In our midyear outlook, we break down some of the biggest factors driving markets in 2025 — tariffs, AI, and the potential for rate cuts — and attempt to help investors sift through the short-term noise while keeping a long-term perspective.
(Stay tuned for additional important disclosure information at the end of this episode.)
Nicholas VanDerSchie: US stocks were up 7% for the first half of the year. Taken at face value, that sounds solid and maybe even a little uneventful. But with markets, it's always the story underneath the headline that really matters. And that's exactly what we're unpacking in this mid-year outlook episode.
Today, we'll touch on tariffs, the Fed, and where interest rates maybe headed next and what that means for bonds. We'll also discuss one of the biggest stock market stories of the year, the broadening of market leadership. Just look at Apple and Tesla. They lost nearly $1 trillion in combined market cap in the first half of the year and yet stocks are still at new all-time highs. We'll also hear from our guests on why international stocks are outperforming US stocks by one of the widest margins we've seen at mid-year and whether that can continue. And finally, we'll cover AI's impact on returns and how much of the rally is really an AI story. And always, we'll wrap it up with what this means for portfolios and practical ideas to help you guide clients for the rest of 2025.
This is Simple But Not Easy, a podcast from Morningstar's Wealth Group where we turn complicated financial developments into actionable ideas. I'm Nick VanDerSchie, head of strategy and execution for Morningstar Wealth and I'm delighted to be joined by Ricky Williamson and Al Bruno, two of Morningstar's investment leaders, who will help us dig into what's already happened this year and where we may be headed.
Before we get into the conversation, if you'd like to know more about how we support advisors, we welcome you to email us at simple@morningstar.com or me directly at Nicholas.VanDerSchie@morningstar.com.
Now, let's get started. Ricky, Al, welcome to Simple But Not Easy.
Ricky Williamson: Thanks for having us.
VanDerSchie: Great. So, Ricky, you're welcome back again. I think you've been on a of couple times over the last year. What have you been up to since your last time on the show?
Williamson: Thanks, Nick. Yeah, it's great to be back. So, I think I was last on in December and since then to perhaps state the obvious, I'd say it's been a really interesting period to do what we do. There's been a lot to think about for multi-asset investing that I'm sure we'll get into. But fortunately, we've been able to do a lot of stimulating work to help us think through how to navigate this environment. And that's always fun.
VanDerSchie: And, Ricky, I have to ask you. I know about a year ago you and I sat on the podcast stage at the Morningstar Investment Conference on Navy Pier for a conversation. I was actually out in Cooperstown, New York, a couple of weeks ago, when the conference was going on this summer, coaching my 11-year-old son's baseball team. So, I have to ask, how was the conference this year? Did you have any good engagements?
Williamson: Yeah, I loved it this year. It was actually the first time in several years I didn't have any speaking or presenting responsibilities, so I was able to really enjoy it, listen to some great sessions, meet with clients as well as different in the industry. So, yeah, as always, it was a great event, and I was really able to soak it in this year a bit more than I have in the past.
VanDerSchie: That's great. And Al Bruno, this is your first time on the show. Welcome. We're really glad to have you. Tell us a little bit about your role and tenure at Morningstar.
Al Bruno: Yeah, I appreciate it, and thanks for the invite. Yeah, so I started at Morningstar in 2018. I've been with MIM or Morningstar Investment Management since about 2019, where I started as an analyst. And now, I co-manage four mutual funds alongside Ricky, the Total Return Fund, Defensive Bond, Multisector Bond, and then our Global Income Fund.
VanDerSchie: All right, so it's been quite a year so far. US equities are up 7% through mid-July, but that headline number leaves out a lot of context. Ricky, let's kick it off with you and looking at where we are now relative to January, what jumps out and is there anything that's caught you off guard or maybe made you rethink expectations?
Williamson: Yeah, I mean, to your point, it's been a pretty wild year in equity markets so far. I think it's sort of easy to forget that the news of DeepSeek, its reasoning model, and then the ensuing impact to AI names happened just in January. It sort of feels like it was years ago at this point. But look, I think from our perspective, we came into the year with concerns around this American exceptionalism theme and what level of valuations that have led to across many areas of US markets, not just equity markets, but also credit markets. And while we certainly weren't making any short-term predictions about an ensuing economic downturn or equity market crash, we were just getting pretty uncomfortable with the expectations embedded in US assets.
And so, that allowed us to be positioned relatively well for what happened in markets in Q1 and the immediate aftermath of Liberation Day. And certainly, the magnitude as well as the breadth of those tariff announcements in April were a surprise to everyone, were a surprise to us, were a surprise to markets. So even though we had planned for kind of the impact of various equity markets via tariffs, if the trade war was going to ramp up again, the degree to which those initial tariff threats were at least came as a surprise, which is why, of course, equity markets reacted the way they did.
But I think what's actually been an even larger surprise is what's happened since. The pace and magnitude of this recovery that we've seen since Liberation Day has just been quite remarkable. And I'm sure we'll touch on a bit why that has happened. But what's surprising about that to me is, one, there were cracks in the economy that were already starting to show prior to Liberation Day. And two, while peak uncertainty around the trade war may be behind us, the tariff levels moving forward are undoubtedly going to be higher than what they were prior to this year, no matter what kind of deals are made in the coming weeks and months. And so, we have a decelerating economy that is now going to have to deal with the economic impacts of higher tariffs. And it's very likely going to impact the consumer. And yet the market seems to be comfortable with that or ignoring that, I'm not sure. So, I think that's probably the biggest surprise to me so far this year.
