Market Recap

Positive year-to-date market returns for 2025 mask the volatility of the past two quarters.  While US equities bounced back strongly after the tariff-induced sell-off in April, they are dramatically trailing their international counterparts.  The uptick in economic and geopolitical uncertainty has likely caused investors to re-evaluate portfolio concentrations, which is reflected in the varied equity performance we’ve seen globally.  An environment of higher and relatively stable interest rates has allowed fixed income to provide a steadying influence during volatility in the equity markets.

Looking Ahead

While uncertainty around growth and trade remains elevated, pockets of opportunity remain for the patient, long-term investor.  Diversification is likely to continue to provide better risk-adjusted return opportunities than a concentrated approach.  US growth is expected to remain sluggish due to inflationary concerns, a weaker consumer and broader economic uncertainty.  Although the consumer has weakened, the employment picture remains stable.  Long-term yields have declined slightly during the year but remain at historically attractive levels.  While the Fed has signaled the potential for one to two rate cuts this year, the specter of inflation is likely to stay their hand until meaningful inflation progress is evident or a deterioration in the labor market occurs.

Asset Allocation

Thus far, 2025 has been a case study in the benefits of diversification and long-term planning, as opposed to trying to react to the latest headlines.  US equity markets were set up for volatility coming into the year, given elevated levels of concentration and inflated valuations.  The market bounce-back has done little to assuage those concerns, as domestic equities again appear priced for perfection.  While concerning headlines are likely to continue, diversified portfolios have weathered the storm relatively well.  We seek to construct portfolios to match client objectives and risk tolerances, not in response to short-term market movements.  Please don’t hesitate to reach out to your advisor to schedule time to discuss your financial plan, including your goals and planning assumptions.  Letting planning drive the investment approach helps ensure that your portfolio remains aligned with your vision for the future.

Leading Topics

Economic Fundamentals

US GDP growth expectations for 2025 have been drastically reduced over the past few months to 1.4%, according to the Fed’s projections.  Fortunately, growth expectations for the rest of the world look much more appealing, at nearly 3% per the IMF.  Domestically, the cumulative impact of elevated interest rates and the persistent inflation of the past five years has placed a strain on the consumer, while concerns over fiscal sustainability limit the ability of the Federal Government to stimulate growth without exacerbating long-term borrowing costs.  This is juxtaposed against a labor market that, while cooler than in the post-COVID era, remains near full employment.  As such, it appears that the outlook is tilted more towards a slowing of growth rather than a recession, barring the imposition of meaningful additional tariffs or some other unforeseen shock.

Global Equity Markets

US equities bounced back quickly in the aftermath of the tariff volatility, thrusting valuations back to elevated levels, about a full standard deviation above the 30-year average.  These valuations are akin to those reached in late 2020 and 2021 but with a key differentiator: the cost of capital is substantially higher than it was at that time.  At the end of 2020, the 10-year Treasury provided a yield of just under 1%.  That same instrument now bears a yield of over 4x that amount, discounting future earnings at a much more substantial rate.  Higher interest rates and the prospect of potential slower growth disproportionately impact companies with high earnings growth expectations, such as those in the Tech sector.  Historically, the performance gap between Growth and Value equities is minimal in higher interest rate environments.  The other element of diversification that has proven useful this year is geographic diversification.  Exposure to countries with different yield curves, varied trade exposures and heterogenous demographic mixes allows portfolios to better endure higher levels of economic uncertainty and opens multiple avenues for growth.

The Federal Reserve, Inflation & Fixed Income

The Fed has been cautious in easing financial conditions after several years of stubborn inflation.  The market and the Fed are fairly aligned on their expectation of 1-2 rate cuts this year.  The Fed’s decision-making process has been further complicated by the impacts of shifting trade policy and geopolitical uncertainty on inflation.  Since the initial tariff-related volatility, long-term yields have remained fairly stable.   Treasuries currently offer minimal term premium out to the 10-year portion of the yield curve.  Extending duration along the Treasury curve reduces reinvestment risk but doesn’t offer a compelling yield improvement.  However, corporate and municipal bond spreads have widened relative to Treasuries, offering attractive yields without the need to assume excessive credit risk.  Investors with large cash holdings are vulnerable to reinvestment risk and should consider duration extension.

