Wall Street at a crossroads as record highs face growing risks

The US stock market completed a roller-coaster first half of the year at record-high levels but a host of factors could knock equities off their perch over the rest of 2025.

The benchmark S&P 500 (.SPX) is up over 5 per cent on the year so far, rebounding from an April plunge after an economic scare stemming from President Donald Trump’s “Liberation Day” tariff plan. Here are some of the key questions facing US stock investors at the start of the second half.

WILL TARIFFS BITE, OR JUST BARK?

While worst-case fears about Trump’s tariffs have eased, more near-term volatility could be in store as the US seeks to hammer out trade agreements in the coming weeks. A July 9 deadline on many tariffs, if it holds, could be an early second-half test for stocks.

Even if some of the harshest levies are rolled back, higher effective tariffs this year still could drive up inflation and cut into company profits and consumer spending. The effective US tariff rate based on announced policies has climbed to 13 per cent from 3 per cent at the start of the year, Goldman Sachs analysts said last week.

After strong first-quarter profits, US corporate earnings will be a critical gauge to assess whether Wall Street has properly factored in the fallout from tariffs. Second-quarter reports begin later this month, with S&P 500 earnings in the period expected to have increased 5.9 per cent, according to LSEG IBES.

WHEN WILL THE FED CUT RATES?

Fed Chair Jerome Powell has pointed to concerns that tariffs will push up inflation as a reason for the central bank to hold off on interest rate cuts. Still, fed fund futures indicate nearly three cuts expected by the end of this year, with the first likely in September, LSEG data showed.

The Fed and Powell have endured a barrage of pressure from Trump to cut rates and the president has mused about picking a replacement for Powell soon, well ahead of the expiration of the chair’s term in May 2026. That move could increase expectations for more cuts but also bring turbulence to markets concerned about the Fed remaining independent.

A weakening US economy could also prompt the central bank to ease rates, and some signs of softening in the labor market mean that incoming data poses a test for asset prices. The latest monthly employment report is due on Thursday.

IS BIG TECH BACK IN CHARGE?

After a rough start to the year, technology and growth shares have retaken the reins of the market. Tech (.SPLRCT) was the best-performing S&P 500 sector in the second quarter, while the “Magnificent Seven” megacap stocks overall (MAGS.Z) have surged since the market’s April lows.

The performance has revived concerns about a relatively small number of large stocks propelling the market, including that the advance may not be as strong beneath the surface. Many investors still expect more stocks to support market gains as the year goes on.

The equal-weight version of the S&P 500 – which better captures performance of the average stock in the index – is up nearly 4 per cent in 2025.

“I would suspect that if the market is going to continue pushing higher, you’re going to need to see broadening,” said Brent Schutte, chief investment officer at Northwestern Mutual Wealth Management.

HOW EXPENSIVE CAN EQUITIES GET?

With the market’s rebound, stock valuations have also ascended. On Friday, when the S&P 500 hit its first record high in over four months, the index’s forward price-to-earnings ratio reached 22.2. That was the highest level since February and well above its long-term average of 15.8.

As investors seek to value equities, they are increasingly looking to future earnings prospects, including whether 2026 profits significantly improve. S&P 500 earnings are expected to rise 8.5 per cent this year and 14 per cent next year.

Another factor is Treasury yields, which tend to pressure equity valuations when they rise. While benchmark yields have subsided since earlier this year, any spike in the 10-year yield could rattle stock investors, such as if the US fiscal bill moving through Congress prompts concerns about the widening deficit.

WILL ‘US EXCEPTIONALISM’ DOUBTS DENT EQUITIES?

Questions about the allure of US assets have been a global theme in 2025, triggered by Trump’s stunning tariffs announcement in April that sparked uncertainty over American policy. The US dollar recently hit its lowest level in three years against a basket of major currencies.

After a long period of dominance over other regions, US equities have also trailed their international counterparts so far this year. Non-US equities are still relatively cheap in general, creating questions about which group will win out over the rest of 2025.

WILL GEOPOLITICS RE-EMERGE AS A RISK?

Stocks pulled back briefly during the recent Israel-Iran conflict before tensions calmed, but analysts are wary that resumption of Middle East hostilities could cause fresh volatility. That would particularly be the case if constraints on oil supply led crude prices to soar above $100 a barrel.

Spikes in geopolitical unrest over the past 30 years have rarely been a headwind for US equity returns, Barclays strategists said in a recent note. But they added that “geopolitical risk flare-ups do motivate bouts of elevated volatility, and risk assets in general would be vulnerable should the current conflict escalate.”