Investment Commentary – July 28 2025

Executive Summary

We believe the tariff situation represents more of a consumption tax that will be more similar to a one-time price adjustment than stoking runaway inflation expectations.  We also believe that housing is an important component of inflation metrics, where home prices have been recently deflating across the country, and mortgage rates remain elevated. Housing-related costs account for approximately 41% of the Consumer Price Index (CPI) and 15% of the Personal Consumption Expenditures (PCE) inflation index. Inflation expectations appear well anchored, where the 5-year breakeven inflation expectations fell 3bps last week to 2.49% vs. a low of 1.88% on September 10, 2024.

Investors are pricing in roughly two Fed cuts by year-end. Tariff rates remain substantially elevated compared to last year,but they appear manageable. We believe it’s likely that the cost can be shared amongst exporters, importers, and consumers without a meaningful impact on growth or inflation, but it will likely impact margins for some companies. Investors also appear willing to react positively to any degree of certainty in the new trading relationships.

Investors around the world have begun to look past tariff-related uncertainty and appear to be pricing an optimistic outcome for the second half of this year. 

• The S&P 500 Index, Nasdaq Composite, and Dow Jones Industrial Average were all at all-time highs as of the end of last week, led by solid corporate earnings and reassuring economic data.
• In Japan, both the Nikkei 225 and Topix indexes recently hit record levels, as improved policy clarity with the U.S. helped fuel a rally in Japanese stocks last week.
• The MSCI Europe Index is just shy of a record high.
• Over the past month, low-quality and other speculative themes have appreciated higher. This has spread in recent days to retail investor FOMO with a few “Meme” and “DORK” stocks (e.g., Denny’s, Opendoor, Rocket, Krispy Kreme) characterized by potential wild price fluctuations driven by retail investor interest and often high short interest.

In the world of credit, we believe municipals may be suitable for certain taxable investors due to the potential combination of attractive taxable-equivalent yields, strong credit quality, and the diversification benefit they offer to portfolios. Credit spreads remain near 10-year tights in both investment-grade and high yield asset classes. We wouldn't expect significant spread compression from here.  In sum, we believe the bond market opportunity is more of a coupon-clipping exercise where we are below benchmark on duration and believe in the benefits of credit selection.

Equities

The S&P 500 returned 1.5% rising each day and hitting all-time highs. Optimism on tariff deals, resilient economic data, and generally solid corporate earnings were the key catalysts. Market breadth has improved with the S&P Equal Weight index rising 1.9%. The continuous rally has, however, stoked concerns about high valuations and a revival of meme-stock froth. All sectors in the S&P 500 saw positive returns with healthcare (+3.5%), materials (+2.3%), and industrials (+2.3%) leading. EAFE markets returned +1.9% while EM markets returned 0.7% on trade deal optimism.

From a valuation perspective, the S&P 500 and NASDAQ trade above +1 standard deviation based on historical forward P/E ratios, with the S&P 500 at +2.2 and NASDAQ at +1.4. For the next 12 months, EPS growth for the S&P 500 is expected to be 6.3% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for the NASDAQ is expected to be 7.9% (vs. 10.7% annualized over the last 20 years). Equities across markets caps in the U.S., and in non-U.S. developed and emerging markets, trade at or above their 20-year averages based on forward P/E ratios.

Fixed Income

Investment grade fixed income sectors had positive returns as yields fell at the long end of the curve. Municipals returned +0.3%, U.S. AGG returned 0.4% and U.S. IG returned +0.6%. HY bonds returned +0.4% as spreads compressed 9bps while bank loans returned +0.1%. EM debt returned +0.8% even while the U.S. dollar fell 0.8% as spreads compressed 12bps.

Rates

Rates fell slightly at the long end of the curve. The recession-watch 3M-10Y spread compressed 4bps to +3. The 2Y-10Y spread compressed 8bps to +546. Rates fell slightly in other developed markets except in Japan; the BTP-Bund spread is at 0.84%. 5-year breakeven inflation expectations fell 3bps to 2.49% (vs. low of 1.88% on Sept 10); 10-year breakeven inflation expectations were flat at 2.42% (vs. recent low of 2.03% on Sept 10); the 10Y real yield fell 1bp to 1.97%. The market now expects between one and two cuts in 2025 vs the Fed’s guidance of two cuts. At year-end 2025, the market expects the Fed Funds rate to be 3.89% vs. the Fed’s guidance of 3.75%-4.00%.

Currencies/Commodities

The dollar index fell 0.8%. The commodities complex fell 1.1% as energy prices fell 2.1% for the week. Brent prices fell 1.2% to $68/bbl. U.S. natural gas prices fell 12.8% while European gas fell 2.6%, both due to expectations for the weather.

Market monitors

Volatility fell for equities and bonds (VIX = 15, MOVE = 82); the 10-year average for each is VIX=19, MOVE = 80. Market sentiment (at midweek) rose from 0 to 3.