Economic Outlook: Clouds on the Horizon

In the US, consumer spending accounts for nearly 70% of GDP.  The cumulative weight of several years of elevated inflation and interest rates has taken a toll on consumers.  Households have increasingly turned to debt as COVID-era excess savings have been depleted to keep pace with rising price levels.  This is evidenced by increasing consumer debt flows into early delinquency, which have reached levels not seen in over a decade for auto loans and credit cards.  Elevated debt service costs, sharply increasing delinquencies and a consumer savings rate well below the long-term average indicate that the US consumer is strained.  Wage growth and unemployment levels have normalized to pre-COVID levels.  While the lower-income consumer has felt the strain for some time, a tightening of the purse-strings in wealthier households could have an outsized impact on growth, as the top 10% of households represent approximately 50% of consumer spending.  Slower growth in asset prices and a weaker transaction environment for private and public businesses could have an outsized impact on those wealthier households.

US GDP growth has steadily weakened over the past four quarters and is expected to continue to deteriorate through the end of the year.  In the first quarter of 2025, GDP contracted by 0.5%.  However, that figure was distorted due to the acceleration of imports in anticipation of tariffs.  If you exclude the impact of tariffs in the first quarter of 2025 (a dramatic jump in inventories and a pull-forward of imports), GDP grew at around 1.5% on an annualized basis.  While less than optimal, that’s also far from a recessionary level.  In summary, the GDP growth and consumer outlook appear to be signaling a gradual slowdown in the US economy, rather than a rapid deterioration.  While the risk of an imminent recession remains modest, the increase in policy uncertainty and a weaker domestic consumer point to a strong possibility of slower growth.

Equity Outlook: Valuation & Concentration

Although the brief US equity downturn in April felt jarring, valuations remain well above their historical averages.  Even in the depths of the tariff-induced panic, the forward-looking PE ratio of the S&P 500 bottomed out around 20x, a full standard deviation above the 30-year average of 17x.  Concentration in the S&P 500 also declined minimally in April, before roaring back to near all-time highs.  The top 10 stocks in the S&P 500 now represent about 36% of the index.  The first half of the year demonstrated the perils of concentration.  Through the end of June, the S&P 500 experienced a positive return of 6.2% while the headline-grabbing Magnificent 7 appreciated by just 2.5%, a marked gap.  Although concentration is a compelling reason to broaden exposure away from the largest components of the S&P 500, it’s not the only one.

While these large companies have driven a substantial portion of equity returns over the past decade, such narrow markets are historically unusual, particularly in a higher interest rate environment.  Historically, the returns between Value and Growth equities have been similar when interest rates are elevated (10-year treasury over 4%).  Given the US Government’s prolific debt issuance, the likelihood of substantially lower long-term interest rates appears minimal in the near term.  Additionally, we’ve seen a divergence in global equity performance as investors re-evaluate long-held beliefs about the nature of global trade relationships.  International equities provide a compelling complement to a domestic allocation as they provide access to the world’s fastest growing economies, while adding a valuable dimension of diversification, at far more reasonable valuations than their US counterparts.  The gap in returns between US and non-US equities in 2025 offers a powerful example of the benefits of a geographically diversified portfolio.

 

 

Locked Up: US Housing Outlook

Mortgage rates have been remarkably stable in 2025, with the average rate for a 30-year mortgage range-bound between 6.6 and 7%.  Additionally, housing prices rose dramatically during COVID and haven’t come back down.  Over the past 5 years, home prices have increased by about 53% nationally, per the Case-Shiller US Home Price Index.  The combination of elevated prices and interest rates limits affordability for buyers.  This is exemplified by the premium of homeownership vs. renting.  Over the past decade, the average premium for owning a home was about 14% more than the cost of renting.  Currently, it’s about 43% more expensive to own a home relative to renting.  The current slow-down in housing activity is very different from the decline we saw in the aftermath of the great recession.  There’s plenty of inventory on the market (the most since 2019), it’s just not priced at a level that’s attractive for most buyers.

