From Tariffs to Tech Stocks: Q3 Equity Market Outlook

“Every picture tells a story , don’t it?”

“I just dropped in to see what condition my condition was in“

(Kenny Rogers & The First Edition, 1967)

By Scott Welch, CIMA®, Chief Investment Officer & Partner

Reviewed by Carter Mecham, CMA®, IACCP®

April of this year saw extreme market volatility following “Liberation Day,” when President Trump announced his global tariff policies and the domestic equity market cratered accordingly.

Since then, something known as the “TACO” trade evolved. That is, with respect to tariffs, “Trump Always Chickens Out.” We know he certainly did not do that with respect to the bombing of Iran but, from a trade policy perspective, his bombastic tariff threats do seem to be more of a negotiating tactic than actual statements of policy.

The result has been that the markets decreasingly react to the next tariff announcement. In our opinion, this has been a complacent market to begin with, and so this market “shrug” to potentially bad tariff news is just the continuation of a year-long pattern.

We can see this reflected in the current low level of market volatility.

Source: Ycharts, 5-year data through July 16, 2025. You cannot invest in an index and past performance is no guarantee of future results.

So, let’s take a look at where we’ve been year-to-date in the equity markets and where we might go from here.

Global Market Performance

The first thing we notice is that every major capital market is in positive territory YTD, with non-US investments leading the way. We believe this is a function of a steadily declining dollar and “easier” central bank policies in many non-US markets. In addition, most European countries have vowed to increase defense spending to meet their NATO commitments, which should provide a catalyst for economic growth.

Source: The Capital Spectator, as of July 14, 2025. The ETFs listed are for illustrative purposes only and do not represent specific investment recommendations. Past performance is no guarantee of future results.

A partial explanation for the outperformance of non-US markets has been the steady decline of the dollar – something the Trump administration is aiming for to make US products more competitive in the global markets. We expect this trend to continue.

Source: Ycharts, YTD through July 16, 2025. You cannot invest in an index and past performance is no guarantee of future results.

At a more granular geographic level, we see Central and Eastern Europe as the top performers YTD, with the US markets pulling up the rear. We attribute this to the dramatic decline in the “mega-cap” tech stocks following the “Liberation Day” announcements.

Remember that those stocks represent roughly 30%-35% of the S&P 500 index market capitalization so to paraphrase the old expression: when those stocks sneeze, the index performance catches a cold.

Source: The Capital Spectator, as of July 11, 2025. The ETFs listed are for illustrative purposes only and do not represent specific investment recommendations. Past performance is no guarantee of future results.

US Mega-Cap Tech Stocks

Continued Dominance

Let’s visualize the market cap domination of the mega-cap tech stocks in the US. We dislike the phrase “Magnificent Seven” because it is overused and seemingly disparages the other 493 stocks in the S&P 500 index. However, we acknowledge it has become an industry cliché term, similar to the “Nifty Fifty” and “Dot.com.” We prefer the more generic “mega-cap tech” stocks, but the idea is the same.

In any event, we see that these stocks represent 30%-35% of the S&P 500 market capitalization index.

Source: Yardeni Research, as of July 11, 2025. Past performance is no guarantee of future results.

Within the US, we see the continuing leadership of large cap stocks over smaller cap stocks, although the equal-weighted S&P 500 index has held its own in comparison because it did not fall as much during the “Liberation Day” downturn.

Small cap stocks continue to suffer because they tend to be more sensitive to economic conditions and interest rates. We believe in small cap stocks over a reasonable time horizon, and they hold a strategic allocation within our model portfolios. However, on a tactical basis, it may be too early to reallocate there just yet.

Source: Ycharts, YTD as of July 14, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Emerging Pressure

Let’s dive a little deeper into the mega-cap tech stocks. We see the dramatic downturn in April following “Liberation Day” followed by an equally as dramatic retracing upward back to the pre-April highs, except for Apple, Amazon, and Tesla (not shown on the chart, but it is down ~21% YTD).

We believe Apple and Amazon have lagged in their rebound due to slower adoption of artificial intelligence compared to peers and ongoing supply chain disruptions, largely driven by trade tensions between the U.S. and key supplier nations—particularly China.

