Market Perspective - Summer 2025

Guide to the markets

Sifting through financial information online is becoming quite onerous with so many opinions out there, so we've consolidated what we believe to be informative and insightful into one Market Commentary.

The U.S. economy (the largest economy in the world and – still – our most significant trading partner) seems to be losing steam as several forces work against it. Higher tariffs, government spending cuts, and lower levels of immigration and tourism are slowing growth. After a reasonable start to 2025, with real economic activity up 2% early in the year, growth is expected to slow dramatically — close to zero or even negative by late 2025. Fewer immigrants and less hiring mean the labor force isn’t growing much, so even as job creation slows, unemployment shouldn’t rise too sharply. The jobless rate may reach about 4.5% by year-end, which isn’t severe by historical standards. A stimulus package, in the form of lower tax withholding and big income tax refunds coming in 2026, could give the economy a temporary lift in early 2026. But that boost likely fades later that year as the deeper effects of tariffs and weaker immigration continue to weigh on the economy.

Inflation has been tame so far, holding at 2.4% in May, but this calm could be short-lived. Tariff costs haven’t fully shown up in consumer prices yet, but as businesses adjust prices on new inventory, we could see inflation rise toward 3-3.5% by the end of 2025. That would be above the Federal Reserve’s 2% target. Some of this inflation might linger into 2026 as consumers spend their tax refunds, keeping demand strong for a while. However, as the economy slows again, inflation is expected to cool back toward the Fed’s goal. The Fed, meanwhile, has been cautious about cutting interest rates. With inflation risks still on the table and unemployment only modestly above its long-term average, they’ve kept rates steady at 4.25%-4.5% and might only cut slightly later this year — unless the economy slows more sharply.

Financial markets have been shaped by these crosscurrents. Mega-cap U.S. tech companies have continued to dominate, with the largest firms in the S&P 500 making up over 35% of the index’s value. Much of this reflects investor enthusiasm for technologies like artificial intelligence. But these stocks have very high valuations, which could leave them vulnerable if economic or political surprises occur. For long-term investors, it may be prudent to rebalance away from these giants and toward more diversified holdings. Bond markets are offering reasonable yields, but rising government debt and persistent inflation could limit future gains. The traditional bond rally during slowdowns may not play out as strongly this time.

The U.S. dollar has weakened notably this year, in part due to its high starting point and America’s ongoing trade deficits. A weaker dollar has helped international stocks outperform their U.S. counterparts, as both local stock gains and currency moves worked in their favor. Despite this rally, foreign markets still trade at lower valuations than U.S. stocks, suggesting more room to run. For investors heavily tilted toward U.S. assets, adding to international positions may still make sense. Over the long run, as U.S. growth slows and trade deficits persist, the dollar could decline further, providing another tailwind to overseas investments.

Given this backdrop, many investors are thinking beyond the traditional stock-bond mix. Higher inflation has reduced the usual protective role of bonds when stocks fall. This has increased interest in alternatives like private equity, infrastructure, and real estate — assets that offer different return patterns and, in some cases, strong income streams. These investments can provide valuable diversification but tend to be illiquid, so they work best as long-term commitments. Finally, with recent market gains pushing many portfolios to be more stock-heavy than planned, now may be a good time for investors to rebalance and manage risk - ideally in a tax-smart way.

From JP Morgan’s Dr. David Kelly:

The collective impact of tariffs and tariff uncertainty, federal government cutbacks, and

declining immigration and tourism appear to be slowing the U.S. economy. Looking past

swings in imports and inventories, we expect real final sales of domestic product to slide

from 2.0% annualized growth in the first quarter to 0.2% in the second quarter to a negative reading in the third.

However, passage of the reconciliation bill should inject stimulus into the economy, both

through lower income tax withholding from the third quarter on and, more powerfully, via very strong income tax refunds in 2026. This should boost economic activity in the first half of 2026. However, we expect growth to slow again in the second half of 2026 as the refund effect fades and the effects of higher tariffs and lower immigration linger.

A slower-growing U.S. economy will mean slower job growth, with average monthly payroll gains likely falling below 100,000 for the rest of 2025 before reaccelerating slightly in 2026. However, the impact of this slow job growth on the unemployment rate should be suppressed by a sharp decline in immigration.