VanDerSchie: And as you mentioned, Ricky, the recovery has certainly been unbelievable. But is there anything you'd say investors shouldn't be surprised by?
Williamson: Yeah, I think it's a really good question. I think, in some respects, it speaks to the way we think about investing here at Morningstar Wealth. We aren't going to make many investment decisions based on short-term macro forecasts or predictions or about what type of policy announcements may be coming out of The White House. But as I mentioned, what we did think going into this year was that the US equity markets, particularly those large tech, AI-related names were a bit expensive. And what we mean by that was that the expectations embedded into them were quite optimistic. So, things would need to continue to go as they had been for the previous two years or so in terms of earnings growth. And we do know that company fundamentals can be impacted by things outside of their control, even if they are solid high-quality companies, which these are. But things like the emergence of DeepSeek or of course, a change in the economic landscape can impact these companies. And I think oftentimes when people consider valuations, they think about the upside. A stock or asset class has a price to fair value of 0.8, for example, and therefore it has good upside potential.
But I think getting to your question, investors shouldn't be surprised that valuations also matter on the downside and when expectation is embedded in stock prices get on shaky ground. And so, when that uncertainty arises, whether that'd be from new competition or from policy shocks or just from sort of the natural flow of the economic cycle, assets that have the highest valuations can often fall the most. And that's sort of what we saw not only in April immediately following Liberation Day, but also in Q1 around DeepSeek and uncertainty around the economic landscape. And that started to impact these share prices pretty meaningfully. So, I don't think investors should necessarily be surprised by that. It's not just the "riskiest assets" that viewed through a modern portfolio lens or something that have the potential for the highest volatility or the highest dry downs. It can also just be the most expensive.
VanDerSchie: Okay, let's switch gears to the fixed income market now. Bonds have had a story all their own this year. What should investors know?
Bruno: Yeah, they certainly have.
VanDerSchie: Actually, I'm going to re-record that.
Okay, let's switch gears to the fixed income market. Al, bonds seem to have had a story all their own this year. What do investors need to know?
Bruno: Yeah, they certainly have. And it's certainly been a market that's been masked by volatility among interest rates for sure, especially in US Treasury markets, but even in other developed market sovereign bonds, you know, think of Germany, the U.K. going through it right now with another budget crisis that occurred just a couple of weeks ago, and then, obviously, in Japan as well, which is seeing long-end bonds really move higher into levels that we haven't seen in history. So that's all admits heightened macro uncertainty as Ricky was just outlining with respect to tariffs and potential inflation, but also due to the fact that markets have had to continuously reprice their expectations for rate cuts in 2025 and even beyond. So, we came into the year with three, some even saying for four rate cuts that has now been brought down to two, at least per the Fed. But it's looking more and more likely that perhaps it's even one.
So, it's not an original story. We saw the same thing occurring back in 2023 when people were anticipating the Fed to cut rates, but inflation remained sticky. So that has certainly kept volatility high within the interest rate market.
However, similar to equity markets and as Ricky has outlined, credit markets like investment-grade corporates and high-yield have been positive with spreads tightening to levels of sometimes that are post-GFC types since the April Liberation Day lows and obviously producing positive absolute returns for investors on a year-to-date basis. And so, what appears to be uncertainty among the broader macro environment right now, it really hasn't fully reached the corporate credit market as fundamentals have really remained solid with limited expected default rates and still solid balance sheets for these companies. And with yields north of 7.5% in high-yield and north of 5% in investment-grade, I think the demand there amongst a broad investor base remains really strong from individuals all the way to institutions such as pension plans, which has kept spreads tight despite some of the volatility that we've seen in interest rates and even irrespective of what's occurring in the broader macro context.
VanDerSchie: So, Al, sticking with you for a minute and with that as the backdrop, in your view, what's been the most interesting or unexpected story in fixed income so far this year?
Bruno: Yeah, I think there's a few things. I think the first one kind of alludes to what I was just talking about in corporate credit markets and that's really how well the bond market and more so how well corporate credit markets have, one, digested the amount of corporate issuance that has been occurring. Year-to-date, I think, we're seeing issuance at levels that we haven't seen since 2021, even amidst this ongoing macro uncertainty, with spreads actually grinding tighter as I've mentioned as a result. So, money continues to be poured into fixed income broadly and even more so more granularly, fixed income ETFs at a really rapid pace.
So, I think heading into the year and certainly around March and April, that a slowdown in economic activity in the US plus this heavy issuance that was anticipated to come from the corporate sector would cheapen spreads. And while it did really for a brief moment there in April, the demand, as I mentioned from insurers, from pensions and from the retail side and ETF has really met that supply. So, it's resulted in areas like IG corporates to revert back to their post-GFC level spread types and that kind of wall of money that's come through really tells you that investors are hungry for income and income that they can see in trade. So, they're using vehicles that didn't exist at scale a decade ago and it's certainly been a structural shift helping any sort of spread widening just get back really quick.
The other item I think I'll mention is not necessarily fixed income but it's out of the US dollar year-to-date and conventional thinking heading into the year as the administration was planning to use tariffs as one of their main economic policies would have suggested that the US dollar should have been appreciating during this time, especially during heightened tariff uncertainty. It's a phenomenon we observed during the first round of tariffs in 2017 and 2018. But the opposite has happened this year as the dollar has appreciated nearly 10% year-to-date.
