By Adam Baley

My goodness, how much has changed in six months!

We entered 2025 with a stable economy and solid momentum. Now, a trade war, tariff whiplash and weakening fundamentals are triggering signs of recession.

The spring ushered in a trade war when the U.S. levied tariffs on our trading partners, threatening to upend a global trading system we helped build. The immediate and sizable tariffs, the likes not seen since the 1930s, caused U.S. trade to grind to a halt. And they took down the global investment markets. After a massive stock decline, President Trump issued a 90-day tariff pause, giving the U.S. a chance to find a path forward on trade. 

Tariff-clouded forecast

Now, deep into that 90-day hold, the market has rallied on the hopes something of substance can be completed before day 91. My colleague, Kyle Tetting, compares the tariff pause to being in the eye of a hurricane, waiting for the other side of the tempest to hit. Once the pause is over, the tariff storm likely returns in force this summer.

Summer usually brings clearer skies, but the financial forecast remains cloudy as the tariff fog persists.

So far, businesses have maintained payrolls even though consumers have pulled back spending. The trade war has caused an extensive collapse in both consumer and business confidence to levels usually seen in the depths of a recession. The worry is that a collapse in confidence will prompt deeper cuts in spending.

Consumer and business spending combined makes up roughly 85% of our economy. So even a small change in confidence can cause a sizable shift in momentum. That is happening already: The U.S. economy shrank in the first quarter of 2025. Then in May, the Institute for Supply Management reported that both pillars of the U.S. economy, services and manufacturing, were in contraction.

Slowing earnings growth

Learn more
Summer forecast: Frenetic, volatile, by Kyle Tetting
5 reasons to watch the dollar, by Steve Giles
My outlook for investing in 2025: 2-0-2-5, by Adam Baley
State of the balanced investor, a Money Talk Video with Adam Baley
When Should I …rebalance my portfolio?

Tariffs are taking a bite out of the U.S. economy – and now, corporate earnings. When we started the year, S&P 500 earnings were expected to grow 15% over 2024’s record year, according to estimates from FactSet. A lot has happened since then, and government policy is impacting business profitability. Earnings growth forecasts fell to 12%, then 10% and are now somewhere between 5% and 10%. Even that is in question because many businesses are so uncertain they have stopped providing earnings guidance.

Despite lower earnings, we still have lofty valuations. That is highly unusual. Stocks do not normally get even more expensive when future profit expectations decline and fundamentals weaken. Historically, expensive stocks and a contracting economy signal trouble ahead. At the very least, this is a sign to temper our exuberance for U.S. markets.

The rest of the world

The rest of the world does not have our issues. There are a lot of well-run, profitable, non-U.S. businesses trading at reasonable prices and paying better dividends than U.S. rivals. Additionally, Europe is spending more than $1 trillion on infrastructure and military and cutting interest rates, all while still trading virtually tariff-free among themselves and with the rest of the world. Non-U.S. businesses have another tailwind – a weaker U.S. dollar. After years of dominance, the U.S. dollar is now falling, thus boosting international investments.

All of this leaves the Federal Reserve in an unenviable position. Higher tariffs complicate the Fed’s game plan because a trade war carries the potential for reduced economic output, higher joblessness and tariff-induced inflation. We have a word for that: Stagflation. The Fed is acutely aware of how painful stagflation was in the 1970s and early ‘80s. The central bankers also know that with their limited tools, they are ill-equipped to fight a trade war. To that end, the Fed left interest rates steady in the first half of the year, awaiting more clarity before they act.

Bonds as expected

With all we’ve gone through, a balanced investment account is positive for the first half of the year. While domestic stocks have been turbulent, non-U.S. businesses and bonds are having their day in the sun. Balance remains the best antidote to uncertainty.

Bonds are fulfilling their traditional role of reducing risk, and they’re now offering more competition to stocks. High-quality bonds are paying around 5%, and even cash pays about 4%. Historically, we’ve run cash very thin in investors’ accounts because you haven’t been paid to hold it. When the facts change, so does the strategy. You can feel confident allowing cash to become a part of the allocation for no other reason than you are getting paid handsomely to hold it.

It’s good to remember the basics at times like these and make practical changes in your account. With lofty U.S. stock valuations and competitive yields on safer assets, now is a great time to make some risk-reduction changes and to look overseas for more opportunities.

As we enter the second half of the year, expect volatility to continue and a new, lower trajectory to take hold while tariffs remain in question.

Adam Baley is a vice president and investment advisor at Landaas & Company, LLC.