The administration has succeeded in reducing illegal immigration to almost zero and has

been ramping up its deportation efforts. However, we are also seeing a significant decline in the issuance of new immigrant visas at foreign embassies. Putting it all together suggests that net immigration could fall to less than 250,000 per year, down from an average of over 1,000,000 per year in the 20 years before the pandemic. This implies a declining labor force, limiting the increase in the unemployment rate to just 4.5% by the fourth quarter of this year. We expect that wage growth will remain steady as recession worries counteract tight labor markets in wage negotiations.

So far, the impact of tariffs on inflation appears to be minor, with year-over-year CPI inflation coming in at just 2.4% in May. However, we believe that the inflationary impacts of tariffs have been delayed, not cancelled, and, as retailers apply mark ups to new inventories, consumer prices should see some significant increases.

By the fourth quarter, we expect inflation will have risen to 3.5%, year-over-year, according to the consumer price index and about 3.0%, according to the personal consumption deflator which is the Fed’s preferred measure. This inflation could be sustained into early 2026 due to the impacts of higher income tax refunds on consumer spending. However, as the economy slows again in the second half of 2026, inflation should gradually return to the Fed’s 2% target.

After cutting rates by 1% in the second half of last year, the Federal Reserve has maintained the federal funds rate in a range of 4.25% to 4.50% throughout the first half of 2025. We expect them to remain on hold at least over the next few months and perhaps deliver just one 0.25% rate cut by the end of the year for two key reasons:

First, there remains very significant uncertainty on the final shape of federal government

policies on tariffs, immigration and the budget and the impact of all of these policies on

inflation over the rest of 2025 and in 2026.

Second, according to their Summary of Economic Projections, by the end of 2025, they

expect the inflation rate to be further above their 2% target than the unemployment will berelative to its 4.2% long-run expectation. In this scenario, it is hard to justify aggressive Fed easing. We do expect, however, that the Fed could cut more, if the economy slows again in the second half of 2026.

One glaring anomaly at the start of this year, was the huge outperformance of the largest

companies in the S&P 500, both in terms of earnings and equity market gains. Much of this reflects the dominant market position of U.S. tech firms and a surge of interest in and

investment spending on artificial intelligence. That being said, in recent years, the stock

market performance of these companies had generally outpaced their outperformance in

earnings, leaving their valuations at generally very high levels relative to the rest of the

market.

Despite huge market volatility during the second quarter, this anomaly persists today with the top 10 companies in the S&P 500 representing well over 35% of the market value of the entire index. For long-term investors, it may make sense to increase allocations to other areas of financial markets in case, economic, geopolitical or idiosyncratic forces turns a mega-cap U.S. equity boom into a bust.

A lack of Fed easing, the prospect of higher inflation, and the likelihood of fiscal stimulus

have all put a floor under long-term interest rates in 2025, despite increasing signs of a

slower economy. We expect long-term rates to remain range-bound as the effects of a

continued economic slowdown are counteracted by increased Treasury issuance in the wake of the passage of the reconciliation bill and an associated increase in the debt ceiling.

For investors, there is not a strong argument for making a bet either on duration or credit in bonds. Even if the economy eventually weakens, any rally in bonds should be limited by rising federal borrowing and stubborn inflation. Moreover, at least in the short run, we

expect the economy to avoid recession, partially justifying today’s tight credit spreads.

However, we do think that roughly normal bond allocations make sense in this environment – historically, today’s close-to-5% yield on the Bloomberg bond index has been associated with close to 5% annual returns over a 5-year period. Provided inflation fades late next year, these yields and potential returns seem reasonable.

The dollar has fallen sharply since the start of the year. This may, in part, reflect its high

valuation going into the year and America’s chronic trade deficits. However, it could also be the result of questions among both U.S. and international investors about their concentration in U.S. assets and the policies of the new U.S. Administration.

A key driver of the dollar in the long run has been the higher interest rates offered on U.S.

debt compared to other DM economies. In the short run, with the ECB, in particular, seeming more willing to cut than the Federal Reserve, this interest rate gap could be maintained, limiting further U.S. dollar declines. However, we still believe that, in the long run, a downshift in U.S. economic growth, combined with a still high trade deficit, should lead to a dollar decline.

The first half of 2025 has seen international stocks outperform their U.S. counterparts by a

wide margin as local-currency outperformance has been amplified by the impact of a falling dollar. Given this dramatic outperformance, many investors may be wondering if they have missed the boat in increasing international allocations.

We don’t believe so - for three reasons:

First, as we show in the chart, even after a 2025 rally, non-U.S. stocks still carry much lower valuations than their U.S. counterparts.

Second, the dollar remains very over-valued given our trade fundamentals and we expect it to fall in the years to come.

