U.S. Blues
“Wave that flag, wave it wide and high,
Summertime done come and gone, my oh my.” – The Grateful Dead
Songs mean different things to different people, and song meanings can certainly change over time. So, I do not profess to know the mind of the Grateful Dead’s lyricist, Robert Hunter, when he wrote the above chorus in the song U.S. Blues, but I know what it means to me. It’s always on my 4th of July playlist not just because in my estimation it is a patriotic, upbeat tune about the American experience and our shared identity, even with all our multitudes, contradictions and imperfections—it is there mainly because it’s a catchy tune with a catchy chorus and it makes me happy.
I also have my doubts that Robert Hunter was writing about the relative performance of U.S. stock indices versus their international counterparts when he came up with the title U.S. Blues, but he could have been. U.S. stocks turned in a solid performance in the first half of 2025, powered by a furious rally in large-cap tech during the second quarter, but the real story was international. Driven in large part by U.S. dollar weakness, international stocks significantly outperformed in the first half, beating their U.S. counterparts by the most over a six-month period since 1993. While major U.S. stock indices posted solid mid-single-digit returns for the first half, international stocks (using the MSCI ACWI ex USA Net Total Return index as a proxy) returned almost 18%.
The Eurozone and, in particular, Germany led the way among major markets, up 28% and 35%, respectively, driven in no small part by advances in aerospace and defense stocks as government spending in those areas is expected to increase meaningfully. Brazil was another international standout, up more than 29% during the first half.
We have long maintained a meaningful allocation to international stocks for two reasons: the first is because we believe in the benefits of global diversification, and the second is because of valuation. Simply put, the implied forward returns from international stocks are just too attractive to ignore when compared to their U.S. counterparts. But while both of these factors are good reasons to invest internationally, a huge part of the outperformance during the first half of the year was from another factor, which is U.S. dollar weakness.
Why U.S. Dollar Weakness?
There has been a lot of ink spilled and handwringing over why the USD turned in its worst first-half performance since the Nixon devaluation of 1973. Certainly, uncertainty over U.S. trade policy was a factor, and also the prospect of more growth in other parts of the world, such as Europe. Pundits were having a field day with doomsday calls about the runaway federal debt and even about the end of American exceptionalism (wrongheadedly in our view). Again, while we have long been committed to international allocation, we believe the reason for U.S. dollar weakness is far simpler. After several years of waiting, the Fed is poised to cut short-term interest rates, which is bearish for the USD. Not that other factors do not bear watching, but this is about interest rates, not the end of the American hegemon.
Despite all the negative early prognostications from three months ago, U.S. markets, in particular those tilted toward tech, ripped higher during the second quarter. The tech-heavy NASDAQ returned 18% during the second quarter, and the Russell 3000 Growth index was right behind it at 17.6%. Both of those domestic indices bested international’s performance for the second quarter. The prevailing wisdom shifted from fear to greed, predicated on the notion that tariffs would not turn out to be as significant as first feared. The underlying economy has shown no glaring signs of slowing down, with corporate profits remaining strong and growth forecasts still fairly robust, especially within the AI camp. We have seen glimpses of a potential private sector hiring pullback, but nothing definitive and nothing that comes close to the growth we are witnessing among the AI giants, where capital expenditures on data centers and other AI-adjacent areas continue to go gangbusters.
While we continue to tilt away from AI tech and its gaudy earnings multiples, we have to at least acknowledge that the earnings growth, so far, has been there. We often point to the market cap concentration of the S&P 500 in the top ten names (more than 38% of the entire index) as a sign of excess, but it is also true, at least for now, that those same names also account for almost a third of the index’s earnings. Moreover, secular growth in AI is not seen as particularly sensitive to whatever happens with tariffs and global trade.
In no small part because of this unusually high concentration of high-priced tech giants in the S&P 500, valuations for the overall index have moved higher this year. As of June 30, the price/ earnings multiple on the S&P 500 was 22.0x, more than one standard deviation higher than its 30- year average. There’s just no getting around the fact that overall index valuations are quite rich by historical standards. While this does not necessarily mean we are headed for an imminent pullback, it does mean that earning the historical rate of return on stocks is more difficult when prices are this elevated.
