A Welcome Relief, but Potential for More Volatility

As we navigate through the economic landscape of 2025, investors face a complex array of challenges that suggest the possibility of continued volatility ahead. While markets have shown resilience thus far (rebounding 13% from the April 8th low), some indicators point to potential headwinds that may have an impact on investment performance in the coming months. It's important to emphasize that these are possibilities rather than certainties, but prudent investors should consider these factors in their strategic planning. 

The Soft Data/Hard Data Disconnect 

One of the warning signs we are paying attention to is the disconnect between "soft" and "hard" economic data. Consumer sentiment surveys and business confidence indices have been trending downward for several months, while GDP growth, employment figures, and retail spending have remained relatively robust. 

Historically, this divergence tends to resolve eventually—and usually in favor of the soft data. What consumers and businesses are feeling about economic conditions tends to be a leading indicator of where the economy is heading. The sentiment indicators may be capturing early signs of economic stress that have yet to manifest in the broader economic statistics. 

If this pattern holds true, we may soon see the negative sentiment reflected in declining economic performance metrics. This transition could trigger a market reassessment as investors adjust to deteriorating economic fundamentals. 

Tariff Negotiations and Business Uncertainty 

The ongoing tariff negotiations have created a pervasive environment of uncertainty. The longer these negotiations persist without clear resolution, the more likely businesses are to postpone major capital investments and hiring decisions. 

In the initial phase of tariff-related uncertainty, businesses typically try to weather the storm by maintaining their workforce while adopting a wait-and-see approach to expansion. However, if clarity on trade policy remains elusive, companies will eventually be forced to make more difficult decisions, potentially including workforce reductions. 

This cycle of delayed business investment followed by eventual cost-cutting measures may deepen and extend any economic downturn. The uncertainty doesn't just affect companies directly involved in international trade—it ripples throughout supply chains and across industries, creating a broad economic drag that may impact market performance. 

Shifting Global Investment Flows 

The global investment landscape may be undergoing a subtle but important shift.  Global pension funds, sovereign wealth funds, and even some central banks are reassessing their allocations to U.S. assets and publicly listed equities.  Trends in sovereign wealth funds' asset allocation over time: a survey | IFSWF 

As of June 30, 2024, foreign investors held approximately $31.3 trillion in U.S. securities, according to the U.S. Department of the Treasury.  If these entities begin to reduce their holdings of U.S. stocks and bonds—even marginally—the resulting selling pressure could drive prices lower across asset classes. 

Such reallocations are typically gradual rather than sudden, large endowments, pensions and sovereign wealth funds have investment committees that must follow a very methodical process before executing any changes.   If this trend is carried out it’s more likely to be a persistent headwind on markets rather than an observable one-time move. 

Legislative Uncertainty and Fiscal Concerns 

Beyond trade policy, markets are closely watching developments in Congress, particularly regarding the reconciliation bill that includes the tax cuts highlighted during the presidential campaign. The path and ultimate form of this legislation remain uncertain, creating another layer of unpredictability for corporate decision makers and investors. 

If the proposed tax cuts cannot be offset through the planned combination of spending cuts and tariff revenue, concerns about growing U.S. debt levels may intensify. Such concerns could put upward pressure on interest rates and potentially weaken the dollar, creating a challenging environment for both US equity and fixed-income investments. 

The interplay between fiscal policy, monetary policy, and market sentiment is complex, but the resolution of these legislative questions will likely have significant implications for investment performance across asset classes. 

How We're Approaching This Environment for Clients 

In times of heightened uncertainty, we are reminded of the fundamental importance of diversification. This principle is proving particularly valuable in the current market environment, where asset classes are responding differently to economic stressors. 

International equities have outperformed U.S. stocks year-to-date and may continue this outperformance if global investment allocations shift. If the U.S. dollar continues to weaken—a possibility if fiscal concerns intensify—international investments could receive an additional tailwind through currency translation effects.  On top of this, many international markets are also still trading at more attractive valuations than their U.S. counterparts.   

The fixed income portion of client portfolios has also served its intended purpose, delivering positive returns this year despite market volatility. Bonds have helped buffer against declines in growth stocks, demonstrating the value of traditional asset allocation even in complex market conditions. This stabilizing effect underscores why we maintain meaningful bond exposures even during periods when growth assets are performing well—because diversification shows its true worth during times of stress. 

For clients approaching or in retirement, this diversification becomes even more critical. The sequence of returns risk—the danger that market drawdowns early in retirement can permanently impair portfolio sustainability—makes defensive positioning particularly important for these investors. By maintaining exposure to multiple asset classes that respond differently to economic conditions, we aim to smooth the journey and protect long-term financial goals. 

We continue to calibrate portfolio allocations based on individual client circumstances, time horizons, and risk tolerances. While we remain vigilant about the warning signs discussed above, we also recognize that market timing is notoriously difficult even for professional investors. Our approach emphasizes sustainable, diversified strategies that can weather various market environments while remaining positioned to capture upside when opportunities emerge. 

Conclusion 

While predicting market movements with certainty is impossible, investors should be aware that several warning signs suggest the possibility of more volatility ahead. The disconnect between sentiment indicators and economic data, ongoing trade policy uncertainty, potential shifts in global investment flows, and unresolved fiscal policy questions all represent significant headwinds that may lead to market disruptions in the short term.  While market drawdowns are unwelcome during times of volatility, they do present opportunities for when markets ultimately recover.  Historically the largest negative returns for equities have come in close proximity to the largest positive returns as evidence in the chart below. 

These factors don't guarantee poor market performance, but they do suggest that investors would be wise to review their risk exposures and ensure their portfolios are positioned appropriately for their goals and investing time horizon.  Diversification, liquidity management, and realistic return expectations may be particularly important in navigating what could be a more challenging phase of the market cycle.