Drama Meets Dramamine - 2nd Quarter 2025

Market volatility during the second quarter was dramatic to say the least. It began with Trump’s Liberation Day announcement on April 2nd that sent equities into a tailspin. Broad indices fell roughly 12% in just four trading days. The administration then announced a 90-day pause on the proposed tariffs, and stocks rebounded sharply. Though the details remain mercurial to this day, it became clear that trade negotiations were the desired outcome, rather than an abrupt disruption to global trade that would have caused severe economic damage. The quarter was bookended by the first direct US attack against Iran since 1988. Cooler heads tend to prevail even in the darkest times, and calmer investors tend to win out. As geopolitical concerns shrank from view, investors turned their focus to economic fundamentals, corporate earnings, and AI. All said and done, the stock market had its best quarter since 2023, rising by over 10%.

The latest data according to the Federal Reserve points to a resilient US economy, a healthy but weakening labor market, and slowly declining inflation. Global trade tariff impacts are a known variable that could disrupt this goldilocks picture. As we’ve discussed in the past, tariffs are inflationary and lead to slower economic growth. The tariffs themselves are a business-paid tax on imported goods, typically passed on to consumers in the form of higher prices. Additionally, companies aiming to avoid tariffs may invest in domestic supply chains which may result in increased costs as well. With rising prices, businesses and individuals alike may be forced to curtail spending, leading to slower economic growth. The Fed is watching, and they want to avoid a policy misstep that could fuel inflation or exacerbate an economic downturn. The latest expectations from Wall Street suggest the Fed will cut interest rates by 0.25% in September and again in December. This, like all predictions, is subject to change pending new data.

Corporate earnings were solid in the first half of 2025. Approximately 77% of companies in the S&P 500 exceeded earnings estimates, and analysts expect continued earnings growth of approximately 9% for the full year. Equity valuations, however, are also high by historical standards. At current levels, investors may have already priced in said corporate earnings. Although we would caution against using broad market valuations as a litmus test. Stocks can remain richly valued for extended periods and may ultimately grow into once lofty valuations. We know too that valuations are not uniform across segments. While large US tech companies trade at over 30 times earnings, the rest of the US stock market trades around 19 times. Renewed enthusiasm for the AI trend is one obvious culprit behind this disparity.

According to a recent Gallup survey, 67% of US firms now say they utilize AI in some capacity. Tesla and Waymo are expanding robotaxi services and Amazon is on the verge of using more robots than humans in its warehouses. Google recently unveiled a new AI video generator capable of producing cinema quality clips, as well as a medical imaging assistant that can interpret X-rays and MRIs. Even the FDA has launched a new AI tool to fast-track drug approvals and flag safety risks. In Minneapolis we have heard from legal professionals that AI is accurately automating routine, but customizable tasks, including the drafting of lengthy and complex legal documents. The impact from AI is so great that legal firms are revising their fee and client relationship structures because their traditional service model is no longer competitive.

Though these stories are exciting to read, the road to widespread AI adoption and profitability is filled with challenges, some are known but many more are not. This will affect both tech and non-tech companies alike. The AI phenomenon may continue to drive investor enthusiasm resulting in new highs. Although a bubble may form at some time, it is our view that diversified exposure to businesses building the infrastructure, using data and developing the applications of the future prove rewarding.

Thank you for your support, and please reach out to continue the conversation.

EPIQ Partners

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