So, this is likely for a few reasons. I think, one, global investor confidence in US has shaken a bit following the volatile tariff policies that have come through as we all know. And also, the Fed is looking to cut rates to counteract any economic drag from these policies that can certainly make dollar denominated assets less appealing for foreign investors. That reduces the US dollar demand. And the last thing is just the ongoing fiscal issues that we're wrestling with here in the United States, the Treasury issuance and deficit growth following the One Big Beautiful Bill has brought some uncertainty and a lot of limelight into the question of the long-term strength of the US dollar. So, I wouldn't say that we're necessarily calling for a structural move away from the US dollar completely as the world's reserve currency. But I think what's happened is foreign investors have really taken notice of what's occurring. And perhaps it's just a decent time for them to diversify away from their dollar assets of which they've been very, very exposed to since the post-COVID period.
VanDerSchie: Okay. Now that we've set the table, I want to hit on some of the big topics that advisors are talking about with clients. Think of this as a lightning round of sorts. And I think a good place to start is tariffs. Ricky, stocks have rallied 26% since the April 8 lows and that type of rally and that amount of time is incredibly uncommon. So, tell us how we got there.
Williamson: Yeah, well, I sort of already mentioned that this is the most surprising aspect of markets this year to me. But I do think with the benefit of hindsight we can point to a few drivers of this kind of remarkable V-shaped recovery that we've seen. One, and I won't call it the taco trade, but as days and weeks went by post-Liberation Day, it did become pretty clear that these initial tariff announcements were more threats or starting points in negotiations rather than firm policy stances. Therefore, we had seen in that period in April what the worst possibly could be, and that the reality was that the magnitude of these tariffs would be less moving forward.
It's important to remember that what the markets hate the most really is uncertainty and Liberation Day, given its element of surprise and sort of disjointed way that these levels of tariff were explained, did create mass amounts of uncertainty. But as more clarity began to roll in, markets did calm down.
I think related to that, what we saw with the administration is that they clearly did care about the market reaction. We saw that just by looking at President Trump's social media posts effectively telling people to calm down and buy stocks. So that sort of signaled to the market that if it had reacted really poorly to their policy announcements, they would be willing to dial them back a bit. Relatedly, there is this buy at the dip mentality that we've seen in markets, particularly from retail investors really since COVID. For better or worse, many investors seem to think that anytime the market quickly and sharply falls, that the recovery will be just as severe and rapid. And so far, to be fair, they've been largely correct.
That being said, there are also fundamental reasons for this recovery. Corporate earnings have been strong, which means that prices can rise without multiples getting out of control. And also, despite an economy that may not be as strong as it was a year or two ago, it's still acting quite resilient, despite the fears that many forecasters had on the impact of higher interest rates, et cetera. The economy has continued to surprise to the upside, and that fear of the inflationary impacts of tariffs that Al mentioned hasn't really come to fruition either, at least yet. And so, the market has gotten pretty comfortable. I think at this point the question is really whether or not it's gotten complacent.
VanDerSchie: And so, Ricky, even over the last couple of weeks, we've recently seen new tariff announcements, some real, some potentially rumored, but markets have mostly shrugged it off. What's your read on that? Have investors just tuned it out at this point?
Williamson: Yeah. Again, I think it could point to at least the potential for too much complacency. I think it's one thing to acknowledge that we've moved past peak uncertainty and that the level of tariffs may not end up at the extreme levels that we initially may have feared in April. But it's pretty clear that tariffs are a tool that this administration is going to use. Trump used them in his first term, and if you've followed his views through time, he clearly believes in their effectiveness in reaching what his policy goals are. And one of those goals that he has is to reduce trade deficits with other countries. We can certainly debate the efficacy of that view, but he does believe that trade deficits are unfair, and this is a tool to adjust that. But we know that tariffs can and will have an impact to both company fundamentals, the consumer, and the economy. And we've done a lot of work with both our colleagues in equity research as well as our economists that Morningstar has to sort of have the potential impact to earnings, to GDP growth, to inflation. And the reality is that those risks are real. So, it's important in our view to be somewhat cautious right now.
To be fair, those impacts have not really come through in the data so far. Earnings have been strong. The economy remained resilient. And while we saw some tariff impacts in the most recent inflation prints, they weren't that severe. So, I think the market may remain bullish until the data suggest it should act otherwise. I think we just want to be prepared for when that turns.
VanDerSchie: The next topic I want to address is the Fed. Specifically rate cuts or lack thereof have been an important first-half story. Al, what's going on there and what's realistic between now and year end?
Bruno: Yeah, for sure. I mean, the Fed's been parked at 4.5% since they last cut in September of 2024 when they went to that 100-basis-point kind of mini easing cycle prior to the election. But it's now string together multiple kind of on hold meetings while it watches this messy mix of basically moderating growth, tariff-related price noise and kind of like a still okay labor market. It's certainly stalling, but definitely not one that you would be completely concerned about right now that would warrant multiple rate cuts from here. So, if you look at their June meeting, the summary of economic projections median still pencils in two quarter point cuts in 2025, as I mentioned, but officials have been crystal clear. They need to be data-dependent, and markets have had to repeatedly reprice that path.