To illustrate the impact of higher interest rates on home affordability, consider the following example.  The average US home is now worth about $440,000.  Given a 4% interest rate on a 30-year loan, with 20% down, the monthly mortgage payment on that home would’ve been about $1,700 per month a few years ago.  Assuming the same terms, but a 6.8% interest rate, the monthly payment jumps to $2,300, approximately a 36% increase.  That increase is much greater than the growth in wages over the past three years.  Furthermore, those metrics only encapsulate the difference in the mortgage interest and exclude the surge in maintenance and insurance costs, which are also hampering affordability.

Thus far in 2025, the biggest shift in the housing market has been the dramatic increase in inventory.  Housing prices tend to be somewhat sticky as sellers cling to some anchor value of what they think their home is worth.  The discrepancy is likely to resolve one of two ways: either sellers will begin making concessions on pricing or interest rates will eventually decline, making today’s prices more palatable to buyers. 

Inflation & The Fed

The slow but steady inflation progress of the past two years is threatened by the uncertainty surrounding trade policy.  As of the end of June, the fears surrounding an escalation in the Middle East seem to have passed, minimizing the risk of an energy price shock.  Energy prices, while not a major component, have helped place downward pressure on inflation.  In fact, oil prices have declined about 20% over the past year.  The major factor complicating the Fed’s decision-making process is assessing the impact of tariffs.  Currently, the average tariff on imported goods is about 15%, although it changes on a nearly constant basis.  The US imports about 15% of its goods.  While determining the precise impact of tariffs is an exercise in speculation, most forecasters expect tariffs to increase CPI by about half of a percentage point.  Since COVID, consumers have become more accustomed to price increases, raising the risk of a re-acceleration of inflation if the tariff cycle continues.  That represents a significant difference in the current environment as compared to the first Trump administration.  In 2018 and 2019, the CPI fluctuated between 1.5% and 2.9%, making it more difficult for companies to pass along costs.

The inflationary bright spot has been housing, which represents about two thirds of the total inflation figure.  Housing inflation has declined by more than half in the last year from 6.5% to 3.9% on an annualized basis, as of May, 2025.  Given elevated trade uncertainty and a healthy labor market, the Fed is likely to wait for further evidence of downward pressure on inflation before reducing rates.  At present, the market expects approximately two rate cuts this year, beginning in September.  More rapid cuts would likely require a deterioration in the labor market.

Fixed Income: The Land of Quiet Opportunity

In December of last year, something profound quietly happened to the yield curve.  The yield on the 10-year Treasury surpassed the Fed Funds rate, meaning that investors no longer had to accept a yield discount or added credit risk to extend duration.  In the wake of the rapid rate hikes of 2022, many investors have been cautious about shifting from cash to fixed income, particularly with nominal money market yields well above their recent averages.  While that concern is reasonable, it reflects a lack of understanding of the nature of risk.  Interest rate risk is just one element of the risk equation.  Another key component is reinvestment risk: i.e., for how long is your rate locked in?  With money market instruments, your interest rate changes almost immediately when the Fed decides to cut rates.  While rate cuts are likely to be gradual, the trajectory for short-term rates is very likely to be downward, providing little upside potential for cash equivalents.  Core bonds on the other hand, offer better yields, with minimal credit risk and the potential for upside.  This upside could come in several forms, including a decline in interest rates or a flight to quality, as we saw during the equity market downturn in April.  While cash equivalents offer an element of safety, they lack some of the benefits that can be found in fixed income.

So, what areas of fixed income look appealing?  Unfortunately, the term premium on offer in Treasuries is minimal given the flatness of the curve.  However, corporate and municipal bond spreads relative to Treasuries expanded in April and remain at attractive levels.  Given the volatility present in the yield curve, we advocate utilizing fixed income managers with wider mandates.  International fixed income provides additional diversification while offering compelling yields.  Exposure to different interest rate regimes and currencies can be beneficial, particularly given a weaker Dollar and a volatile yield curve.  Notably, municipal bonds offer tax-equivalent yields near 7% for investors in the highest Federal tax bracket, without having to stretch on credit quality.  As asset allocators, we’re constantly searching for ways to optimize risk-adjusted returns.  We believe that the current fixed income environment presents a valuable opportunity for investors to lock in attractive yields without undue risk.

