Why Diversification Is Winning in 2025

Despite ongoing volatility, equity markets, including the S&P 500's 20%+ rebound from April lows, and most fixed income and commodities posted significant gains in H1 2025. The Federal Reserve held rates steady at 4.25-4.50%, citing persistent inflation (Core PCE 2.7%) and a contracting Q1 GDP, yet their updated projections imply two 25bps rate cuts by year-end 2025 despite revised forecasts for lower GDP and higher inflation/unemployment. This environment, alongside projected S&P 500 EPS growth and a weakening dollar, signals potential tailwinds for risk assets, with diversified multi-asset portfolios, particularly those with international and real asset tilts, outperforming concentrated US exposures.

Analysis

Equity and fixed income markets demonstrated notable resilience in the first half of 2025, delivering strong returns despite persistent macroeconomic headwinds. International developed equities led the gains with a 20.7% increase, while the S&P 500 recovered over 20% from its April lows. This rally occurred alongside a complex economic picture, with the Federal Reserve holding its policy rate at 4.25-4.50% as Q1 GDP was revised down to -0.5%, yet core PCE inflation remained elevated at 2.7%. Forward-looking guidance presents a mixed outlook: the Fed's own projections have lowered real GDP forecasts while raising inflation and unemployment expectations, yet they simultaneously signal approximately two 25bps rate cuts by year-end. Key tailwinds are emerging, including Morgan Stanley's forecast for nearly 10% S&P 500 EPS growth, driven by a recovery in earnings revision breadth, and a weakening US dollar, which historically benefits risk assets. The period's performance has underscored the value of diversification, as multi-asset portfolios with exposure to overseas markets and real assets like gold (+25.9%) have outperformed concentrated US equity positions.

Key Decisions for Investors

• Investors should consider maintaining or increasing exposure to diversified portfolios with strategic tilts towards international developed equities and real assets like gold, which have demonstrated significant outperformance year-to-date.
• Monitor upcoming economic data closely, as the Federal Reserve's intention to cut rates later in the year appears at odds with its own projections for higher inflation and lower growth, creating potential for policy-driven volatility.
• Factor in the weakening U.S. dollar as a potential catalyst for U.S. multinational earnings and broad risk assets, aligning with historical trends and positive earnings revision breadth.
• Given the outperformance of bonds and the Fed's accommodative forward guidance, re-evaluate fixed income allocations, particularly in intermediate-term Treasuries and Treasury Inflation-Protected Securities which have posted solid gains.