The second quarter of 2025 was a stark reminder that a longer-term lens is critical for investors.

Amid volatility around “Liberation Day”,1 global equities fell 11% and VIX jumped north of 50. But over the full quarter, global stocks are up more than 9%, VIX is down over 5 points, and U.S. policy rates remain on hold.

Several secular themes, highlighted in our 2025 Long-Term Capital Market Assumptions, define the economic landscape this year: fiscal activism, economic nationalism, and accelerating technology adoption. German fiscal commitments underpin European growth, the trade-off between fiscal boost and tariff drag creates economic uncertainty in the U.S., and the artificial intelligence (AI) theme continues to be a dominant force in equity returns.

For all the market turmoil unleashed early in the quarter, the U.S. economy remains solid. True, soft data reflect a dip in investor and business sentiment. Still, we judge the economy overall to be in late cycle, seeing few signs of major imbalances or excesses.

Our portfolios are lightly positioned in equities, with U.S. exposure concentrated in tech and communication services, alongside regional overweights in Japan, Hong Kong and emerging markets. We also overweight credit, global duration and the euro, and underweight USD.

Growth holding up, inflation diverging

We expect a solid second quarter GDP print in July to show that the economy was running roughly at trend in the first half of this year. Trade uncertainty could push economic growth below trend in the second half, nevertheless recession risk is contained. In 2026, the impact of the U.S. fiscal and tax package should push growth back toward trend.

Internationally, fiscal stimulus and easier monetary policy combine to give some upside risks to growth, particularly in 2026. These will potentially offset tariff concerns, creating a favorable environment for risk assets in regions such as Europe and China.

Inflation dynamics are nuanced. In the U.S., tariffs will likely cause a temporary spike in inflation, peaking toward the end of 2025 with the core Consumer Price Index (CPI) hitting 3.8% 4Q/4Q at year-end. We expect inflationary pressure to subside over 2026, returning toward the Fed’s target by 4Q26.

Outside the U.S., tariffs represent a disinflationary impulse, particularly in goods markets. This environment allows central banks in Europe and Asia to adopt a more dovish policy setting without triggering inflation. Looser financial conditions are an upside risk for growth outside the U.S. and may serve to narrow the U.S. vs. rest of world growth gap in 2026.

By contrast, the Federal Reserve (Fed) Chair Jerome Powell maintains a hawkish tone and a keen focus on inflation risks. The Fed’s Summary of Economic Projections (SEP) and market pricing point to two rate cuts in 2025. But given ongoing labor market resilience and risks of inflation rising in the second half, we expect just a single cut in 2025 with an additional two in 2026 as inflation moderates.

This positions U.S. policy settings on the tighter side of neutral, even as real rates temporarily decline with rising CPI. In contrast, the European Central Bank (ECB) and Bank of Japan (BoJ) are now in accommodative territory, with the Bank of England (BoE) moving in that direction.

These policy settings may seem to favor USD, but we expect narrowing growth differentials between U.S. and other economies to weigh on the dollar in 2H25. Efforts by the U.S. to reduce the current account deficit through tariffs are also likely to result in lower net demand for USD. So, while we see little evidence of the “Sell America” theme highlighted by financial media, we acknowledge that demand for U.S. assets may decline slightly, at the margin.

Earnings expectations more reasonable, valuations still stretched

Our multi-asset portfolios are modestly long risk at present. Many managers prefer to express this view through credit, and others through modest, but targeted equity overweights. Our quantitative models today signal a reduced level of confidence in taking directional risk, but also highlight ample relative value (RV) opportunities. Thus, we complement our top-down RV views in stocks and bonds with bottom-up securities selection alpha from end-managers across our platform.

We overweight sovereign bonds and expect U.S. 10-year Treasuries to trade in a 3.75% - 4.50% range. The steepening bias in the U.S. is likely to persist but may face near-term risks due to crowding and potential adjustments in Fed pricing. We prefer sovereign bond markets outside the U.S., such as Italian government bonds (BTPs) and UK Gilts, over Japanese bonds.

In extended fixed income, we favor high yield bonds, which, despite spreads of just 300 basis points (bps), offer value with all-in yields near 7.5% supported by strong corporate balance sheet metrics.

In equities, most portfolios sit close to neutral but with a targeted pro-risk tilt achieved through regional and sectoral RV views. Our benign economic view, with growth risks likely greater to the upside, supports earnings growth, especially into 2026. However, valuations in many markets are well above long-term averages, a headwind to future returns.

In the U.S., the “Mag-7"2 tech stocks have both valuation and earnings support, while the remainder of the S&P 500 trade close to all-time peak valuations. Since we expect tech adoption to continue to drive rapid earnings growth in the sector, we tilt our U.S. exposure to tech and communication services.

Outside the U.S. Japan and Hong Kong equities find valuation support. Momentum is building in Hong Kong and Chinese equity more broadly and we expect this to persist. Japan, meanwhile, offers a catch-up opportunity in 2H25. By contrast, Canada and Australia both screen as expensive and with muted earnings upside.

In summary, while the economic landscape presents near-term challenges, we believe the U.S. economy remains resilient. Away from the U.S. we see combined fiscal and monetary support as an upside risk, especially into 2026. Together this supports a modestly pro-risk stance, but also calls for greater emphasis on RV and end-manager return streams.

¹“Liberation Day”: The April 2 announcement of U.S. tariffs.

²“Mag-7” or Magnificent 7 refers to the largest U.S. technology names: Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla.