more valuable than the present.
Before we dive into asset classes, I think it’s worth pointing out these asset classes are doing the work in portfolios this year. The S&P is up a little more than 1% year to date, Gold is up more than 23%, we’ve cover international stocks already, but bonds are also outperforming the stock market so far this year, and with significantly volatility and risk.
Let’s start with bonds and interest rates.
What is our Outlook for Interest Rates and Bonds?
Intermediate bonds are up about 3.6% for the year so far. Interest rate volatility has been very high, but ultimately longer-term bonds have not fared as well. You see them in the pink line up just 1.4% for the year. Higher yield bonds backed by corporations and bonds from emerging market countries have been the best performers so far this year – and these have been a staple of our bond portfolios for the last few years. As long as we stay out of a significant recession and credit crunch, which is our expectation, then these bonds should continue to lead the pack.
I do think its worth noting that floating rate high yield bonds are among the worst performers this year. This is a good proxy for private debt. The companies that issue high yield bonds to the market have fixed rates once the bond starts trading and those companies have continued to pay their interest and principal over time. As rates have risen, companies with variable rate structures in floating rate funds and private have had more challenges as rates ratchet up incrementally. There isn’t a crisis brewing, but I do think there is a lot of “kick the can” happening in that space, and if rates don’t come back down some companies with floating rate debt will start to run out of rope. I think this is something to watch out for – even in the high yield space -which I like in general – stick to fixed rate debt.
The next chart shows fixed income assets based on yield. I put this in here just to reaffirm the point that a diversified portfolio can help you accomplish your investment goals, stocks don’t have to do all the work. Certainly high yield bonds yielding 6.5% or more help, but even investment grade credit in the 4-5% range goes a long way to building portfolio returns when your targets are 6-8% each year.
We started the year with the market expecting 2 Fed rate cuts, sticky inflation and of course GDP and earnings growth. The market is back to pricing in between 1 and 2 cuts this year. That’s probably more realistic than my original expectation of 4. Make no bones about it, The Fed should be cutting with economic growth softening. The problem is that tariff rates have been higher than everyone expected and that will drive inflation meaningfully higher in Q3 and Q4. Without really serious layoffs picking up, its hard to see the Fed cutting rates significantly this year. The result is that rates will continue to put downward pressure on the economy – and by the time the Fed cuts – even if its early in 2026 – it might be too late. That probably makes us worse off in the long term, but it is the situation we find ourselves in.
We already covered the Big Beautiful Bill and the Deficit, but the bond market is generally now trading two distinct sets of data. You can see in the Yield Curve, the red line is the curve from last June and the Green line is the current curve. Short-term rates have moved lower over the last 12 months as the Fed cut rates on a softening economy. But long-term rates have been more stable. Rates out past 10 years are trading less on the near term economy and more on the U.S. fiscal situation. So the continued expansion of the u.S. deficit is keeping longer term rates higher than they probably should be. I think short-term rates do need to eventually come down to close to 3%, but as has been my view for a while, that could leave the 10 year trading somewhere close to today’s levels between 4.25 and 4.75%. That makes longer term bonds – especially treasuries - less attractive today – our view continues to be to buy corporate bonds vs. waiting for rates to collapse in a recession that may never arrive.
What about other assets outside of Bonds?
What is our Outlook for Gold?
Gold has also provided strong returns in a challenging environment, up more than 20% for the year. My overall view on gold has not changed, as long as central bank demand remains above average, which it has, then gold should continue to do well. You can see central bank demand in the chart on the right side of the page. It did come off a little bit in Q1, but it still remains above that 200 ton level and that should be sufficient to at least keep prices stable.
This year we have also seen inflows from investors recently as market volatility and geopolitical concern has increased, which is typical. You see in the chart on the right side the Bue section of the bar, which sort of appears out of nowhere in Q1 of 2025, that is Gold ETF demand, which shot up. Financial demand for Gold tends to be finnicky – trades move in and out quickly. I expect some of the increases we saw in the 1st half to reverse in the second half. So overall, we may have seen most of the total return for Gold that we get in 2025 already, but Gold is one of the best hedges against the kind of stagflationary environment we find ourselves in, so continuing to own gold makes sense for now.
What’s Happening in Housing?
Let’s round out the discussion with real estate. U.S. home prices are starting to flatten out in the Case Shiller data after years of upward motion. Technically prices are still up about 3% YoY, but in many markets I suspect prices are actually started to fall just a bit. That’s certainly true in Huntsville. If you look at the existing home market, we have been stuck at about the 4M sales a month and the number of homes on the market has been gradually rising, that makes it more of a buyers market and should start to lower prices. Sales at new home builders have been down as well and though many have not cut prices directly, they are adding incentives in to new home purchases like rate buy downs and free upgrades that essentially act like price cuts. You can see in the home builder sentiment data, its basically the worst environment since the financial crisis in 2008. Traffic is down and future expectations are also very weak. Homes are still good assets to own, being choosy on the specific house in this market is important. From an investment perspective, apartment vacancies are also rising as more new units come online, so rents are flat to down as well. That means it harder to make investment rental properties work with high interest rates, high cost mortgages and lots of competition on rental prices. If you can find a good property on sale, it might work, but otherwise I think it prudent to sit tight and wait for a better rate and rental environment before making investments in residential real estate.
Conclusions:
We’ve covered a lot of ground, so I’ll try to summarize it all here.
We have gone round trip, we started the year looking for stagflation, then a recession, now we are back to a stagflationary environment. Growth is still positive, but slowing, and I expect it to remain that way for the next 6 months. Inflation will likely rise given the price impacts of tariffs on consumers. The biggest risk is that the tariff discussion heats back up and substantially higher tariff rates kick back in. That would drive up prices and drive down growth more quickly than I currently expect. U.S. stocks look expensive, the rest of the world looks a bit better when you consider growth and valuation.
Its markets like these – high uncertainity – where diversification really matters. Not just in a theoretical sense, everyone always says to be diversified to manage risk, that’s easy. But in an environment where you can generate similar returns across lots of different asset classes, you are far better off owning different kinds of assets than just depending on one asset class, like stocks, to drive your portfolio’s growth. Stocks, Bonds, Gold, Real Estate, Infrastructure and other assets can help drive returns and some of those assets will likely outperform no matter which way the economy breaks. So diversification is really key to navigating this market perhaps in a way that it hasn’t been in recent years.
So I hope this perspective on markets has been helpful as you think about the rest of 2025. If you have questions about your investments and would like to discuss further, I’m always happy to connect. There is a link to schedule time in the show notes and I look forward to talking to you all very soon.