In terms of what's realistic, the path that's priced in is certainly realistic without being too macro forecasty here. But I think if I kind of just assess the ongoing macro environment, what's happening with tariffs and combine that with their dual mandate of inflation and the labor market, I think one cut is just a little bit more likely than two just given – we did see in the latest June CPR report some good pass through and inflation coming in, despite the fact that the services side of the economy has been a little bit on a disinflationary type of trend. So, from that standpoint, I wouldn't be surprised if they continue to wait and see how this tariff news plays out into inflation. So, if that's the case, it wouldn't be surprising if the Fed kind of just stayed put all year so long as the labor market stays intact. And that's really the second variable. The labor market is certainly slowing. I guess it's stalling out. But we still have one job opening per worker looking for a job and also with immigration changes, that can keep the labor market a little bit more tight than the many were anticipating heading into the year. So, any premature cuts or cuts that can be enough to ignite the inflationary pressures again from increased demand, especially from the services segment of the economy, any reversal in that segment can certainly put a lot of pressure on inflation just at a time when goods inflation is starting to increase. So, that's the exact scenario that the Fed is trying to avoid.
And the last thing is, we have to remember that the One Big Beautiful Bill Act that was passed is expected to have a pretty modest increase to GDP in 2026. So, it's very possible that the US really remains a robust economy and it's pretty resilient to these tariff effects heading into the new year. So, if rate cuts occur when inflation is still in the 2.7% to 3% range, the risk of cutting prematurely is certainly heightened. And that's kind of the environment that the Fed is looking to avoid.
VanDerSchie: So, Al, while we're on the topic, I do have to ask – assuming the Fed does cut rates later this year, is Jay Powell still going to be the one in charge?
Bruno: Yeah. I'll probably eat my words after I say this, but I think almost certainly yes, even if rates aren't cut barring some sort of political earthquake that can occur, which is not out of the realm of possibilities. But you have to remember, the Fed chair is just one vote among the FOMC members. So, it's not a dictatorship. So, even if he was replaced, that doesn't necessarily mean that monetary policy reverses course immediately. There's other FOMC members that have voting rights that go into it.
The other thing too, and I'm sure many of the audience and others are aware, legally the President doesn't have the authority to remove the Fed chair without cause and cause in this context can't just simply mean policy disagreement. Now, there has been news that have come into play that the Federal Reserve building renovations have gone beyond budget, and that can be viewed as malfeasance by the Fed chair, and they can hold them accountable for that and use that as cause. I don't know how realistic that is. And even the legal team that's advising the President has already publicly said that the path to winning any inevitable litigation that would come from this is really cloudy at best. And every time we've gotten a headline around this news, the President has been pretty quick to squash any truth to that saying that it's not likely that this will be happening.
What likely will happen though is continued pressure from the administration to lower rates as we've seen repeatedly, especially if tariff pass-throughs, as Ricky was mentioning, just aren't coming in as expected. And further because Powell's term is up in May of next year, the front runners for the position are already making their way through the media. You think of guys like Kevin Warsh or Kevin Hassett, for example, and they're providing details on how they would like monetary policy to be implemented if they were in charge. So that's nothing new.
The idea of this so-called phantom fed driving markets is kind of akin to history. We saw the same thing happening when Janet Yellen was starting to become Fed chair following Bernanke, knowing that she was very dovish and that had an impact on markets, et cetera. So, this allows markets to adjust to the impending chair and how they will perceive monetary policy direction going forward. And it also provides a sense of clarity for markets. So that's kind of a good thing that's happening.
However, what's not akin to history is the repeated verbal attacks of the sitting Fed chair from the President directly. I think the news that broke earlier this week showed what could happen in the case of a firing of Jay Powell. You had the dollar decline pretty rapidly, which is inflationary for the country and the long end of the Treasury curve rose. So, any credibility that's left to be preserved of the central bank has to be cherished right now. And my guess is that the outspoken disagreements are going to continue until May unless policy changes direction on a sustained basis, which is probably not likely. But the likelihood of a firing or at least an attempting to fire the Fed chair is probably not going to be pursued.
VanDerSchie: The last follow-up I have on this topic, maybe it's an obvious question, but does this market actually need…
Bruno: I think Nick cut out there for me.
VanDerSchie: All right, Al. So, the last question I have about rate cuts is, do we actually need rate cuts in this market environment. I mean, we're seeing stocks, home prices, Bitcoin, gold all at all-time highs. And so, through that lens, things are actually looking pretty good.
Bruno: Yeah, I think certainly from a market or financial asset perspective. But we have to remember, right, the financial asset strength does not equal the economy. We saw the same type of argument happening during the initial COVID onslaught in 2020, when the markets started to rally following the March drawdown and you had the typical tech names skyrocketing following the 20%, 30%, 40% drawdowns that we saw in some of these names. And when markets or the government was deciding how much fiscal policy to be enacted, some of the arguments were, well, look at the stock market, the economy is actually in a pretty decent shape. But in fact, it was certainly struggling and definitely needed some assistance.
So, I wouldn't use markets as a way to determine how the Fed is determining monetary policy going forward. But you're right, mega-cap equities, Bitcoin, as you mentioned, other crypto, national home prices have pushed to near or to or at records for sure. But we can't use that as a measure of the real economy, nor is the Fed really using that as an input in their decision-making. I think it certainly gets discussed at least to examine whether policy is restrictive enough or easy enough at times, but definitely not a leading factor in their decision-making.
I think if it were, seeing Bitcoin at $120,000 right now and Nvidia hit $4 trillion market cap even in this volatile uncertain macro environment, I think they would probably be talking about increasing interest rates right now and not cutting them as policy isn't restrictive enough. That said, I think the interest rate sensitive parts of the economy, though – think of things like existing home sales or like mortgage origination, for example. And if you look at some of the statistics within that – like, if you look at the median age of home buyers right now, it's 56 years old, it was 30 in 1980. 46%, 45% of home buyers right now are aged between 60 and 81 years old and just 29% are millennials aged from 26 to 44.