In the case of Tesla, we suspect its downturn is more politically motivated as Elon Musk became a polarizing figure during his “DOGE” days.

The now-beginning Q2 earnings season will be interesting, for two reasons. First, the mega-cap tech stocks are expensive, so their earnings results will have to be robust to maintain current valuations.

Second, we believe analysts will be paying close attention to the guidance offered by these firms, specifically as it relates to capital investment and hiring plans as they attempt to navigate the ever-changing trade environment.

Source: Ycharts, YTD through July 14, 2025. Past performance is no guarantee of future results.

Looking at the valuations of these mega-cap tech stocks illustrates our comment above about their need to continue to deliver robust earnings to maintain their lofty valuations.

Keep in mind that the overall S&P 500 index valuation is only as high as it is because of the inclusion of the mega-cap tech stocks.

Source: Yardeni Research, as of July 9-15, 2025. You cannot invest in an index and past performances is no guarantee of future results.

Earnings Expectations

Given the importance of this earnings season, what are the expectations?

Here are the earnings expectations for technology sector stocks – stable but lower than historical levels, and remember we believe robust earnings will be essential to maintaining their high valuations. The keys will be (a) actual versus forecasted earnings and (b) guidance on how these companies plan to respond to ongoing trade/tariff uncertainties.

Source: Zacks Earnings Report, as of July 11, 2025. The hatched bar is an estimate and subject to change.

Within the overall market S&P 500 index, we see expectations for reduced earnings for the quarter, with modest improvements as we move through the next three quarters.

Source: Zacks Earnings Report, as of July 11, 2025. The hatched bars are estimates and subject to change.

Outside the US, we see global earnings are also expected to rise modestly (ex-India, which is forecasted to post strong earnings growth) as we move through the second half of the year.

Source: FactSet, MSCI, Standard & Poor’s, J.P. Morgan Asset Management. Countries are represented by their respective MSCI country index except for the U.S., which is represented by the S&P 500. Past performance is not a reliable indicator of current and future results. Guide to the Markets – U.S. Data are as of June 30, 2025.

Valuations

First, let’s look at US vs. non-US valuations. Historically, non-US valuations have been lower than the US for a variety of reasons, but the gap today is as wide as it has been in decades.

Source: Yardeni Research, as of July 15, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: WisdomTree, as of June 30, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Now let’s look at US large cap versus small cap. As mentioned above, small caps continue to suffer from a performance perspective. And, while we believe in the “size factor” over time, more tactical investors may want to wait until we have more certainty regarding economic and interest rate environments before “leaning back in” to small caps. But, for fundamental investors, the valuation gap remains compelling.

Source: Yardeni Research, as of July 15, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: WisdomTree, as of July 15, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Next, let’s look at the growth versus value comparison. We see that, on a broad market basis, value has outperformed over the past twelve months, though growth has caught up YTD.

Source: Ycharts, 12-month data as of July 15, 2025. You cannot invest in an index and past performance is no guarantee of future results.

As with the US versus non-US, we see the growth versus value valuation gap as wide as it has been in decades. We note, however, that the gap is closing as value stocks have performed relatively well over the past twelve months.

Source: Yardeni Research, as of July 10, 2025. You cannot invest in an index and past performance is no guarantee of future results.

Source: WisdomTree, as of July 15, 2025. You cannot invest in an index and past performance is no guarantee of future results.

If we look across the global equity landscape, we see no “screaming buys” from a valuation perspective – the market is “fully priced” by historical standards.

There may be some slight relative value in both US and non-US small cap stocks which are two asset classes we strategically allocate to (though we have not been rewarded for doing so over the past twelve months or so).

Source: Eaton Vance and FactSet as of 6/30/25. NTM P/E is market price per share divided by expected earnings per share over the next twelve months. Data provided are for informational use only. Forecasts/estimates are based on current market conditions, subject to change, and may not necessarily come to pass. You cannot invest in an index and past performance is no guarantee of future results.

Risk Factor Performance

Finally, let’s look at risk factor performance. Regular readers of these blogs know that we are believers in both asset class and risk factor diversification. We believe this can help deliver a more consistent performance over full market cycles.

