Mid-Year Market Outlook: What’s Next for Investors?

Both the U.S. economy and global financial markets began 2025 on sound footing. Inflation was easing, and labor markets were strong and stable. The U.S. stock market, as measured by the S&P 500 Index, was coming off two consecutive years of returns in excess of 20%. Even with this positive backdrop, concerns lingered regarding the looming impact of policy changes and an undercurrent of unease amid ongoing geopolitical conflict. The rollout of a wide range of policy changes and rising geopolitical tensions in the first six months of 2025 did little to ease these concerns.

Despite the “noise”, financial markets, for the most part, seemed to shrug off these worries, rallying through the end of the second quarter. Investors who tuned out the news, and only observed their investment performance, at the end of June would have seen the S&P 500 up 6.2% for the year, the MSCI-ACWI ex US Index up 17.9%, and the Barclays Aggregate Bond Index up 4.0%. They would have undoubtedly wondered what all the worry and fuss was about. However, tuning out the noise to that degree is both unlikely and, probably, unwise. Investors in the real world must still contend with these challenges and deal with them accordingly. But we should always keep the big-picture perspective front of mind and follow Stephen Covey’s advice to “keep the main thing the main thing.”

Stock Market Outlook

• Although markets were volatile throughout the first six months of the year, U.S. stocks rallied sharply through the end of the second quarter, adding to the gains accrued in the previous two years.
• Valuation levels remain elevated, though valuation levels alone have never been a particularly good short-term indicator of future market performance.
• Broadly speaking, international stocks have outperformed U.S. stocks thus far in 2025, and continue to present opportunities for investors seeking both diversification and value.

After experiencing significant volatility early in the year, U.S. stocks rallied late in the second quarter, with some indices reaching all-time highs. Unlike the previous two years of strong market performance, which were dominated by the ultra-large-cap growth stocks known as the “Magnificent 7,” there was much greater dispersion in performance across a wide range of sectors and companies.

Equity Snapshot

Despite the broader market dispersion thus far in 2025, it’s likely prudent for investors to avoid giving up on growth stocks and the Magnificent 7 simply because of elevated valuations or high levels of market enthusiasm. The themes focusing on artificial intelligence that permeated markets in 2024 remain an important part of the growth story for both the U.S. and global economy going forward. However, it may make sense to consider the impact of artificial intelligence as more of a long-term margin tailwind rather than a short-term gold rush.

International equity markets continue to offer both a value proposition and diversification benefits for investors. The recent outperformance by international stocks has been buoyed by a trifecta of tailwinds:

1. A weaker dollar, making overseas gains more valuable as they buy more dollars when repatriated to the U.S.
2. Both China and Europe continue to adopt expansionary economic policies. Increased defense spending in Europe is the latest pro-growth policy change bolstering non-U.S. economies.
3. The valuation gap between U.S. stocks and foreign stocks persists, implying investors are paying less for a dollar of earnings from foreign companies relative to U.S. companies.

Foreign stocks have become much less correlated to the U.S. over the last year

1-Year Rolling Correlation of International and U.S. Stocks

Should growth paths across economies continue to diverge, global diversification will remain an important building block for diversified portfolios. This allows investors to both spread their risk exposures and broaden their investment opportunity set. Heightened market volatility should continue to provide portfolio managers with opportunities to execute disciplined rebalancing and tax-loss selling processes when appropriate.

Fixed Income

• The yield curve steepened in the first quarter as short-term rates fell and long-term rates trended higher, making longer-duration bonds relatively more attractive.
• Municipal bonds have become more attractive thus far in 2025.
• Diversification in fixed income, while often neglected, remains important as we move through uncertain economic and fiscal terrain.

In the years following the Global Financial Crisis of 2008-09, fixed income investors became accustomed to earning meager returns on their investments. It was a challenge for those invested in a traditional portfolio of investment-grade bonds to generate a significant rate of return above the rate of inflation.

U.S. Treasury Yield Curve

With these changes in the yield curve, the environment for bond investors has fundamentally changed. Higher rates and a steepening yield curve have created a more favorable environment for prospective returns. Investors can now lock in higher rates while simultaneously increasing the ability to profit should interest rates decline. The steeper yield curve also allows investors to lock in higher long-term rates, thereby reducing the capital they may need to invest in order to immunize themselves from long-term obligations.

Tax-adjusted municipal bond yields are trading at a significant premium to broader taxable bonds

Municipal bonds continue to trade at attractive yields relative to taxable bonds. This has resulted in compelling yields for municipal bonds on a tax-adjusted basis. In addition to the attractive yield spreads, the summer months often result in lower net-new supply in the municipal market, as fewer new issues come to market while demand for municipal bonds tends to accelerate as bond investors seek to reinvest income payments. While bond investors should remain vigilant and aware of any credit issues that may arise from the impact of federal policy decisions, the combination of attractive tax-adjusted yields and a favorable structural environment could create an opportunity for investors seeking to take advantage of the tax-exempt income offered by municipal bonds.

