Where to Find Investment Opportunities in the Tariff Era

Susan Dziubinski: Hello. And welcome to Morningstar’s second-quarter 2025 US Stock Market Outlook. My name is Susan Dziubinski, and I’m an investment specialist with Morningstar.com and co-host of The Morning Filter podcast.

Now, if there’s one thing that’s certain about investing in 2025, it’s that uncertainty has reached a fevered pitch. Uncertainty around tariffs, inflation, the economy, and artificial intelligence has led investors to sell risk-on assets in favor of risk-off investments. 2025 has been a good reminder of the value of diversification.

Here to share their second-quarter outlooks for the stock market and the economy are Dave Sekera, chief US market strategist with Morningstar Research Services, and Preston Caldwell, chief US economist with Morningstar Research Services. And this quarter we’re joined by Morningstar Europe’s Chief Market Strategist, Michael Field, who will share his forecast for Europe’s markets.

So, let’s begin. Dave, over to you.

Dave Sekera: All right. Thank you everyone for joining us, and thank you Susan for that introduction. As always, I’m just going to provide our overview for the US equity market outlook for the second quarter. I’ll then pass the baton off to Preston, who will then update us on his recently revised US economic outlook. And as Susan mentioned, we’ve got a special guest star today. We’ve got Michael Field, who’s joining us from Europe to provide an overview of the European market outlook and a bit of a teaser for his webinar in the next couple of days as well. So with that, let’s just take a look at where we are today.

So first of all, I just have to note: These numbers are going to be different than what you may have seen in the second-quarter outlook that we published at the end of March. At that point in time, we had used data as of March 24 in order to come up with our outlook. Needless to say, the market has changed quite a bit since then. So yesterday I updated all of our slides, using data as of close of trading on April 4, last Friday.

So coming into this week, we are trading at a 17% discount to a composite of our fair values.

And as a reminder, or maybe for those of you that haven’t joined our webinar in the past, just a little synopsis in how we look at the markets. Many other strategists usually start off with a top-down approach in order to come up with a valuation for the market. Oftentimes they have some sort of model, some sort of algorithm to come up with S&P 500 earnings that they expect for the year, and then they’ll apply a forward multiple to that. I always find that to be a little bit of an exercise in goal-seeking. Seems like for the most part, they’re usually always saying the market’s 8% to 10% undervalued. We actually do the exact opposite. We cover well over 700 stocks that trade on US exchanges, and then we’ll take a composite of the intrinsic valuations of all of those companies, the fair values as assigned by our equity analyst team, and we’ll compare that to a composite of the market price. And that’s how we come up with that price/fair value composite.

And when we take a look at these fair value composites, break it down by the Morningstar Style Box, I’d note that value stocks still remain the most attractive part of the market. We still recommend investors staying overweight in value stocks. That has been our recommendation all year. And then looking at core stocks and growth stocks, and as you’ll see in a couple more slides, growth stocks were the ones that got hammered the most thus far this year. They’re now starting to look a little bit more attractive than they did at the beginning of the year. So I think this is a good time now to start moving into more of a market-weight position in growth stocks as opposed to our prior recommendation, which was underweight. And core stocks, we started off the year as a market-weight position. They did outperform growth stocks to the downside, but looking at valuations being a little bit higher than growth, I think now is a good time to start moving into an underweight position in core stocks.

Looking at the valuations by capitalization, I’d note that small-cap stocks still remain the most attractive part of the marketplace, trading at a 29% discount to fair value. Our recommendation at the beginning of the year was to be overweight small-cap stocks; we’re still holding that recommendation to an overweight there. Mid-cap stocks looking attractive, but on a relative value basis, being the more expensive part of the capital structure, so I would move into more of an underweight position in mid-cap. We started in a market-weight position at the beginning of the year. And then lastly, looking at large-cap stocks, I think now is a good time to start moving from that underweight position that we recommended at the beginning of the year to more of a market-weight position today.

Now people always ask, How has our price/fair value worked out over time? So you can see at the beginning of the year in 2025, as we came into the year, we started at what I would call a rarely seen premium over fair value, at that 5% premium at the end of 2024. Less than 10% of the time, going all the way back to 2010, had the market traded at that much of a premium or more. And then it actually traded a little bit higher in mid-January before the selloff began. And what we noted to start off with is that selloff really began with a bear market in artificial intelligence stocks. When we look at our valuations on AI stocks and those stocks most correlated to AI, we noted that by mid-January they become at best fully valued a lot of them trading slightly above our fair values. And a lot of them, even in 2-star and 1-star territory, getting to be very overextended and overvalued.

