The first half of 2025 has presented investors with a paradox. Equity markets have demonstrated remarkable resilience, staging a powerful recovery from the lows of early spring, while the fundamental economic and policy backdrop has become increasingly clouded by uncertainty. This divergence between market sentiment and economic reality has created a complex and challenging environment. Following a sharp, tariff-induced correction in the spring that saw the S&P 500 fall 20%, markets executed a rapid rebound, surging 30% to all-time highs. This rally has been fueled by a persistent risk-on sentiment, with speculative appetite visible in the strong performance of recent Initial Public Offerings (IPOs) and the climb of Bitcoin back to all-time highs.
Market strength has pushed equity valuations into elevated territory. The forward 12-month P/E ratio for the S&P 500 now stands at 22.2, well above its 5-year average of 19.9 and 10-year average of 18.4. Such a premium implies a highly optimistic outlook, one that assumes corporate earnings growth will re-accelerate and policy risks will be resolved without major economic damage. This optimism, however, stands in direct conflict with a deteriorating fundamental picture, as analysts have been actively cutting their earnings forecasts. According to FactSet, while earnings growth was strong in Q1, the outlook for Q2 has deteriorated significantly. The estimated earnings growth rate for the quarter has been slashed from 9.4% to just 5.0%.
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