Alternative Investments

• Alternatives continue to offer the ability to generate attractive returns for investors while avoiding some of the mark-to-market volatility brought about by economic and geopolitical uncertainty.
• Alternative investments provide an opportunity for investors to further customize their portfolios across a broad range of strategies, from income generation to long-term growth opportunities.
• As the size of private markets continues to grow, we believe that skilled manager selection with institutional-quality terms and pricing will be important factors in driving successful implementation of an allocation to alternative investments.

For investors who have the capacity to bear illiquidity risk and meet the required income or asset thresholds, alternative investments may provide an interesting rebalancing opportunity. When combined with a portfolio based on the foundational asset classes of traditional equities and fixed income, alternative investments may offer enhanced diversification opportunities, the potential for attractive returns, and the ability to deliver a more bespoke overall allocation that’s tailored to an investor’s specific risk preferences and return goals. In a market environment plagued by uncertainty, alternative asset classes may offer unique opportunities for investors. Examples of these opportunities can be found in both capital appreciation and preservation strategies. Two examples of these opportunities in today’s environment are real asset/infrastructure investments and asset-based financing strategies.

Real asset and infrastructure investments are often made in industries that are important to fundamental economic and social needs, which could make them more resilient in difficult economic environments. Private funds may offer ways to directly invest in these opportunities without exposing investors to the general equity market risk associated with public companies. This direct exposure to the cash flows of individual real asset and infrastructure projects might also provide interesting diversification opportunities for investors, as their returns may experience lower correlations with public markets. There may also be an alignment between some of these infrastructure investments and current political and policy agendas, such as the reshoring of manufacturing and support for key domestic industries.

Alternative investment opportunities in asset-based financing (ABF) strategies could help diversify investors’ exposures to public debt markets. ABF strategies may be a complementary and diversifying opportunity in portfolios that already have exposure to private credit strategies, such as direct lending. A key feature of ABF lending strategies is that they’re backed by pledges to underlying assets to support repayment, rather than being backed by the cash flows of the borrowers, which may be more exposed to the risks associated with a slowing economy. ABF strategies offer investors exposure to a wide array of sectors, such as residential mortgage lending, data infrastructure lending, music royalties and aviation finance, among others. Since the pools of ABF loans often come from a broad and diverse set of borrowers, overall portfolio risk tends to be broadly diversified as well.

Executing a successful implantation in alternative investments can be a difficult task. Investing in alternative assets typically depends on the ability to access top-tier funds at favorable terms and attractive pricing. However, rising to this challenge can help investors build a diversified allocation of alternative investments that may improve the likelihood of their portfolio meeting their goals.

Conclusion

The investment landscape investors have witnessed so far in 2025 underscores the importance of a thoughtful, disciplined approach to portfolio allocation and management. The current market regime, characterized by policy uncertainty, macroeconomic volatility and waning consumer confidence, has created an environment where a well-diversified portfolio has been an essential tool for risk management. The sheer volume of policy changes, and the uncertainty around their particulars, may widen the range of potential outcomes. While risk reduction is typically considered to be the primary benefit of diversification—by owning assets with low correlations to each other—investors can not only hope to reduce portfolio volatility, but also maintain exposures to potentially attractive returns across different asset classes and market segments.

While 2025 has been an example of why diversification remains a cornerstone of prudent investing, implementing effective diversification strategies requires addressing several modern challenges. Despite the higher levels of dispersion in returns across market segments in 2025, a more tightly integrated global financial system, in tandem with constantly evolving technological advances, has resulted in more efficient investment markets that often experience higher correlation among asset classes compared to earlier time periods. These higher levels of correlation may be particularly pronounced during periods of extreme market stress, when diversification is most needed. One solution for modern investors may be an increased allocation to alternative investments. In fact, alternative investments that are not publicly traded may provide substantial diversification benefits for investors in a market environment where public markets are tightly interconnected. 

Narratives and their accompanying market psychology can shift rapidly, as we experienced in the first half of 2025. For portfolio managers, risk management is a constant process, not something that happens in a vacuum in response to specific events. Once recognized, risks tend to be quickly incorporated into market prices. In general, it is uncertainty, rather than any specific risk, that drives elevated levels of market volatility.

As markets continue to evolve, we believe the fundamental principles of portfolio diversification will be a core tenet of prudent investing, providing investors with the tools needed to manage uncertainty while allowing them to capture a wide range of opportunities across a variety of asset classes. Taking a broad, big-picture view with a well-diversified portfolio is not a capitulation, nor does it indicate a lack of conviction. Rather, it can be viewed as an expression of humility in the face of unprecedented geopolitical and macroeconomic upheaval. We continue to believe the ability to remain humble and focus on a strategic plan is the best prescription for long-term investment success.

If you have any questions about your portfolio and where you should invest given the current challenging circumstances, don’t hesitate to contact your Corient Wealth Advisor.

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