The 2025 Midyear Outlook: Guidance for expected challenges

By: Katie Klingensmith, Chief Investment Strategist

The economy enters this year’s second half facing challenges – tariffs, a rising deficit, potentially higher inflation – just to name a few.

Could these challenges mean rough sledding for the markets at times? Yes. And, if volatility strikes, expect another round of anxiety-inducing media headlines.  

Don’t get caught up in that.

The second half of 2025 may involve the economy digesting some complicated policy news, but our experience tells us that maintaining a well-diversified portfolio and a long-term view has been a winning strategy.

Also, remember that our markets and economy have proven to be resilient time and again. You need only look at the year’s first half as a reminder.

Key takeaways from the first half

The year kicked off with disruption, from extensive government job cuts to geopolitical strife. But it was the new administration’s tariff plans that rocked the markets the most.

The announcement in early April of massive tariffs pushed the S&P 500 into a freefall, dropping more than 10% within two days. U.S. Treasurys, typically a safe haven in market crises, fell as well.

Then, a tariff pause was announced; the fever broke, and a market recovery took hold by April’s second half. The pause in tariffs ultimately morphed into where we are today – ongoing negotiations for new trade deals, including lower tariffs than threatened.

Back on its feet – for now

Despite bouts of market volatility since April, both the markets and the economy enter the second half on relatively solid ground on several fronts.  

The S&P 500 and the Bloomberg U.S. Aggregate Bond Index, a wide measure of the U.S. bond market, are both higher.

The labor market remains relatively strong, and inflation sits slightly lower than it was at the start of the year. While the economy marginally contracted in the first quarter, economists believe it was mainly due to U.S. firms front-running tariffs with massive imports – which reduce Gross Domestic Product – rather than a substantial slowdown in economic activity.

Key takeaways

We’ve experienced unsettling market declines before - the Covid-19 sell-off, the 2022 bear market, the 2008 financial crisis. But, if you had sold during those declines, your portfolio wouldn’t have benefited from the market recoveries that followed. The same is true with the sell-off earlier this year.

Market declines never feel good, and gloom and doom headlines can just create more anxiety. Sometimes being reminded of the financial strengths and knowledge that we may have already helps us stay on track.

1. Your globally diversified portfolio is designed to capture the world’s opportunities  
We believe long-term retirement portfolios should have exposure, not only across market sectors and asset classes, but also across geographies. You never know what’s going to lead gains in any given year (see chart below). European stocks are crushing it this year after taking a back seat to U.S. stocks for more than a decade.

Asset class index performance

Calendar Year Returns

Source: Morningstar Direct. NOTE: 2025 performance as of May 31. Asset class returns are represented by the following indices: Cash (USTREAS T-Bill Constant Maturity Rate 1 Yr), Corp Bonds (BBGBarc US Corp Bond TR), Interm Gov't (BBgBarc US Govt Interm TR), Long Gov't (BBgBarc US Government Long TR), MBS (BBgBarc US MBS TR), Non-US Bonds (FTSE WGBI NonUSD), Large Growth (S&P 500 Growth TR), Large Value (S&P 500 Value TR), Mid Growth (S&P MidCap 400 Growth TR), Mid Value (S&P MidCap 400 Value TR), Small Growth (S&P SmallCap 600 Growth TR), Small Value (S&P SmallCap 600 Value TR), Europe Stocks (MSCI Europe NR), Pacific Stocks (MSCI Pacific NR), Emg Markets (MSCI EM NR), REITs (FTSE NareitAll Equity REITs TR USD). An index is a portfolio of specific securities (common examples are the S&P, DJIA, NASDAQ), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. Past performance does not guarantee future results.

2. Diversification can help provide a smoother ride
Stocks historically have been much more volatile than bonds, so a diversified portfolio that includes bonds can help protect you from the market’s extremes versus a portfolio of stocks alone.

3. The market has a long-term upward bias
The global stock market has risen over time despite sharp declines in between. If you’re retired or not receiving a paycheck, make sure you have enough cash reserves to draw on as an alternative to portfolio withdrawals during market declines.

Global equity performance over time

Source: MSCI, Bloomberg as of Dec. 31, 2024
NOTE: Data reflects MSCI ACWI Index

4. Your professionally managed portfolio has your back
During market turbulence, your portfolio allocations can get out of whack, skewing your portfolio’s risk/return profile. Edelman Financial Engines uses its expertise to systematically rebalance your portfolio allocations and maintain your portfolio’s risk/return profile during periods of market volatility.

