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After a gut-wrenching 19% drawdown in the S&P 500, the stock market staged a remarkable recovery to end the first half of the year in positive territory. The worst of the tariff news appears to be in the rearview mirror, and calls for a global recession have receded. But risks still remain, and investors still need to put money to work. So, what is the outlook for the second half of the year? Here are the bull and bear case scenarios.
Bull Case Scenario
Momentum Is Positive
The April drawdown did not upend the current bull market, although it was close. The standard definition of a bear market is a 20% drawdown from the highs. According to data from Bespoke Investment Group, there have been six other instances in the last 80 years where the S&P 500 experienced a near bear market—defined as a decline between 18.5% and 19.99%—and then rallied more than 20% in under two months. In every one of those cases, the market was higher one year later, with an average gain of nearly 24%. Momentum is still positive.
Market Breadth Is Improving
Unlike the mega-cap tech rallies of the previous two years, the current rally has been supported by broad participation. Except for consumer cyclicals, which have been pulled down by Tesla stock’s 25% fall, all sectors of the S&P 500 are positive on the year. Industrials are the top-performing sector year-to-date, rising 13%, with General Electric’s 50% gain being one of the key drivers.
Valuations Are Not Extreme
With the cap-weighted S&P 500 index back near its four-year high valuation of 23.1 times forward earnings, critics point to overvaluation as an impediment to further price gains. However, valuation is not nearly as much of a concern if one strips away the influence of the largest stocks. On an equal-weighted basis, the S&P 500’s 18.1 price-to-earnings valuation is more in line with historical norms. In other words, the average stock is not nearly as expensive as the index suggests.
Stable Inflation And Interest Rates
Tariff concerns prompted the Federal Reserve to become cautious about its interest rate outlook. Policymakers took a wait-and-see approach to the impact of the new tariffs, expecting the higher import prices to drive up consumer prices. That has not materialized as of yet. In fact, the outlook appears to be improving. Markets are expecting additional deals to be announced before the Trump administration’s July 9 deadline, with the result being lower tariffs than initially projected.
Financial markets have reversed course and begun to price in additional cuts to the Fed Funds rate by year-end. Several large investment banks, including Goldman Sachs and Citigroup, now expect the Fed to ease monetary policy by 0.75% in 2025. Lower interest rates should act as a tailwind to the stock and bond markets. Meanwhile, longer-term government bond yields have also started to decline, which should have a positive impact on the housing market and other interest rate-sensitive sectors of the economy.
The Bear Case Scenario
Risk Appetite Has Gone Parabolic
Risk-taking has come roaring back. Bloomberg reports retail investors are piling into meme stocks, which rose 44% in Q2 2025. The CNN Fear & Greed Index, a compilation of seven indicators that measure aspects of stock market behavior, including market momentum, put and call options, junk bond demand, market volatility, and safe-haven demand, has moved firmly into greed territory. In the past, this kind of euphoria has made the market vulnerable to bad news.
The AI Boom May Be Peaking
Capex growth in AI infrastructure, while still positive, is beginning to slow. Data center construction spending, which had been rising at a 30% growth rate, is now closer to 10%, according to Bespoke Investment Group. Analysts also expect capital expenditures spending as a percentage of revenue to plateau through year-end. If true, one of the market’s biggest growth engines may be running out of steam, with implications for semiconductors, AI hyperscalers, and electrical utilities.
Labor Market And Housing Markets Show Signs Of Strain
Job growth has slowed significantly, with monthly payroll gains averaging below 125,000, well off the pace of prior years. Job openings per unemployed worker are falling, and private indicators show growing slack. Sectors like healthcare and leisure & hospitality are driving most of the new jobs, while other sectors such as tech, retail and government, are seeing hiring slowdowns or outright declines. For example, Microsoft announced a second wave of layoffs on July 2, which would eliminate roughly 4% of its workforce, or approximately 9,000 people.
Challenges To U.S. Exceptionalism
U.S. equity markets are no longer the lone engine of global growth. Year-to-date, the U.S. has lagged its G7 peers and underperformed global equities more broadly. Countries such as Spain, Mexico, Germany, and Italy have posted gains of 30% or more, driven by expectations for defense-related fiscal stimulus and a weaker U.S. dollar. The U.S. is no longer the automatic first choice for global equity investors, and many international investors are overweight in U.S. markets within their asset allocation. If relative growth prospects outside of the United States continue to improve, the non-U.S. equity markets could sustain their outperformance.
Stay Invested And Stay Diversified
Markets are forward-looking, and much of the good news may already be reflected in prices. That doesn’t mean the rally will end tomorrow, but it does mean investors should temper their expectations.
Fundamentals remain solid, but sentiment and valuations are stretched. Breadth is encouraging, but trade policy jitters could return as the July 9 deadline for agreements approaches.
Diversification will matter in the second half of 2025, just as it did in the first six months of the year. Maintaining exposure to international markets, which are generally less expensive from a valuation perspective, can also help protect portfolios if the U.S. dollar continues to weaken. The remainder of 2025 may not be as terrifyingly volatile as the first half, but investors need to be prepared for anything. Staying invested has proven to be a better long-term strategy than trying to pick a top and time the market.
