One of Wall Street’s oldest aphorisms is that “markets like to climb a wall of worry.” Certainly that appears to be true as we begin to push deeper into the second half of 2025. The S&P 500®, a widely used proxy for U.S. equities, has reversed course from a weak first quarter and sharp April pullback to reach to new all-time highs this summer. Nevertheless, the path ahead is anything but certain, and this has potential ramifications for how investors choose to position portfolios.

Tariffs, Inflation and Interest Rates

By and large, investors have recently brushed off uncertainties, of which tariffs top the list. The narrative regarding tariffs is constantly shifting, though reports of new trade deals negotiated with our trading partners appear to have helped assuage worst-case scenario fears for investors. Nevertheless, we believe headwinds from on-again-off-again tariff uncertainty have yet to work through the economic data—this story is not over.

The potential impact of tariff uncertainty is not exclusive to economic growth. Investors continue to watch inflation closely. A previous downward trend in inflation has effectively stalled, with both headline and core measures of the Consumer Price Index rising in June, according to the Bureau of Labor Statistics. While the overall pace of inflation is only slightly elevated at this point, the potential impacts of tariffs and other new policies are likely not fully evident yet in data. While uncertainty around tariffs has driven some apparent pull-forward of imports and stockpiling of inventory that temporarily clouds impacts to the economy, we are beginning to see more actual tariffs take effect. How the associated costs of tariffs get passed on to customers, are absorbed by companies, or affect corporate investment and consumer behavior is likely to influence economic growth, corporate earnings, and inflation data more clearly in the coming quarters.

Given ongoing economic and policy uncertainties, the path of interest rates is also somewhat murky. The yield curve has steepened, and we see two potential paths for this to continue. Longer-term rates could rise if inflationary pressures or inflation expectations increase due to tariffs or fiscal policy, which would likely limit the likelihood of Federal Reserve easing in the near-term, in our view. However, near-term economic weakness, including labor market weakness evident in recent payrolls data revisions, suggest increased potential for the Fed to cut short-term interest rates later this year.

Positioning Portfolios to Balance Risk and Opportunity

So how should investors handicap all these uncertainties? At WestEnd, we continue to see the U.S. economy experiencing prolonged late-cycle economic conditions. The combination of uncertainties outlined above—along with reduced private-sector hiring and slower household wealth gains—has the potential to weigh on economic growth this year, keeping it at a rate that is at or below trend. Overall, we currently see a near-term slowdown in economic growth with the potential for a subsequent extension of late-cycle growth as the most likely path for the economy, rather than a robust reacceleration to early-cycle growth.

In this environment, our positioning across U.S. equity allocations includes avoiding the economically cyclical Industrials, Materials, and Energy sectors, which tend to benefit from strong early-cycle growth. We also recently reduced our allocation to U.S. Financials, though we still see the sector benefitting from a steeper yield curve and potential deregulatory actions. In general, we continue to emphasize a mix of sectors with moderate economic sensitivity and secular or cycle-specific tailwinds, like Information Technology (especially Software) and Communication Services, along with late-phase defensive sectors such as Health Care and Consumer Staples in U.S. equity allocations.

While uncertainty may seem to rule the day, remember that late-cycle economic environments have traditionally presented opportunities for macro investors, even as these conditions highlight the need to navigate risks. While we are seeing some signs of ongoing economic slowdown, we continue to see a realistic path for extension of late-cycle U.S. economic growth in the intermediate term. As always, we will continue to adjust portfolios as warranted as our outlook evolves.

This report should not be relied upon as investment advice or recommendations and is not intended to predict the performance of any investment.  The information contained herein is not intended to be an offer to provide investment advisory services.  Such an offer may only be made if accompanied by WestEnd Advisors’ SEC Form ADV Part 2. These opinions may change at any time without prior notice. All investments carry a certain degree of risk including the possible loss of principal, and an investment should be made with an understanding of the risks involved with owning a particular security or asset class. Portfolio characteristics and/or allocations are generally averages and are for illustrative purposes only and do not reflect the investments of an actual portfolio unless otherwise noted.  Portfolios that are concentrated in a specific sector or industry may be subject to a higher degree of market risk than a portfolio whose investments are more diversified.  While every effort has been made to verify the information contained herein, we make no representation as to its accuracy.