A Solid First Half of the Year
Despite an otherwise choppy start to the year, equity markets have had quite an incredible rally from the lows tested in early April.
Broad-based US equities experienced low single digit returns with small caps still remaining negative for the year. International markets are largely up double digits with nearly half of that return from a U.S. dollar perspective a result of the US dollar depreciation amid uncertainty.
While there is clarity on tax policy, global geopolitics remain uncertain, and it is unclear the future path of tariffs. As such, uncertainty remains for businesses and consumers in planning for future expenditures (and day-to-day aspects) when the environment is shifting with such frequency – especially given that most products take six+ months from creation to landing in the US.
Fixed income markets across short term, intermediate, and global bonds experienced low- to mid- single digit returns for the year. Some of the price increases were due to interest rates moderating with modestly declining rates in June with the remaining component of total return largely driven by higher cash flows realized from the higher interest rate environment. The FOMC held rates steady in June to leave room to begin cutting rates later this year. While Jay Powell maintains a wait-and-see stance, the Fed remains split on how tariffs might influence the outlook.
Interest rates tip-toe the delicate balance between lower rates to help fuel the economy while also not stimulating the economy too much and creating excess inflation that could potentially persist for years. It seems unlikely that rates could head to the near 0% levels they had been in the post-Global Financial Crisis world, but it seems reasonable to expect rates to remain range bound at current levels given the influence of inflation on higher rates coupled with the push for lower rates to help stimulate the economy. Municipal bond markets have underperformed broader fixed income in the US this year, and as a result, continue to be currently attractively priced on a prospective basis. A significant component when selecting municipal bonds over other taxable strategies is the tax advantage, and current pricing has brought compelling opportunities even into some of the mid and lower tax brackets.
One monumental change after the end of the quarter was the passage of the One Big Beautiful Bill. Given the sweeping changes and making permanent several components from the Tax Cuts and Jobs Act of 2017 (TCJA), we will dedicate a separate thought piece on just this bill and potential implications to individuals, so please be on the lookout for that. Largely, there were some noticeable changes on the state and local sales tax (SALT deduction) that could benefit a number of high real estate tax states like Texas as well as high income tax states like California and New York. Further, the increase in the estate tax exemption to $15 million per person ($30 mm as a couple) for January 2026 (indexed for inflation) was a win for taxable estates since those levels were otherwise set to revert back to half of the current levels. Lots to digest and unpack from the bill, so more to come! Read on as we discuss AI, international markets, and the role of diversified portfolios.
It has been a difficult year for weather from L.A. wildfires to south Texas flooding, and our thoughts are with those impacted by the devastation.
Continued Geopolitical Uncertainty
Markets generally dislike uncertainty since it makes it very difficult to predict what decisions and capital expenditures to make in the short-term which then drives how decisions are made over the long-term. It often forces companies and individuals to bifurcate decision making to make short-term decisions to simply get over the hurdle of near-term uncertainty to be able to later plan for the long-term once tax clarity, tariff implications, and other large factors are able to be understood.
The Vanguard chart below demonstrates a few of the major geopolitical events over the last 60 years. Often, the initial reaction is negative, but over the long-term, the news settles in and companies adapt, so outside of a few limited exceptions, growth-oriented markets tend to resume their upward ascent after some (typically minimal) downward adjustment. When making decisions for the long-term investor, it’s important to not let the short-term gyrations drive decision making processes and instead keep a lens for that longer-term picture. By having structures in place to deploy capital with discipline, rebalance when holdings get out of target, and tax-loss harvesting, those actions in the short-term can often help add value over long periods of time.
It has been quite a run in the growth components of the market since the lows of April as markets have largely moved on from the doom and gloom during the first quarter. Given that price levels have increased so significantly, markets are not exactly at “cheap” levels, so we remain cautious looking forward given that a scenario that leads to lower than expected growth or return expectations does create potential for downside volatility. Ultimately that is a short term phenomenon that can happen over the course of several quarters (or years), but we believe it should not cloud one’s judgment for the long-term on the ability as consumers and an economy to pick ourselves up, dust ourselves off and build a brighter tomorrow. But, it can sometimes create opportunity for cash or other shorter-term holdings waiting to be deployed to a long-term strategy if markets present more compelling opportunities in the coming quarters.