So, I think there's specific things and nuances within the data that we can look at. And the Fed isn't necessarily about equality, but they do want a broad and expansive economy to sustain on a go forward basis. So, interest rates being higher hasn't really helped the home affordability problem, given the fact that prices have continued to go up due to a lack of supply. But it's likely that lower mortgage rates even accelerate home prices as demand would increase in that type of environment.
The thing we have to look at, too – we certainly have to segment the economy based on income cohorts as well. And if you look at the lower-income consumer right now, I think they're certainly feeling it with rates being where they're at for the sustained period that they've been, is either the most lever cohort of the country as well. So, if you look at things like auto delinquencies or credit card delinquencies or even some on home loans, they're starting to pick up at a pretty modest pace.
So, to your question, no, markets don't need a cut to levitate risk assets, but they might need cuts to broaden the expansion beyond some of these capital market winners. So, in other words, cuts would be about the breadth of growth, not fueling asset price appreciation. Though, really admittedly, like that's probably a consequence of them cutting rates from here.
VanDerSchie: Okay. So, let's broaden out the rate conversation to the overall bond market. Obviously, the direction of rates and the Fed's heavy hand in that has had a major impact. And for years, the bond market has been the Rodney Dangerfield of asset classes. It gets no respect. Al, do you think anything is changing there?
Bruno: Yeah, I think it's definitely changing, and Rodney is getting invited back to the dinner table. Broadly, the asset class in general is becoming more and more democratized, as I mentioned, through the advent of new ETFs that capture high yield, it captures both hard currency and local currency emerging market debt, bank loans, et cetera, and even in some cases, in an actively managed fashion. I think these new ETFs help investors, they help advisors, they help retail investors become a bit more granular in their fixed income positioning.
Additionally, we've also seen other asset classes like CLOs, for example, which are collateralized loan obligations, which have been primarily exclusive to institutional investors, get broadly used by retail as they've created actively managed ETFs in the space. So, these are floating rate securitized bonds that are made up of a bunch of leveraged loans and below-investment-grade bank loans. So, the structures are really solid. AAA CLOs, which have specific ETFs following them haven't had a default in their history and that's inclusive of the GFC.
So, with that, the other thing is income is back, right? So, we saw this certainly during this rate rising period. I guess the consequence of rates increasing was certainly price loss at the onset. But what's allowed now is, rates that are higher for investors to generate income over sustained period of time. So, when you combine these two aspects of democratization of the asset class along with income, you're really able to get granular in your positioning and you can create diversified bond portfolios that really generate solid income streams. And this actually moves the needle now and you can do it in a low-cost liquid ETF wrapper.
The last thing I'll mention too is the hype around private credit and maybe some of the innovative ways firms are trying to capture the retail audience here. So, the ability to add private exposure is certainly unique for the retail base and private credit markets have been providing 9% to 12% all-in yields, which really made them quite compelling for risk-appropriate investors. And all that to say is, the ability to add fixed income has, one, never been easier, and creating multi-sector bond portfolios that can generate solid income streams going forward should definitely be in the toolbox for all investors on a go forward basis.
VanDerSchie: All right. I want to switch back to the equity markets now. Ricky, last year at the Morningstar Investment Conference in Chicago, you and I were talking a lot about market concentration, the Magnificent 7, all that. Give us an update. Has anything shifted at the top?
Williamson: Yeah, I mean, I think at least at the headline level. I mean, not really. Last July, the Mag 7 made up about a third of the market cap of S&P 500. And sitting here today, the Mag 7 make up about a third of the market cap of S&P 500. That being said, it certainly hasn't been in a steady state. Those names sold off last summer, then had a strong end to the year. Then they had a weak Q1 this year, kind of around that DeepSeek news. And then, of course, that sell-off accelerated in April before fully recovering since then. So, it hasn't been a straight line. But we're about at the same place we were a year ago.
That being said, that does hide some of the dispersion across those seven names for sure. Despite its weakness this year, Tesla is up around 60% or so since this time last year, and Meta is up close to 50%. On the other hand, you have Apple and Alphabet that are effectively flat over the last 12 months. So, they're certainly not moving in lockstep like they may have to some degree the previous two years. And there are dispersion across valuation across the names. We don't necessarily think they're all overpriced. Meta and Alphabet still seem reasonably priced, even attractive, while Tesla and Apple look quite a bit expensive to us.
VanDerSchie: Ricky, we're also seeing that artificial intelligence spending has been a huge catalyst for stocks. Can you maybe help provide broader context around that? It seems like the optimism is obvious but maybe help us think through the associated risks.
Williamson: Yeah, absolutely. And this is the topic we're actually spending some time on right now. So, more to come in terms of perhaps a more robust conclusion. But obviously, we all know that artificial intelligence has the potential to be this transformative technology. And it's already reshaping several different aspects of both our personal and professional lives. And that has led to this sort of arms race across technology companies trying to become the leader in the space and not get left behind. And in some respects, in our view, it can resemble a prisoner's dilemma where companies are potentially spending in excess because they just want to keep up with their competitors or outpace their competitors. Whereas if those peers did not exist or if they all decided to just come together and agree on something, they perhaps wouldn't spend as much. And so, the CapEx perhaps would be more efficient.
So, there are potential risks to inefficient capital allocation that could rear its ugly head if the expected benefit of being a leader in the space does not necessarily come to fruition in terms of sort of the benefits to each of these companies' earnings growth. So that's a risk we're digging into right now. And I think it's worth calling out that it may have ramification across companies that people don't necessarily think of as related to the AI space. So, if you think about the utility sector, for example, that sector has been on the tear because it's been the beneficiary of this CapEx spending spree. If you think about sort of the building out of data centers, for example.
