2Q25 Letter: "Balancing Risks and Resilience"

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Business Update

During 2025, Evolve Investing continued to grow the number of households we serve, and year-to-date our assets under management are up by 28%. We anticipate that this positive trajectory will continue through the rest of the year. Chris and I are exploring opportunities to expand our team by adding an advisor with tax preparation experience (CPA or EA). If you know of someone who might be a strong fit, we’d greatly appreciate your referral.

From Pause to Pressure: The Trade War Returns

In my 1Q25 letter, I wrote about the shock and rapid escalation of President Trump’s broad-based tariffs, and how quickly those threats became concrete policy. What had been dismissed as political posturing emerged as sweeping measures, reshaping global trade and prompting sharp market reactions. As I said then, "This is not a shift away from equities - we remain long‑term investors." The lesson was that discipline, clarity, and a long‑term lens matter more than ever when policies evolve by tweet and headline.

Today, that lesson applies with even more urgency. We now stand about one week from the end of the 90‑day tariff pause announced after the President’s April 2 "Liberation Day" levies. Despite claims of active negotiations across more than 90 issues, almost no substantive progress has been announced, except a superficial agreement with the UK. Meanwhile, a second 90‑day truce with China and the crisis with Iran have pushed tariffs down the news agenda.

The ”TACO Trade” Prevails

Markets have responded with skepticism. The so‑called "TACO trade", shorthand for "Trump Always Chickens Out," reflects the market belief that sharp tariff threats will be delayed or watered down at the last minute. Yet this is better understood as negotiation rather than capitulation. As the New York Times observed, Trump has framed this approach as a strategy: stake a strong opening position, unsettle markets, and secure concessions later.

We’ve watched this play out before. The initial sell‑off following the April levies was sharp across the S&P 500, Nasdaq, and global indexes, fueled by fears of disrupted supply chains, rising consumer prices, and an increased risk of recession (with Goldman Sachs putting recession odds as high as 45%). But when the 90‑day pause was announced, equity markets surged, gaining nearly 9.5% in a single day and regaining all prior losses within weeks.

Today, markets appear unprepared for a fresh wave of steep tariffs. Instead, the prevailing theory is that the status quo - roughly 10% across imports - may hold indefinitely. In this view, the world has become like the proverbial "frog in slowly boiling water": a 10% global tariff, the biggest new trade barrier since World War II, has become a baseline condition. At this point, "only 10%" would be treated as a victory.

Inflation Remains Low

Importantly, this hasn’t yet triggered a significant shift in core goods inflation. Inflation has ticked slightly positive, but hasn’t surged alarmingly.

U.S. Inflation and Core Inflation, Last 10 Years

Firms have brought forward production and adjusted supply chains to mitigate the shock, and purchasing managers indices, which measure the economic health of the manufacturing and services sectors, suggest that manufacturing and economic activity have adapted remarkably well.

U.S. Manufacturing & Services PMI, Last Two Years

Implication for Fed Policy

At its most recent meeting, the Fed held rates steady, as expected, but its tone was cautious. Their updated projections show growth slowing, unemployment rising, and inflation ticking back up. Specifically, Fed Chair Jerome Powell stated recently:

“If it turns out that inflation pressures do remain contained, then we will get to a place where we cut rates, sooner rather than later. But I wouldn’t want to point to a particular meeting. I don’t think we need to be in any rush because the economy is still strong.”

Yet in testimony before the House Financial Services Committee, he added:

“Ultimately the cost of the tariff has to be paid, and some of it will fall on the end consumer… We know that’s coming, and we just want to see a little bit of that before we make judgments prematurely.”

Meanwhile, Fed Governors Christopher Waller and Michelle Bowman have argued that the Fed could ease policy as early as July if tariff impacts and rising inflation can be managed. Against this backdrop, long‑term investors can draw an important lesson: Policy clarity takes time. Premature decisions, whether in Washington or in portfolios, can be costly.

Fundamentals Continue to Support Equity Valuations

Against this backdrop, we again review earnings growth, a critical tailwind supporting equity valuations despite rising concerns around tariffs.

Tariffs have been at the forefront of corporate commentary this earnings season, with mentions reaching a record high in earnings calls, according to Morgan Stanley. Roughly 30 firms pulled or paused guidance due to tariff uncertainty, especially across autos, consumer durables, and industrials.

Yet 1Q25 results delivered a broadly positive picture. Earnings grew 13.3% year‑over‑year, with revenues rising 4.9%. As usual, the “Magnificent Seven” (Alphabet, Amazon, Apple, Meta, Microsoft, NVIDIA, and Tesla) led the way, delivering 27.7% earnings growth, while the rest of the S&P 500 grew earnings by a solid 9.4%. Notably, earnings gains were broad‑based across eight of eleven sectors, with Energy the lone significant laggard, down 12.7% due to weaker oil prices.

Following 1Q25 results, Goldman Sachs’ strategists raised their 2025 and 2026 EPS growth estimates to 7% (from 3% and 6%, respectively). They cited an improved US economic outlook, lower assumed tariff rates, and stronger‑than‑expected performance year-to-date. “Our 2025 EPS growth estimate is now above the top‑down consensus estimate of 4% and in line with the bottom‑up consensus estimate of 7%,” the team noted.

U.S. Earnings Revisions, February 2024-Present

Fixed Income: Attractive Yields Amid Uncertainty

In fixed income, despite tighter spreads, we still find yields in high-quality and crossover credit compelling, especially when considering risk-adjusted returns. These instruments offer contractual income streams that are far less exposed to the day-to-day swings of political developments or market sentiment, though they do carry some default risk. For income-focused clients, we continue to favor BB-rated corporate bonds, short-term government securities, and investment-grade corporates.

S&P Earnings Yield vs. BB and BBB Effective Yield, Last 10 Years

Our 2025 Outlook Remains Favorable

Over the last couple of months, we’ve received some feedback from clients about the sanguine nature of our outlook, especially given the noise around tariffs, rising recession odds, and other headline risks. It’s worth noting that when we compare the current environment to prior periods of disruption, including the 2020 pandemic and the 2008 financial crisis, the underlying fundamentals today appear far more favorable.

The US consumer remains on solid footing, bolstered by strong employment and healthy balance sheets. There are no structural issues within the banking or financial system akin to those that triggered the 2008 crisis. Geopolitical tensions, while present, appear largely contained, and tariff threats, while significant, seem to be well‑managed.

U.S. Consumer Sentiment Index, Last Three Years

The interplay between tariff policy and economic activity is challenging to forecast precisely, but its impacts can be managed within well‑diversified, risk‑aware portfolios. We continue to emphasize quality and resilience across both equity and fixed income allocations, a balanced approach that can weather uncertainty, regardless of headline risk. We continue to maintain a tilt toward US megacaps, especially within the Information Technology sector, where long‑term secular tailwinds, including artificial intelligence, remain intact.

In short, while we recognize and respect the uncertainty, it’s precisely in moments like these that discipline and long‑term perspective matter most. As always, our focus remains on making prudent, risk‑aware decisions aligned with your long‑term objectives.

If you’d like to review your positioning or discuss how these policies might affect your long‑term objectives, we’re here to help. As always, we’re grateful for your trust and partnership.

Best,

Peter Hughes, CFA, CPWA®, CEPA® & Chris Stevenson, CFA