From policy proposals to policy implementation

We believe the second half may be more about policy implementation after policy proposals dominated the first half. The changes could create challenges for the economy as well as uncertainty that could result in market turbulence. But we think the market has absorbed a lot of the initial “shock” that this new era of policy uncertainty has brought.

To get a better handle on the possible outcomes that policy implementation may bring, let’s broadly explore what the markets will be considering.

• When will tariffs show up in inflation?
  Trade deals are still being negotiated, so it’s no surprise that inflation remains somewhat contained and just a bit above the Federal Reserve’s target.
  
  Inflation expectations vary widely. June’s University of Michigan survey showed households expecting inflation to rise a sharp 5.1% over the next year. However, as of June, market expectations for inflation are for a more subdued 2.6% rise over the next year.

Source: Bloomberg as of June 17, 2025.
Note: Market expectations for inflation represent the difference in yields between traditional Treasurys with the maturities listed and Treasury Inflation-Protected Securities (TIPS) of the same maturities.

• President Trump’s tax and spending bill, the fiscal deficit and bonds
  Trump signed a sweeping tax and spending bill into law on July 4. The legislation promises to cut taxes on both consumers and businesses, which could spur spending; however, it will also cut government spending, which has contributed to GDP growth. 
  
  One of the biggest concerns about the law is that it’s projected to increase an already large fiscal deficit. That could impact both the markets and the economy. For example, a rising fiscal deficit may push Treasury yields higher, which could indirectly elevate rates on consumer loans as well. The deficit also potentially threatens the U.S. dollar’s status as a reserve currency over the longer term. That could continue to weigh on the U.S. dollar’s value versus other currencies.

• Whither the Federal Reserve and its interest rates
  The Fed is caught between a rock and a hard place as it enters the second half given its dual mandate of maintaining price stability and maximum employment. If the Fed needs to decrease interest rates to counter a weakening labor market and economy, it may be hindered by tariff-induced inflation. And it remains unclear how developing immigration policies will affect the labor market, corporate profits as well as inflation. For now, the markets predict at least two rate cuts of 0.25% each by year-end, though interest rates are notoriously hard to predict given the complexities.
  
  
• Deregulation
  Trump’s “10-to-1” deregulatory agenda aims for 10 existing regulations to be eliminated for every new regulation implemented. While deregulation has occurred at a number of agencies already, more is planned. Companies may be withholding spending until they have a clearer idea of how deregulation, as well as other unknowns like tariffs, will play out. Companies have proven to adapt to policies once they’re clarified, and that can fuel economic and market resilience.

What this means for you

While tariff implementation, spending cuts and other policy changes may be headwinds, deregulation, tax cuts and potential policy stability could offset them.

As these dynamics play out, remember that the markets and the economy don’t move in a perfectly straight, upward line. They move through cycles. The overall trend for both economic growth and the equity markets has been upward over time thanks to their resilience.

Your portfolio and personal economy

It’s easy to focus on headlines about the nation’s economy, but that won’t help you or your financial future.

What will help is focusing on your “personal economy.” Do you still have a job? Can you still afford to buy the things that you need to buy? Can you still save enough for retirement? That’s what matters. Focus on what you can control.

If you have an Edelman Financial Engines diversified portfolio, you have a reason to feel confident long term. We design your portfolio to withstand the vagaries of the market and the economy and to benefit from their historical resilience, so your financial plan can too.

Remember that we’re here for you. If you have any questions about your financial plan, no matter how small, don’t hesitate to reach out to your financial planner.

Watch Edelman Financial Engines Chief Investment Strategist Katie Klingensmith discuss the 2025 Midyear Outlook.

An index is a portfolio of specific securities (such as the S&P 500, Dow Jones Industrial Average, MSCI ACWI Index and Nasdaq composite), the performance of which is often used as a benchmark in judging the relative performance of certain asset classes. Indexes are unmanaged portfolios and investors cannot invest directly in an index. The MSCI ACWI captures large and mid-cap representation across Developed Markets and Emerging Markets countries. The index covers approximately 85% of the global investable equity opportunity set.