So again, not only is this question of who will be the winners or losers in the space, but also the risk that the benefits of being a leader in the space aren't quite as rosy as what the expectations are. And that could of course lead to disappointing returns on equity and therefore impacts to share prices. So again, it's something we're looking at, no hard conclusion at this point, but we certainly think it's a risk to monitor.
VanDerSchie: I also want to get your take on international stocks, which have outperformed US stocks in the first half of the year by one of the widest margins in a long time. And so, maybe just unpack that a little for us, Ricky.
Williamson: Yeah. I mean, I think obviously we enter this year with a long period where the opposite was the case. On a broad market basis, US equities have been outperforming non-US equities for quite a while. And while fundamentals have certainly driven some of that, if you think about earnings growth, payouts, both dividend yield and stock buybacks, that's certainly been driving some of that. But most of that divergence has really been driven by valuations going in the opposite direction. So, US equities getting a bit expensive for non-US equities have not. So, we entered this year with US equities, again, on a market cap basis, not necessarily across the board, but on a market cap basis, US equities were pretty expensive in terms of their valuations. And many non-US markets looked a bit cheap. And that was, of course, buoyed by this idea of American exceptionalism. And that sentiment was put a bit on supercharge in the immediate aftermath of Trump's victory in November with, of course, the themes around de-regulation and lower taxes, et cetera. And then, of course, the economy had continued to show strength coming into this year.
But as we touched on earlier, whether that'd be some deceleration in the economic data or fear around the policies coming out of The White House, again, particularly the impacts of tariffs on the US economy, there's no doubt that uncertainty around US markets rose in the first half of the year. So, investors definitely looked elsewhere for opportunities. And that certainly benefited non-US markets. And as I mentioned, a lot of non-US markets looked like decent valuation opportunities.
And then, of course, there are also some fundamental tailwinds in some of these markets to be clear. I mean, Germany rolled out a fiscal stimulus plan that many people never thought they would see. Chinese markets have also benefited from government stimulus and an economic reality that may not have been as bad as some feared. And then going back to something Al mentioned, non-US markets also got this extra tailwind of a weaker US dollar. So, for a US investor that was investing in non-US markets, you got a decent extra amount of return by just owning non-US currencies as the dollar weakened.
VanDerSchie: You know, Ricky, it feels like price moves often change sentiment, yet sentiment around international stocks has been in the gutter for years. Do you think that's finally turning and is that even something that you track?
Williamson: Yeah, I think that's right. I mean, it's always tough to generalize about all international stocks. But certainly, sentiment has turned in places like China, for example, though that had started really in the back half of last year. Sentiment in Europe had been terrible for a while, and we saw that pick up earlier this year. European financials are one of the star asset classes in 2025, for example. Latin America had terrible pessimism last year. But then coming into this year and that certainly turned.
And then of course, some of this is going to be driven by the more negative sentiment around US markets that we discussed. Al touched on how the perception of US assets to foreign investors may have shifted given the degree of policy uncertainty we are seeing this year. But yes, it's something we track. We are contrarian investors in our hearts. So, we look at investment flows and survey data and other sources and they help inform our conviction in different asset classes. If we view a market as cheap, and then that's sort of confirmed by the data suggesting there's negative sentiment around it, then we do have some extra confidence that when that sentiment turns, there is the potential for some outsized returns.
VanDerSchie: All right. So, it wouldn't be a mid-year outlook, guys, without a little prediction talk. And before both of you roll your eyes at me, I know you hate price targets. Let's tee it up. In April, strategists across Wall Street were slashing targets and then the snapback rally hit and suddenly those targets moved right back up. Ricky, you and your team didn't have to change any price targets because Morningstar doesn't play that game to begin with. But maybe just tell our listeners why.
Williamson: Yeah. And I think that sort of gets to the heart of what being a long-term valuation-driven investor is all about. I mean, if uncertainty rises or economic forecast turn negative, sentiment obviously turns and the market tends to panic a bit in sell-off and then price targets from analysts can change, they can drop. As for long-term valuation-driven investors, on the other hand, what we want to do is sort of avoid that behavioral tendency and instead, when that type of environment comes to fruition, we go out and start seeking out what opportunities may be out there when volatility is elevated. And I think there's several reasons why we believe that approach and have that approach and why we think it's best for our clients.
And I think first is that short-term macroeconomic forecasts are often wrong. It's a really hard thing to do. I can't count the number of times that recession forecasts have been wrong over just the last three years. I still always go back to that Bloomberg headline in October of 2022, I think, that stated that 100% of their economists predicted a recession in the following 12 months. And obviously that didn't happen. And I'm not criticizing economists or their forecasts. It's just nearly an impossible job. But that's why we aren't going to panic just because we're being told that recession probabilities are increasing and we're not going to make investment decisions based on those forecasts.
Second, I think it's worth noting, and Al mentioned this as well, that economy and markets are different things. Markets are forward-looking discounting mechanisms. So that means that stock market prices almost always bottom out before the economy or before company earnings bottom out as well. So, you want to be buying assets when prices are troughing, ideally, not when the economy is. If you look back at GFC or in 2020 in the COVID period, if you had waited until the economic data started to recover, you would have missed out on massive recoveries in stock markets. And so, we don't want to be put in that position.