AI and International Outperformance
Artificial Intelligence (AI) continues to evolve quite rapidly. As with most technologies, people tend to overestimate the impact in the short-term, but they significantly underestimate the impact over the long-term. Our clients are often our eyes and ears of the economy, so we welcome any feedback on how/what you are seeing as far as AI use-cases. There are some potentially significant benefits on both personal and professional levels (noting caution on data integrity and privacy considerations which should not be glossed over) to reduce the repetitive and time consuming operations of things like meal planning, trip planning, and more broadly, idea generation, but there are several compelling use cases for leveraging AI to enhance analyses and thought processes. Next time you’re stuck on a topic, ask AI to help you poke holes in your theory or troubleshoot “what could go wrong”. It can be a great tool in helping think critically about an array of topics. While there are some areas to invest in AI more directly, the broader economic growth picture may be about how existing companies (or yet-to-be-created companies) are able to leverage efficiency gains and productivity enhancements from such tools.
For the first time in recent memory, international markets are enjoying their day in the sun compared to U.S. counterparts. Roughly half of the return from overseas has simply come from translating those revenue values and earnings back to U.S. dollars as the U.S. dollar has depreciated. I.e. the same revenue overseas is simply worth more in U.S. dollar terms compared to where the U.S. dollar was at the end of the year. However, there is still a rather large tailwind that may exist when comparing U.S. versus international companies given there has been a roughly 15 year underperformance of international markets. With increased political uncertainty, those outside of the U.S. have begun to question the U.S.’s dominance in the global economy.
As we have noted in the past, markets dislike uncertainty, so it is no surprise that with a heightened level of ambiguity regarding how the U.S. responds to conflicts (and addresses tariffs), other nations are reevaluating their relationships with the U.S. Ultimately, the U.S.’s position as the dominant economy and global store of value as a currency can be questioned, but a fundamental shift away from U.S. assets may likely be a very slow and gradual process over decades and is not an overnight process.
Having exposure to international markets can be a nice diversifier away from U.S. large technology that has dominated the U.S. markets for years. But, innovation can come from anywhere, so having exposure to pockets of the global markets that could benefit from some of those tailwinds as well as ones that are coming from a starting point of lower valuations may help participate in the next cycle of growth for however that may unfold.
One aspect worth noting when evaluating portfolios is to recognize some estimates suggest upwards of 40% of the S&P 500’s sales come from overseas, so even having a U.S. centric approach still encompasses some of the emerging market and developed markets’ growth opportunities that exist globally.
Ultimately that is the role of diversification so that not all things are moving in tandem with everything else, so as life experiences and goals are realized, accessing capital to fund a lifestyle allows the potential ability to pick and choose from differing options along the way.
CLOSING REMARKS
Not all uncertainty is a negative thing since the AI space is replete with uncertainty, but it could potentially lead to large tailwinds for a number of companies, industries, and individuals. It is still nascent in how to think about or plan for what AI may be able to help people accomplish, but by being (cautious) early adopters of technology and systems, there appears to be a lot of promise in a pick up in efficiencies across a lot of industries and daily functions. Some of the more interesting use cases we’ve seen have been at a personal level, supporting everyday household needs, helping route and plan family experiences, curating ideas for exercise programs or general thought-provoking content when one is stuck. Just like any new technology though, there is a learning curve for figuring out how to efficiently and effectively use a system – much like we all continue to evolve with social media, use of smart phones, and any new technology that comes to market.
Market dynamics are always changing, and it’s important to assess any substantive changes on either goals, circumstances, or resources (i.e. money and assets) alongside those dynamics so your financial plan can take into consideration fundamentally new information. The financial planning process (sometimes frustratingly) is never done, so it is important to set yourself up with a process and plan from which you can make informed decisions. Much like the seats people are in today were largely unpredictable 10 years ago, it would be misguided to assume with too much clarity what the next 10 years could bring. However, having a framework from which to assess things allows you and your trusted advisors to adapt to new information, act on new and changing tax strategies, and ultimately attempt to improve the chance of success and resilience to the long-term plan, so as not to be a forced seller in times of stress or crisis. Not that the lows of the market in April were out of line from a historical perspective, but not being a seller at temporarily depressed prices helps to be accretive to long-term wealth for future goals.
As always, should your goals evolve or you wish to explore strategies tailored to your unique circumstances, we encourage you to consult your Client Advisor. Together, you can thoughtfully assess your options and take proactive steps that align with your long-term vision—while avoiding the pitfalls of reactive decision-making.