As the second quarter of 2025 drew to a close, markets remained cautious amid a persistent mix of optimism, speculation, and geopolitical tension. Equities continued to show resilience despite a patchwork of conflicting economic indicators. And though inflation has gradually shrunk to around 2.4%, a figure nearing the Federal Reserve’s target, the Fed has notably refrained from making policy adjustments. Their silence speaks volumes as current data is both noisy and conflicting, and any premature action could have unintended consequences.
Meanwhile, the S&P 500 demonstrated wild volatility with a strong close which began with a double-digit drawdown but finished with a near 10 percent total return by the end of June. However, investor sentiment remains mixed, with concerns over stagflation, geopolitical risk, and the unknown impact of AI on labor and productivity.
Federal Reserve Taking Wait-and-See Approach
One of the most striking aspects of the quarter was the Fed’s inaction despite inflation readings that appear to be near target. Several members of our investment committee pointed to unique, “one-time” anomalies in both GDP and inflation readings. For example, companies front-loaded inventories ahead of tariff announcements. Such actions artificially dragged GDP into negative territory while suppressing inflation through excess supply and potential discounting.
The Fed’s inaction, while frustrating for some market participants, reflects prudent caution. Chair Jerome Powell appears deeply committed to preserving the Fed’s independence, especially amidst political pressures. With political rhetoric heating up and inflation trends hard to pin down, the Fed is opting to wait for more clarity before shifting policy in either direction.
Stagflation Concerns are Real but Not Probable
With inflation showing persistence and growth data offering little enthusiasm, the specter of stagflation — a stagnant economy paired with rising prices — has re-entered the conversation. Historically associated with the 1970s, stagflation requires both supply shocks and an expansionary monetary policy. While geopolitical developments (such as rising tariffs and Middle East tensions) could mimic supply shocks, today’s higher interest rate environment acts as a counterbalance.
Our view is that while concerns about stagflation are legitimate, it remains a tail risk. More likely scenarios involve either softening inflation amid slowing growth or continued economic resilience with some price pressures. The Fed’s cautioned approach suggests they, too, are unconvinced that stagflation is imminent.
Geopolitical Risk: Energy and the Middle East
Tensions in the Middle East intensified this quarter as Israel’s longstanding conflict with Iran was enhanced by U.S. military involvement towards the end of June. These actions made the implications for global oil supply a focal point in our end-of-quarter discussions. Iran’s oil output, while significant, would only marginally increase global oil prices if disrupted directly. However, the broader concern lies in the “risk premium” — currently estimated to add up to $12 per barrel due to fears around disruptions in shipping lanes, primarily the Strait of Hormuz.
A significant disruption, particularly to this key waterway, could push oil prices to around $110 per barrel, reversing their recent role as a drag on inflation and rekindling some consumer price pressures. Yet despite rising tensions, oil prices actually declined late in the quarter, reflecting markets’ confidence in a contained conflict and/or short-term overstocking.
Artificial Intelligence: The Boom Before the Benefit
AI remains the dominant investment theme in global markets. Major tech companies continue to pour billions of dollars into infrastructure, from data centers to specialized computer processing chipsets. However, questions persist about when (or if) this investment will yield measurable bottom-line results.
Our team views AI as one of the most transformative innovations of our lifetimes. Yet its deflationary effects — through increased automation, efficiency, and potential job displacement — may be years away. For now, AI is inflationary, driven by capital expenditure, energy consumption, and speculative enthusiasm.
Microsoft recently disclosed that as much as 30% of its codebase is now generated by AI, signaling significant long-term implications for labor productivity. Yet, from a valuation and trading perspective, AI’s contribution is still largely speculative.
Interestingly, AI has also reshaped trading patterns. A notable trend is the increased concentration of trading volume in the final minutes of the day, possibly driven by algorithmic or index-based strategies. This behavioral shift affects daily liquidity and could contribute to unexpected spikes in volatility.
Labor and Unemployment are Stable — For Now
Despite other concerns, labor markets remained strong through the second quarter. The unemployment rate was stable at around 4.2 percent over the quarter, slightly higher than last year but still historically low. Immigration and automation (AI) are two key variables to monitor going forward. While AI has not yet meaningfully displaced workers on a large scale, its maturation will pose structural challenges to traditional employment sectors.
Psychological Risk and Investor Behavior
As economic narratives grow more complex, another emerging risk is psychological. The sheer number of variables, including AI, politics, inflation, energy, labor, and tariffs, can cause even the most seasoned investor to take a deep breath. Emotional decision-making, driven by news cycles or political sentiment, could lead to suboptimal portfolio moves.
Our approach at Richard P. Slaughter Associates remains grounded in maintaining a long-term focus, promoting diversification, and advising clients against making impulsive decisions. History has repeatedly shown that attempting to time the markets, especially during periods of extreme volatility, is a recipe for disappointment.
Looking Ahead: Cautious Optimism with Targeted Adjustments
Heading into the second half of the year, our outlook remains one of measured confidence. While we don’t see compelling reasons to make significant portfolio reallocations, we are paying close attention to emerging opportunities, including:
- Infrastructure, particularly related to AI and energy demand
- Utilities, which are evolving from defensive to growth-oriented in specific AI-adjacent sectors
- Alternative investments to diversify away from potentially overvalued public equity sectors
- Active management, primarily through institutional partners who can take advantage of market microstructures
We continue to emphasize balance, informed analysis, and adaptability. As the landscape evolves, we remain committed to guiding our clients toward their long-term definition of financial success.