US stock market: Key questions as second half of 2025 kicks off

The U.S. stock market enters the second half of 2025 at record highs, up over 5% year-to-date, but faces several critical uncertainties that could challenge its trajectory. Key concerns include the potential impact of rising tariffs, now at an effective 13%, on corporate profits and inflation, alongside the Federal Reserve's rate cut path amid political pressure and evolving economic data. Additionally, market breadth remains a focus as megacap tech continues to drive gains, while elevated valuations, doubts about U.S. exceptionalism, and geopolitical risks, particularly in the Middle East, pose further threats to sustained market performance.

Analysis

The U.S. equity market enters the second half of 2025 at record highs, with the S&P 500 up over 5% year-to-date, but its foundation is increasingly precarious amid several unresolved headwinds. A primary concern is the impact of tariffs, with the effective rate climbing to 13% from 3% at the start of the year, according to Goldman Sachs. This poses a significant threat to corporate profitability and could fuel inflation, making the upcoming Q2 earnings season—where S&P 500 earnings are forecast to grow 5.9%—a critical test of whether these costs have been priced in. Concurrently, a disconnect exists between the Federal Reserve, which cites inflation risk as a reason to delay rate cuts, and fed fund futures, which are pricing in nearly three cuts by year-end. This divergence, compounded by political pressure on Fed leadership, creates significant policy uncertainty. The market's advance has been narrow, led by a resurgence in megacap technology stocks since the April lows, raising concerns about market breadth, as the equal-weight S&P 500 has lagged slightly at a nearly 4% gain. Valuations appear stretched, with the S&P 500's forward price-to-earnings ratio at 22.2, well above its 15.8 long-term average, making equities vulnerable to any spike in Treasury yields or a failure to meet ambitious earnings growth expectations of 8.5% for this year and 14% for next. Finally, emerging doubts about U.S. exceptionalism, evidenced by a weakening dollar and underperformance relative to international markets this year, coupled with latent geopolitical risks, contribute to a cautious outlook despite the record-setting performance.

Key Decisions for Investors

• Investors should scrutinize upcoming Q2 corporate earnings reports, specifically focusing on profit margins and forward guidance for signs of compression from the 13% effective tariff rate.
• Given the market rally's concentration in megacap tech and the S&P 500's elevated 22.2 forward P/E ratio, it may be prudent to assess portfolio concentration and consider rebalancing towards broader market segments or relatively cheaper non-U.S. equities.
• Prepare for heightened volatility around key economic data releases, such as the upcoming employment report, as the divergence between the Fed's cautious stance and the market's expectation for rate cuts creates potential for sharp repricing.
• While geopolitical events have historically had a limited long-term impact on U.S. equities, consider tactical hedges against potential oil price spikes and increased market volatility stemming from any escalation in Middle East tensions.