In our 2Q 2025 commentary we delve into the key drivers behind market performance, focusing on six key questions:
1. What are earnings growth estimates for small, mid, and large cap stocks?
Small cap earnings remain under pressure—down nearly 4% in Q1 2025—while large caps, especially the so-called Magnificent 7, continue to drive overall market growth, though we expect small cap earnings to rebound later in 2025 and into 2026.
2. Where are valuations for small, mid, and large cap stocks compared to pre-tariff levels?
Compared to the tariff-driven market lows, valuations across small, mid, and large cap stocks have rebounded and now sit above historical averages, even when excluding the Magnificent 7. While investor optimism around potential rate cuts may be helping to sustain these elevated levels, the Federal Reserve has maintained that the economy is strong enough not to warrant cuts—meaning any shift in that stance could signal economic weakness and weigh on equity valuations.
3. Would lower interest rates help to bolster the performance of small cap stocks?
Lower interest rates alone are unlikely to drive a sustained rebound in small cap performance, as recent weakness has been primarily tied to softer earnings.
4. There seems to be little sign of tariffs in data thus far. Will we actually see a tariff impact in economic data? If so, when?
While tariffs haven’t yet shown a clear impact in hard economic data, we expect their effects—particularly on demand, margins, and inflation—to become more visible as companies begin reporting second quarter earnings later this month.
5. Are defensive sectors gaining traction amid macro-level uncertainty?
Defensive sectors have steadily declined as a share of the overall market over the past 30 years, reflecting investors’ preference for growth over earnings stability—leaving markets more vulnerable to sharp pullbacks when optimism is challenged.
6. Are companies still holding off on capital spending in light of general uncertainty?
Capital spending trends are mixed: while investment in AI infrastructure remains strong, many non-tech companies—particularly those exposed to goods and services—are holding back due to tariff-related uncertainty and cost concerns, as highlighted in recent CFO surveys.