 

Behavioral Finance: Nothing is Free, Except Diversification

The concept of diversification has seemed somewhat less important over the past decade, at least up until the past six months.  Over the past decade, owning the largest US companies would’ve served investors well, if you can stomach the volatility that comes along with a concentrated portfolio.  Broadly speaking, there are two kinds of risk: idiosyncratic and systemic.  Idiosyncratic risk is the risk associated with a single stock.  Systemic risk, on the other hand, is the uncertainty inherent to a broader market segment or the economy in general.  One of the core elements of portfolio theory is that idiosyncratic risk is not rewarded on a risk-adjusted basis.  By combining a large enough pool of individual securities, an investor can minimize idiosyncratic risk and what remains is systemic risk.  This risk is essentially impossible to eliminate in a cost-effective manner.  While much discussion around investing centers around the next hot stock or trend, security selection has minimal impact on long-term investment outcomes.  The variables with far greater explanatory value include asset allocation and an investor’s ability to get and remain invested through all market environments.  The recipe that is most successful for the largest number of investors is not catching the next fad at the right time; it’s remaining invested in a broadly diversified portfolio over a long period.

When a large proportion of market returns are driven by a narrow subset of securities, some question the benefits of diversification.  Our primary focus as asset allocators is portfolio construction, the objective of which is to maximize returns while minimizing risk.  Diversification is fundamental to our approach due to both the behavioral tendencies of investors as well as the lack of compensation for taking non-systemic risk.  One of the oft repeated tenets of investing is that if you’re properly diversified, you’ll always be unhappy with at least one of your investments.  Said another way; if all your investments move in the same direction at the same time, you may be under-diversified.  Our approach at Journey centers around evaluating your unique return requirements and risk tolerance in the context of your overall financial plan.  Individual investment decisions are made with an emphasis on how the investment fits within the portfolio and, by extension, your individual financial plan.

 

What’s It All Mean

Economic Outlook

US consumer health has eroded steadily as the post-COVID stimulus has been depleted, evidenced by declining savings rates and rising consumer debt delinquencies.  The labor market appears stable, although wage growth has slowed. While the risk of an imminent recession remains modest, the increase in policy uncertainty and a weaker domestic consumer points to a possibility of slowing growth.

Fixed Income Opportunities

Investors are no longer required to accept a yield discount to shift out of cash and into core fixed income.  The term premium on offer in Treasuries is minimal, but recent spread expansion in corporates and municipals could present attractive opportunities.  Long-term rates are unlikely to compress substantially, given continued elevated issuance of debt by the Federal Government.  However, we believe that core fixed income represents a more attractive risk-adjusted opportunity than cash, as the most likely trajectory for cash yields is either flat or downward.

Inflation & The Fed

The Fed’s task has become more difficult as trade policy has added a new variable to the inflation equation.  Key components of inflation have improved over the past year, housing being the most substantial.  However, the Fed is likely to proceed cautiously, as trade uncertainty and expansionary fiscal policy pose an upside risk to inflation.  With the real Fed Funds rate around 2%, the Fed’s position doesn’t appear overly restrictive.  The Fed is currently expected to cut rates 1-2 times before the end of the year.

Equity Outlook

The market volatility in the past two quarters was largely a product of the concentration of the S&P 500 in a handful of names, along with elevated valuations.  After a brief pull-back, valuation and concentration levels have returned to concerning levels.  We believe that a meaningful allocation outside of the largest S&P 500 constituents, including international and value equities, offers diversification benefits in addition to exposure to attractive valuations and growth trends.

Relevant Disclosures: This information was prepared by FSM Wealth Advisors, LLC d/b/a Journey Wealth Management, LLC (“Journey”), a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. Journey’s Form ADV Part 2A and Part 2B can be obtained by written request directly to: 22901 Millcreek Blvd., Suite 225, Cleveland OH 44122. 

The information herein was obtained from various sources. Journey does not guarantee the accuracy or completeness of information provided by third parties. The information provided herein is provided as of the date indicated and believed to be reliable. Journey assumes no obligation to update this information, or to advise on further developments relating to it.

Investing involves the risk of loss and investors should be prepared to bear potential losses. Past performance is not indicative of future results. Neither the information nor any opinion expressed herein should be construed as solicitation to buy or sell a security or as personalized investment, tax, or legal advice. For advice specific to your situation, please consult an appropriately qualified professional investment, tax or legal adviser.