Third, given the outperformance of U.S. stocks over the last decade, most U.S. investors are likely very underweight international stocks relative to an appropriate long-term asset

allocation.

The last few years have seen very strong stock market gains. However, that very

outperformance could limit future returns. Moreover, the traditional role that bonds play in zagging when stocks zig has been challenged in recent years by higher inflation which

negatively impacts both stocks and bonds.

In this environment, many investors are exploring alternative assets, such as private equity, private credit, infrastructure and real estate. These assets are all quite different – some provide strong long-run returns, some generate strong current income and some act as good diversifiers to publicly-traded stocks and bonds. Many of them are quite illiquid and so should be thought of only as long-term investments and the performance of different assets within the alternatives space has varied considerably depending on the manager. Still, adding alternatives to a traditional stock-bond portfolio may make sense for many investors and we expect this area of financial markets to continue to grow in the years ahead.

Finally, it is to consider not just economic fundamentals and valuations but how investors are positioned. The last five or six years, while filled with dramatic and difficult national and global events, have also, on balance, seen very strong investment gains. However, these gains have been by no means even, and, if investors have not been disciplined in rebalancing their portfolios, they have not just grown in recent years – they have grown more risky.

Indeed, as we show in the chart, a portfolio which was 60% invested in stocks and 40%

invested in bonds at the start of 2019, would today have over a 70% allocation to stocks,

assuming that dividends were reinvested in stocks and coupons in bonds over the

intervening years. This may not be at all appropriate, given gains in wealth but also uncertainties in the outlook.

For many investors, as we enter the second half of 2025, it may make sense to gradually

rebalance and add diversification to a portfolio, particularly if this can be done in a tax-efficient manner.

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Your portfolio

I try my absolute best to ensure my human outlook does not spill into your investment strategy.

"The stock market is filled with individuals who know the price of everything,

but the value of nothing."

 - Phillip Fisher

As a strategic asset allocator (decisions made based on past outcomes) versus a tactical asset allocator (decisions made based on future outlook), my belief is that future short-term outcomes are not yet known, and that past outcomes are a matter of fact.

Based on this framework, we make systematic determinations for portfolio shifts every quarter. The end result of these determinations was to reduce your overall equity/stock holdings in July of 2021, increase them in July of 2022, reduce them in July of 2023, and then again in April 2024. We again made a systematic change in December 2024 - moving some assets out of US equities in favor of international equity, infrastructure assets, and fixed-income assets.

You'll note that we shifted our quarterly evaluation schedule going forward from January, April, July, and October to March, June, September and December. This should better coincide with end-of year tax planning and less of interference during the income tax preparation deadline.

A graphical representation of what I describe above, contrasted against the S&P 500 index (just one of several market factors) over the past 5 years, can be found below, whereby green dots represent slight shifts into equity, and red dots represent slight shifts out.

From a historical perspective, you may find that this strategy has yielded results that had your portfolio overperform in 2020, underperform in 2021 (shifting out as stocks went up), overperform in 2022 (despite the down year) and 2023, meet, or slightly miss, expectations in 2024, and overperform so far in 2025.

Google and the Google logo are registered trademarks of Google LLC. Used with permission.

We continue to monitor any potential new holdings on an almost daily basis, and continue to evaluate your existing holdings to determine if the reasons we bought them in the first place remain true today.

I hope you find this both interesting and informative in keeping pace with the events of today’s financial world.

This publication contains the opinions of the writer. The information contained herein was obtained from sources believed to be reliable, but no representation or warranty, express or implied, is made by the writer, Designed Securities Ltd. or any other person as to its accuracy, completeness or correctness. This publication is not an offer to sell or a solicitation of an offer to buy any securities. The information in this publication is intended for informational purposes only and is not intended to constitute investment, financial, legal, tax or accounting advice. Many factors unknown to us may affect the applicability of any statement or comment made in this publication to your particular circumstances. Hence, you should not rely on the information in this publication for investment, financial, legal, tax or accounting advice. You should consult your financial advisor or other professionals before acting on any information in this communication.

Avesta Wealth is an investments trade name of Designed Securities Ltd (DSL). DSL is regulated by the Canadian Investment Regulatory Organization (www.ciro.ca) and Member of the Canadian Investor Protection Fund (www.cipf.ca ). Investment products are provided by Designed Securities Ltd. and include, but are not limited to, mutual funds, stocks, and bonds. Adam Schacter is registered to provide investment advice and solutions to clients residing in the provinces of British Columbia, Alberta, Manitoba, Ontario, Quebec, and Nova Scotia.