The first half of the year has left investors with many questions about the path ahead for the economy and markets. Unfortunately, there haven’t been many concrete answers. Tariff announcements and trade negotiations have commanded the room. Then there is the budget bill, which includes tax and spending cuts. It’s also being negotiated at a time when concerns about the country’s deficit have grown, given Moody’s downgrade of the U.S. government’s credit rating. Last but certainly not least, the Fed has yet to lower rates this year.

Turning to the markets, we saw equity markets rally to start the year—and then sell off 20 percent, led by the leaders of the past several years (i.e., the Magnificent Seven). Just when concerns reached their peak, the markets rallied more than 20 percent. While also volatile, 10-year Treasury yields began the year at 4.5 percent but remain in about the same place now.

Given this backdrop, the key question remains: where will the economy and markets go from here?

The Economy: Can It Power Through?

The answer to where markets may go depends on the path of the economy. And that path hinges on whether the weak, survey-based economic data eventually impacts the hard, measurable economic data or whether the economy can continue to power through various obstacles.

Growth Drivers

Assessing the potential positives for the economy, there are three areas to consider.

Labor market. The labor market is the most important piece of economic data. Consumers make up roughly 70 percent of the economy. If they continue to have jobs, they are likely to spend money. While job growth has softened this year (see chart below), it remains in positive territory despite the headwinds from federal government employee layoffs and immigration policy.

Trade deals. To feel comfortable making spending decisions, consumers and business executives need to see progress on trade deals that permanently lower or eliminate implemented tariffs. While the worst-case scenario for tariffs has been mitigated, they remain at a level (15 percent to 20 percent) that is higher than we have seen in almost 100 years.

Budget bill. Progress on the budget reconciliation bill will be important for the economic outlook in the second half. In the version of the bill passed by the House of Representatives, the stimulative measures for the economy would unroll before drags from spending cuts occurred in the out years. Indeed, this stimulus will be needed to help offset the impact of tariffs currently being felt.

The Risks

Tariffs. The concern for economic growth in the back half of the year is that the on-again, off-again tariff implementation has already set in motion a series of events that will pressure the economy. The belief is that this impact has not yet been captured in the backward-looking hard data that has been reported so far.

Consumer and executive sentiment. Here, we’re seeing weakening due to concerns about tariffs. Consumers might dial back their spending and increase savings due to higher prices and worries about job security. Executives might delay making long-term decisions about capital projects and hiring without clarity on global trade. These pauses, if they occur, would likely cause the economy to weaken in the second half of the year.

Rates and spending. The impacts of tariffs and global supply chains, the budget bill’s effect on the deficit, and the Fed remaining on hold have all caused concerns for U.S. Treasury bond investors. Higher rates affect borrowing costs for consumers and could further weigh on spending.

The Markets: More Volatility Ahead?

After plummeting post-Liberation Day, U.S. equity markets have climbed higher on hopes that pauses on tariffs will lead to trade deals, making any economic impact short-lived. At the same time, the investment landscape has broadened this year, with international equities outperforming by a wide margin.

Fixed income has also had a rollercoaster of a first half. But for all the concerns and headlines, the yield on the U.S. 10-Year Treasury bond has stayed around 4.5 percent (plus or minus) for most of the year.

Valuations. On the surface, the S&P 500 is not cheap, but this is masked by the concentration of the biggest holdings. After two years where those stocks led the market higher because they had the best growth stories, this has been a year where the rest of the market has come into focus. The disparity in valuations between those two groups can be seen here:

That disparity in valuations for different parts of the market should lead to continued investor interest in a broadened portfolio across asset classes, geographies, styles, and sectors.

Earnings. For investors to have confidence in valuations, they must believe that corporate America can continue to generate earnings growth. Executives have certainly noticed economic headlines: expected annual earnings growth for the S&P 500 has declined from 15 percent in the fourth quarter of 2024 to 9 percent currently. That said, given all the headwinds, if that level of earnings growth can be achieved with a better outlook going into 2026, it should provide a reasonably positive backdrop for investors.

Interest rates. While the Fed seems content to wait and see how the noise will impact the economic signals, bond investors haven’t hesitated to express their views. Those views have been wide, as bond yields plummeted on concerns about a global recession and then rose on beliefs that the “bond vigilantes” were returning to express their frustrations about the current path of fiscal policy.

At times like these, it is important to step back and look at rates through a longer-term lens. This chart shows that current rates are in a range they have been in over the past two years.

Rates at current levels create opportunities for savers and retirees looking for income. But concerns about the impact of tariffs on inflation and the deficit suggest that diversification across durations is a good strategy for the fixed income portion of a portfolio.

Look to the Data for Answers

Headlines are likely to continue to drive short-term movements in both the equity and fixed income markets over the balance of the year. But it is the economic data that will tell us the ultimate story of how the year will unfold.

There is no doubt that trade policy has tested the resiliency of the U.S. economy so far this year. Still, the economy has shown strength. Excluding the impact of net exports on Q1’s slightly negative GDP report, the underlying economy continued to grow. The momentum that the U.S. economy had coming into the year has persevered throughout the headwinds.

Barring further unforeseen shocks, we anticipate that the U.S. economy will continue to grow slowly in the back half of the year, which should support earnings growth. Volatility is likely to continue, but the April equity market lows priced in a fair amount of bad news on trade, economic growth, and earnings.

Diversification has been the key to weathering the headlines to date, and we continue to believe that is the best way to position portfolios as we enter the second half of the year.

What’s ahead for equities? Find out in tomorrow’s Midyear Outlook post from Rob Swanke, senior investment research analyst.