So far this year, we see the momentum factor dominating performance, but we always take this with a grain of salt, as we believe momentum is a secondary or derivative risk factor. In other words, if one of the fundamental risk factors is rallying, then momentum will rally as well.

With respect to this year, that fundamental risk factor is growth — as it has been for the past several years. This is despite the sharp downturn in the mega-cap tech stocks following “Liberation Day.”

As we have noted in many previous blogs, quality remains the most consistent performer of the fundamental risk factors. We define quality as companies with stronger earnings, cash flows, and balance sheets.

Although we like dividend growers as a strategic allocation, this risk factor continues to lag as dividends are currently out of favor with many investors, who have been concentrating their allocations in growth.

Source: Ycharts, YTD as of July 16, 2025. You cannot invest in an index and past performance is no guarantee of future results.

As mentioned, though, we anchor our risk factor exposure to quality. It is rarely the best or worst performing factor, but it is the most consistent. Quality is illustrated in the blue line below, while the diversified “factor mix” is illustrated by the teal line. Although momentum has led the way so far in 2025, quality has been the best performer over the past three years.

Note the relative consistency as well of the “factor mix” performance.

Source: State Street Global Advisors and Bloomberg Finance, L.P., as of June 30, 2025. Past performance is not a reliable indicator of future performance. Min. Vol = MSCI USA Minimum Volatility Index | Value = MSCI USA Enhanced Value Index | Quality = MSCI USA Quality Index | Size = MSCI USA Equal Weighted Index | Dividend = MSCI USA High Dividend Yield Index | Momentum = MSCI USA Momentum Index | Factor Mix = MSCI USA Factor Mix A-Series Capped Index. Div. Grower = S&P High Yield Dividend Aristocrats Index. The indexes used above were compared to the MSCI USA Index. Index returns are unmanaged and do not reflect the deduction of any fees or expenses. Index returns reflect all items of income, gain and loss and the reinvestment of dividends and other income as applicable. All the index performance results referred to are provided exclusively for comparison purposes only. It should not be assumed that they represent the performance of any particular investment.

Summary and Interpretation

Summer is usually fairly quiet with respect to the markets – people are away on vacations and trading volume tends to be lighter. This is what prompted the market adage, “Sell in May and go away.”

Not this year. Budget bills, geopolitical events, and trade uncertainties have combined to make this a most active summer. Not to mention the market has rallied strongly since mid-April, so investors who followed the market adage missed some strong performances.

After the April disruption, the mega-cap tech stocks once again are leading the way, which is why we believe the Q2 earnings reports will be so important. The artificial intelligence (AI) craze remains firmly in place, and these handful of stocks continue to dominate the space. But the result is frothy valuations – these firms will need to post robust earnings growth and future expectations to maintain those valuations.

We also think that analysts will focus as much on future guidance as they do on historical performance, as they will be paying close attention to companies’ expansion, CapEx, pricing, and hiring plans as they deal with trade and tariff uncertainties.

Perhaps an under-reported story is the impact of AI on small cap stocks. To date, that impact has been minimal, and small caps have accordingly dramatically underperformed. But as AI evolves into a more affordable “tool” (which it will), small cap stocks may actually benefit the most, as it will allow them to increase productivity and margins. We think it is too early to over-allocate there just yet – there is too much uncertainty regarding interest rates and the economy – but we think the day is coming when small caps regain traction, especially given how much more relatively expensive large cap stocks are.

We don’t doubt the continuing strength of the mega-cap tech stocks – they are quality companies generating huge earnings and cash flow. But they are relatively expensive, and we believe we will see a continued rotation into large cap value.

We also believe the state of the non-US economies, combined with a continued slide of the dollar, will continue to make non-US markets attractive for US investors.

At the risk of repeating ourselves, we continue to recommend focusing on a longer-term time horizon and the construction of “all-weather” portfolios, diversified at both the asset class and risk factor levels.

Now is the time for patience, discipline, and a focus on longer-term investment objectives.

We hope you find this helpful and, as always, we welcome your feedback and questions.