So why are stock prices so high right now in the U.S.? Well, we think a lot of it goes back to expectations about interest rates. Markets are forward-looking, and the Fed has been widely expected to cut rates at the first sign of economic softness, most especially if consumer prices were to start to roll over. In fact, markets are betting that rates will fall later this year by more than the Federal Open Market Committee itself is projecting. Lower rates are like oxygen for asset prices, and the market is pricing in abundant and rising oxygen levels.
But what happens if interest rates do not fall as anticipated?
Tariffs: Unknown Territory
This is where the tariff unknowns begin to vex investors. Tariffs are taxes and thus create friction in the global economy. Like higher interest rates, tariffs will, to one extent or another, crimp investment and spending. The end of the initial 90-day negotiation period for reciprocal tariffs is upon us this month, and while the deadline has been extended until August 1, tariff tensions will likely dominate news headlines for the next several weeks. While we have seen a few individual agreements struck, such as with Vietnam (20% tariff on many Vietnamese goods and a 40% levy on goods seen to have been “transshipped” from China), there remains to be seen how extensive new tariffs will be.
We have not had significant global tariffs since the late 1930s, so nobody really knows exactly what will happen, but there are a few different scenarios.
Scenario One: Tariffs turn out to be meaningful, they slow down trade, including retaliatory tariffs that affect the U.S. economy, and the Fed responds by cutting short-term rates. In this scenario, we would expect international to continue to outperform and for sectors seen as tariff-resistant, such as tech, to do relatively well.
Scenario Two: Tariffs turn out to be meaningful, they slow down the economy and also result in significant consumer price increases, so the Fed is limited in its monetary response for fear of feeding inflation. In this environment, one of stagflation, we would expect the U.S. dollar to be unsteady but responsive to rate hikes, and we would expect less “growthy” shares to perform better.
Scenario Three: Tariffs turn out to be more of a negotiating tool than a reality, freeing the economy to continue to grow and not forcing the Fed’s hand in either direction. We would expect the U.S. to outperform international and would expect outperformance from historical sources such as smaller companies.
Temperament Over Timing
No matter which scenario emerges, handicapping how all of this plays out in the short term is not going to have a tremendous impact on our long-term investment performance. Instead, we will continue to focus on staying invested in the areas of the market that historically give investors the best opportunity to outperform, by leaning into lower-priced stocks and away from expensive stocks, by favoring smaller companies over larger ones and by favoring more profitable companies over less profitable ones. We find it more supportive of long-term success to rely on decades of information about sources of outperformance and optimize portfolios accordingly than it is to respond to every shift in the geopolitical or economic wind. At the end of the day, we are still going to be owners of thousands of businesses all over the world that skew toward profitability, generally allocated in a manner that emphasizes maintaining a margin of safety.
And who knows? Robert Hunter seemed to think America would prevail if we all kept our heads, like all good long-term investors. According to the song playing on my July 4th playlist, maybe we have the right temperament:
“Red and white, blue suede shoes,
I’m Uncle Sam, how do you do?
Give me five, I’m still alive,
Ain’t no luck, I learned to duck
Check my pulse, it don’t change
Stays seventy-two come shine or rain.”
— U.S. Blues
For more information, please reach out to:
Burke Koonce III
Investment Strategist
bkoonce@trustcompanyofthesouth.com
Daniel L. Tolomay, CFA
Chief Investment Officer
dtolomay@trustcompanyofthesouth.com
This communication is for informational purposes only and should not be used for any other purpose, as it does not constitute a recommendation or solicitation of the purchase or sale of any security or of any investment services. Some information referenced in this memo is generated by independent, third parties that are believed but not guaranteed to be reliable. Opinions expressed herein are subject to change without notice. These materials are not intended to be tax or legal advice, and readers are encouraged to consult with their own legal, tax, and investment advisors before implementing any financial strategy.