I think that's really the benefit of having a long-term approach. We're not trying to beat the market over the next three months or the next six months. If that was the case, then yeah, maybe you'd want to de-risk when economic uncertainty arises. But if you're able to look through the economic cycle, then you can start buying assets when the economy is on a shakier ground and the stock market is declining because we think we will benefit from doing that over the long term.
VanDerSchie: Okay. So, with that as the background, I guess rather than a prediction, what's a non-consensus outcome that investors should be prepared for in the second half of the year? Maybe if each of you guys could give us one, that'd be great. Al, I'll start with you.
Bruno: Yeah, sure. I think non-consensus view, maybe my risk is more non-consensus, but probably not what others might think of as conventional wisdom. But it's basically a bad steepener for the US Treasury curve. And what that means is really long rates, think the 10-plus year tenures, 10, 20 and 30-year tenures, moving higher while short-term rates move lower. So, kind of imagine a scenario in which long-term Treasury yields are moving higher because of swelling fiscal deficits, maybe heavy issuance and just a lack of foreign demand, even as the Fed is cutting rates or is signaling that they're going to cut rates at the front end. So, what happens is, duration kind of becomes your enemy just when everyone kind of crowds into long bonds to lock in those yields before policy starts to ease. So, I think that combination is going to deliver negative total returns in longer-term maturities, again, like 10 years and out, even in a cutting year. So, I don't think many have anticipated that or might think of that as kind of the natural state of things during a cutting cycle. But what we have seen at least year-to-date and even a little bit beyond that is the long end is moving a little bit irrational relative to history. So, I think we have to be a little bit cognizant of owning duration and owning longer-term Treasury yields and using the thought of, well, the Fed is going to be starting to cut rates, and we should see all of the Treasury curve coming down as a result.
VanDerSchie: Ricky, what about you?
Williamson: Yeah, I think back to when Philip Straehl, our CIO, and I were on this podcast in December, I think for discussing our approach to portfolios entering this year. And the point we emphasized then was that, well, everyone was so optimistic about the US economy and US markets, we were trying to get a bit defensive. And that generally worked through the first half of April. But then we were adding to riskier assets in April as the market was selling off. But now, given that V-shaped market recovery we've seen, it sort of feels like we're back to that state of euphoria, right? And so, while we had made our portfolios a bit riskier in April, what we're trying to do now is look to get a bit more defensive stance. So given the potential complacency in the market from a high level, I would say that's our main non-consensus view. It's just, maybe it's now time to play defense again when everyone is so optimistic.
VanDerSchie: All right. The last thing I want to hit on today is the portfolio realities. What's priced in now and where there might still be pockets of opportunity? Let's start with stocks. And by most statistical measures, US equities are expensive. Ricky, just because the broad index is pricey doesn't mean there aren't those pockets of opportunity. What is your take here?
Williamson: Yeah, that's exactly right. I mean, I always get a bit uncomfortable when we frame any of these conversations as US versus international or say that the US market is expensive, because that's definitely a bit of an oversimplification. It's just that on a market cap basis it does look expensive because some of those high-flying tech names are expensive, and they make up an outsized portion of the market. But in reality, we think you can have a portfolio of US stocks that looks quite attractive. I mean, I think there's several segments of the US market that offer compelling rewards for risk in our view. I won't go into a ton of details on each of them, but in each instance they have been left behind, market sentiment has turned a bit negative and that has led to valuations that we deem attractive. The small cap space is definitely one of them. The area has had its headwinds and has been somewhat left behind given the performance of US large caps. Healthcare is another area. There's been a lot of pessimism driven by RFK, Jr.'s leadership at the Department of Health and Human Services, as well as other potential policies coming from The White House. I think a lot of negativity has been priced in and I think, in our view, the outlook for the sector is not as bad as what the market seems to think.
And lastly, I'd say REITs is an area of the US market that looks interesting to us from higher interest rates to economic uncertainty to doubts around the future of commercial real estate, sentiment around the sector has been quite poor. But we think that's created a bit of an opportunity for long-term investors. And in each of these instances, whether it'd be small caps or healthcare REITs, we are seeing value from a top-down basis, but those views have also been confirmed by our colleagues in Morningstar Equity Research from a bottom-up company-specific basis. And so, we do think the market is mispricing these assets right now.
And that's from a sector or market cap lens. But I'd also note that we don't think that all of the mega-cap names are overvalued. The large cap names in the communication services sector, for example, Meta and Alphabet, we actually think those are pretty reasonably priced. So, we do have some overweight positioning there as well.
VanDerSchie: Ricky, I would like to double-click on small caps for just a minute. Our friends at PitchBook do a great job providing data on this. And even Joanna McGinley mentioned this on the podcast a few episodes ago. But it's clear, companies seem to be staying private longer. And so, when they do go public, they're often bigger. And a lot of times that skips the small cap lifecycle. Help us square that. Should investors have different expectations for small caps than they used to?
Williamson: Yeah, I think it's a really good question. I mean, I think, first I'll just say that I don't think investors should ever have a static view of any asset class. Asset classes will behave different in different interest rate regimes or macroeconomic environments. But I think most importantly to us, the future prospects of an asset class will be impacted by the starting valuations. But to get to the heart of the question, yes, certainly some companies are staying private. They're in a different era, would be public companies and it does have an impact to some extent on the opportunity set.
But we're never going to base our expectations for small caps or any other pocket of the market on what used to exist. We form our views based on the companies that are currently there. And I think small caps is a good place to highlight how we can shape our views on an opportunity and what differentiates what we do at Morningstar Wealth relative to what might take place elsewhere. The advantage of being at Morningstar is that we can leverage resources that allow us to look at an opportunity like US small caps through multiple lenses.
