July 2025

The Market Thinks the Risks Are Manageable – For Now.

The second quarter of 2025 was dominated by three topics – tariffs, the “Big Beautiful Bill” and conflict in the Middle East.  Remarkably, despite dramatic volatility in April when the tariffs were first announced, markets rebounded quickly, absorbing the ongoing uncertainties associated with each issue and finishing the quarter with the S&P500 recording an all-time closing high of 6,205 on June 30th, up 6.2% for the year including dividends.  The Nasdaq 100 similarly closed at a record 20,370, up 5.85% for the year.  The ten-year Treasury finished the quarter at 4.2%, as inflation statistics continue to ease, but the Federal Reserve has held off on any rate cuts because it fears the potential for tariffs to push inflation higher.

At Spinnaker Trust, we have maintained full equity allocations throughout the year.  We did this despite specifically calling out the risks of potential erratic behavior by President Trump, the need to pass a budget bill in the face of massive fiscal deficits and the ongoing risks associated with conflicts in the Middle East and Ukraine.  In April, we wrote, “Trump is unpredictable, and it is not reasonably possible to predict how he will react to the tidal waves he has unleashed.  But US companies, particularly the large cap US companies in the S&P500, enjoy fortress balance sheets, durable competitive moats and generally competent managements.  They will adjust and adapt and very likely emerge stronger.”  At least as of the end of June, this thesis has held, and our clients have benefitted from a strong turnaround in markets.  Many risks remain, and we will review below each of the major risks that we are watching.  For now, the market has concluded that these risks are manageable.  We do not necessarily disagree, but we note that each has the potential to spin out of control at any time.

The Trump Administration’s shifting tariff policies reflect both the deeply held conviction of the President that tariffs are an effective tool for various purposes and a contest within the White House between Counselor to the President Peter Navarro and Treasury Secretary Scott Bessent.  Navarro genuinely believes that tariffs can be used to dramatically reset the terms of trade around the world and return millions of manufacturing jobs to America (see the trade section of Project 2025 authored by Navarro).  Bessent is an experienced pragmatist who must sell $9 trillion of US Treasury securities in the next year.  We understand that Navarro was able to secure a one-on-one meeting with President Trump just prior to the April 2 Liberation Day tariff announcements, and Bessent and Commerce Secretary Howard Lutnick were unable to get a meeting with Trump prior to the announcement. So, the April 2^nd announcement of reciprocal tariffs can be seen as the announcement of Navarro’s recommended trade policies.

The Liberation Day announcement roiled markets, and, by the following weekend, weakness appeared in the US Treasury market.  This provided Bessent with the ammunition needed to argue that a more strategic, targeted and limited tariff approach was required.  So, on April 9^th, Trump announced a 90-day pause on reciprocal tariffs on all countries except China. Markets soared and then plummeted in the ensuing days, as market participants tried to make sense of the administration’s actions.  But by April 21^st, markets began to discern that a more pragmatic tone was being adopted by the administration as they attempted to negotiate new trade deals with the UK and India, among others. Bessent became the primary spokesperson, and Navarro receded.  On Monday, May 12^th, the US and China announced a pause in their reciprocal tariffs, leaving in place a 30% tariff on Chinese goods and a 10% tariff on US goods.

From a closing high of 6,144 on February 19^th, the S&P500 hit a closing low of 4,983 on April 8^th (down 18.9%) and then another interim low of 5,158 on April 21^st before soaring to the May 13^th close of 5,886.55 – up 18.1% from the April 8^th low and just above the December 31, 2024 level of 5,869.  Markets clearly decided that the Bessent approach to tariffs was likely to control, and that there would be a gradual move toward a 10% tariff regime generally with greater tariffs applied to strategic products (steel, semiconductors, etc.) and to China specifically.  While that is a reasonable base case and has remained the market consensus since mid-May, we note that Trump remains erratic (see Trump’s recent announcements concerning both Canada and Japan), and Peter Navarro remains influential and will undoubtedly argue for more aggressive policies.  There may be additional lurches that will roil markets, but we have certainly seen that Trump does respond to dramatic market uncertainty and is capable of changing direction. 