First, we can look at it from a top-down basis. By any metric out there, we think small caps look cheap relative to large caps on a top-down basis. While large caps have benefited from valuation expansion, small caps have been left behind and the price you pay for the potential cash flow you can earn looks really attractive. And we're looking at the fundamentals and valuations of the small cap space based on the companies actually in these public market benchmarks, not based on the characteristics of the market 5, 10 or 20 years ago.
And then we can supplement that top-down view with the bottom-up work done by Morningstar equity analysts. So obviously, this view that they have is going to be based on public companies in the small caps space and they're finding a lot of attractively-priced names in the area.
And then finally, being Morningstar, we have really strong relationships with many third-party small cap managers, and we've asked them this question multiple times, and they've repeatedly said that they're finding many opportunities in public small cap companies.
And so, we can sort of triangulate these three different perspectives that are all based on the actual public companies, and they're all pointing to the same view that this space looks attractive regardless of whether or not the composition of the public small cap market is different than if companies were saying private or not.
VanDerSchie: All right. So, let's pivot to bonds. Rick Rieder at BlackRock recently mentioned this quote, which was, "some fixed income sectors are delivering equity-like returns with lower risk." Al, what's your take on that?
Bruno: Yeah, I follow Rick a lot. He's a fantastic investor. Certainly, he is someone that I look up to. And to be fair, I think that's generally true. But I think it also depends on your time horizon really and how you define equity-like. I think if you look at long-term average returns of global equities, it's probably around 8% on a nominal basis with volatility in the 15% range. High yield is yielding around 7.5% right now. Emerging market debt is roughly the same and both asset classes have historically just shown volatility that is half that of equities in the 7% to 8% range, sometimes even lower. So, definitely lower risk than equities.
The other thing is, I think the time horizon question is the most important, right? So, take high yield as I mentioned, which is yielding 7.5%. It might not produce the 7.5% return over the next 12 months like equities can, but what we do know is that the current yield is really a good predictor of forward five-year returns for the asset class. The R squared is something like above 90%. So, in other words, high-yield and even emerging market debt have a very good chance of providing investors with 7% to 8% returns on an annualized basis over a five-year period from here with half the volatility of that of equities. So, generally agree with that statement and you can certainly do so today.
VanDerSchie: All right, for both of you, what is the best and worst values in the bond market right now? Maybe Ricky I'll start with you and give us the best.
Williamson: Yeah, and this might be the most boring answer of this question. But I think the best value in bond markets right now is in US Treasuries. And you can also throw in government bonds outside of the US as well. It's been a really long time since US Treasuries were out yielding inflation to this extent. Some investors are able to grow their purchasing power. And at the end of the day, we aren't just investing to beat a benchmark. Each of us, each of our clients, we invest to reach financial goals, and Treasury should be a key tool in multi-asset investors' portfolios if you're trying to meet those financial objectives right now.
VanDerSchie: All right, Al, give us the worst.
Bruno: Yeah, I know I just talked it up a little bit in the last segment, but it has to be high-yield for me right now with spreads at 280 basis points and grinding tighter every single day. And the value has just been eroded since Liberation Day when spreads approached 500 basis points. So, I think high-yield should be a part of a broadly diversified fixed income allocation, but definitely at the lower end or even at the minimum of your potential range right now.
VanDerSchie: All right, guys, we've covered a lot. We started with the big picture. We talked about some practical ideas and even threw you some potential curve balls along the way. One last thing, if there's just one takeaway you want our listeners to remember as they look ahead to the rest of 2025, what is that? Al, we'll start with you.
Bruno: Sure. I think it's a good question and I kind of discussed it earlier on, but I think it's really important to refrain from investing in fixed income for the inevitable rate cut but rather invest for the income stream and your liquidity needs right now. Policy timing is certainly going to remain murky for the foreseeable future and potentially even more. And it's harder to guess what the reaction function of the market is going to be to any new policy announcements as well. So, what you can control right now is locking in some resilient cash flows across high-quality building blocks in fixed income. I think short to intermediate-term treasuries, as Ricky just mentioned, some agency mortgages and even short-duration investment-grade corporates that are yielding 5.5%. So, I think ultimately, this is just going to allow you to keep flexibility of adding risk when volatility gifts you better spreads in lower-quality segments of the market. And as Ricky mentioned, as valuation-driven investors, that's kind of the name of the game for us.
VanDerSchie: Ricky?
Williamson: Yeah, I think maybe I'll just build a bit on what Al said briefly. I think it's very likely given uncertainty around macroeconomic fundamentals, monetary policy, and then of course, policy coming out of The White House. It's quite likely that volatility is going to be elevated in the coming months. Fortunately, given the recent rally and market divergence, there are many defensive-natured assets that look appealing. And so, we think we can achieve reasonable levels of return without taking on excess risk right now. But I think to Al's point, this environment also requires being nimble because with volatility comes new opportunities and without active asset allocation, investors may miss those opportunities. So that's certainly where we're going to be spending our time.
VanDerSchie: And there you have it, another episode of Simple But Not Easy. As always, thank our guests for their time and engagement. And once again, if you'd like to know more about how Morningstar can support you, please drop us a note at simple@morningstar.com or me directly at Nicholas.VanDerSchie@Morningstar.com. That wraps up this week's episode. Before we depart, if you enjoy hearing the insights on our podcast, please consider leaving us a 5-Star review on Apple Podcasts or Spotify. Until next time, thanks for listening.
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