The Big Beautiful Bill remains a work in progress as of this writing. The House of Representatives passed a version of the bill on May 20^th, and the Senate Finance Committee released a modified version of the bill on June 16^th.   The full Senate passed a slightly modified version on July 1^st.   All the versions under consideration incorporate extending many of the provisions of the Tax Cuts and Jobs Act of 2017, accelerate depreciation expense for businesses, sunset a number of subsidies related to green energy, tighten eligibility criteria for Medicaid, increase the state and local tax deduction, and implement several promises made by Trump in his campaign.  In all cases, the changes add roughly $3 trillion over a ten-year horizon to annual US budget deficits when measured against current law, which contemplates the expiry on 12/31/25 of many of the provisions of the Tax Cuts and Jobs Act of 2017.  If the bill passes, deficits are expected to run around 7% of GDP, an unprecedented level during peacetime.  The consequences for Republicans of failing to pass the legislation would be catastrophic politically, and so markets appear to be assuming that a variation of the bill will pass.  We agree with that assessment, although we will not be surprised if various legislators attempt to hold the bill hostage in hopes of improving provisions particularly important to their constituents.  So, as we observed in tariffs, the risks appear manageable at this moment, but there is no question that the potential remains for the situation to spin out of control.

Finally, President Trump ordered the bombing of three Iranian nuclear complexes on June 21^st.  While the extent of the damage remains a subject of debate, Iranian leaders agreed to a ceasefire with Israel on June 24^th.  While the short-term consequences of the bombing appear positive, we must acknowledge that US initiatives in the Middle East have rarely led to the expected outcomes over the longer term.  The bombing reflects a fundamental shift.  Whereas nuclear non-proliferation efforts have always been implemented through diplomacy and incentives, we have now moved to preventing nuclear proliferation through force.  Whether that leads to regime change in Iran or simply radicalizes another generation who will pursue nuclear ambitions secretly, only time will tell.  But nuclear weapons have long represented one of the greatest risks to humankind, and we will not know for some time whether the bombing of Iran’s facilities decreased or potentially increased that risk.  Markets have taken all of this in stride.

For clients of Spinnaker Trust, the first half of the year has been successful, although not as rewarding as 2024 or 2023.  Clients invested in our core ETF strategies with a 70/30 equity-fixed income weighting and using our recommended Alternatives allocation have earned a return of over 6% in the first half, roughly 150 basis points better than a 70/30 portfolio of the S&P500 and the Bloomberg Aggregate Bond Index.  However, we did not get everything right.  In our 2024 year-end newsletter, we highlighted that US equities were expensive and that today’s small-cap indices were not as attractive as in the past.  We moved our small cap allocation toward a higher quality index, but it has still hurt overall performance as small caps have substantially underperformed.  We have reduced the small-cap allocation in the past two weeks.  Weakness in the US Dollar and lower relative price earnings multiples have helped propel international stocks to dramatically higher returns in the first half.  We maintained a meaningful allocation to international equities, but we are underweight relative to a market weighting given our long-term preference for the entrepreneurial vigor of the US economy.  However, within our Alternatives allocation, positions in gold and uranium producers have produced gains of 20%, boosting portfolios. 

As we look ahead, we remain fully allocated to equities but are aware of greater-than-usual risks in each of the areas discussed above.  The other major risk remains the fiscal situation of the United States and the willingness of investors to continue to finance our debts at modest interest rates.  Fortunately, we remain the best house on a not particularly good block.  No other country offers the scale, stability of governance, rule of law and economic and military strength of the United States.  The risk of a financial crisis will only continue to grow as we pile up large deficits and add to our overall debt.  We do not see this crisis coming quickly, and there is no question that the United States has the ability to rectify its fiscal situation, but our political system seems unable to address the issue without a crisis.  At that time, we will need thoughtful and decisive leadership.