Once DeepSeek hit the headlines, I think that was the catalyst that caused investors to really start to reevaluate the valuations that they were paying, recalibrate what their expectations were for artificial intelligence going forward. And as you’ll see in a few more slides, we’ve really had a tough bear market in those AI stocks. Most of them falling well over 20%, some of them having even fallen 30% and 40%. And they’ve actually gotten to the point now where a lot of them have not only gone from 1- and 2-star rated to 3-star rated, but several of them actually now moving all the way down into 4-star territory and starting to look attractive at this point.

But of course you have to talk about the tariffs and how that’s impacted the market over the past week and a half. And so while the first leg of the market really didn’t have anything to do with the tariffs—it was really just to sell off on those overvalued AI stocks—we’ve now seen it broaden out to the rest of the market, where pretty much everything was down over the course of last week. Yesterday, the markets were relatively unchanged by the end of the day, even though we had huge intraday volatility. Markets started off deep in the red from overnight futures, popped, and there were some rumors out in the marketplace and then sold off once those rumors were dispelled. Today, we have a very large pop in the marketplace. I really don’t know why. I’ve been scouring the news. So really, I don’t know if it’s much more of just short-covering here in the short term or if it’s really just the beginning of a real rally because people have realized just how far valuations have gotten pulled down. But again, at this point, with valuations where they are, I do think this is a good time to start overweighting stocks here in the US.

Just taking a look at the Morningstar US Market Index: Through last Friday, we were down 13.76% year to date. We were close to almost 20% selloff from its highs in middle of January. Now, value stocks up until last week actually were in the green. They had been holding up very well in the face of the broad market selloff, but like everything else, I think they were down 8% last week, taking us to negative 5%. Core stocks being down more than that, but of course growth stocks with AI stocks being hit the hardest, being pushed down the most.

And then the other thing to point out on this page is just going to be the performance of large-cap versus small-cap stocks. Now in this case, I think it’s interesting that small-cap stocks have only underperformed large caps by a relatively small amount, less than 1%. Typically, I would expect that small-cap stocks in a risk-off market like this would sell off more than large-cap stocks. So I think there’s probably two things going on underneath the surface there. One, I think it’s just a realization for people who are willing to dip their toe into the market today that they’re seeing very undervalued levels in the small-cap space. And then secondly, just the general expectation that small-cap stocks, being more domestically focused, probably would have less impact from the tariffs on their business than we’d see in the large-cap space.

Then just looking at our fair valuations coming into the year as opposed to where they are now: Really, the biggest difference is going to be in that growth category. Coming into the year, growth stocks were trading at a 20% premium to a composite of our fair values, now trading at a discount. And I would just note that coming into the year, those growth stocks, that was really the highest premium that we’d seen in growth going all the way back to early 2021. If you remember at that point in time, we were in the midst of what I call the disruptive technology bubble. All of those disruptive tech stocks were reaching all-time highs. They were trading at just ridiculously high valuations. A lot of them were well if not even higher than 1-star territory. And of course, all came crashing down in 2021 and into 2022.

Just taking a look by sector, just noting that technology is the worst-performing sector thus far this year, followed by communications. Again, it’s for the most part really all of those AI stocks really hitting those sectors the hardest. But both of those sectors also selling off over the course of last week with that broad market selloff as well. And generally consumer cyclical, it’s all about Tesla—Tesla being, I believe, the largest company by market cap within that sector. And again, Tesla skyrocketing after the presidential election all the way through end of last year into this year. But I believe at this point Tesla is down about 40% year to date. So in our view, it’s gone from being well overvalued. I think it did touch 1-star territory earlier this year. It is back to 3 stars. So again, consumer cyclicals starting to look a lot more attractive now that that premium has been taken out of the consumer cyclical sector. And then the more defensive sectors, as you would expect, holding up to the best to the downside here. So seeing better valuations in those sectors as well.

One thing to note, when you look at an attribution analysis, last year, we’re all talking about how concentrated the market return was in the top 10 returning stocks by attribution over the course of last year. So I’d note in the fall of the market this year, seven of those 10 stocks last year are now the ones that are leading the losses to the downside. So we have those listed here by index weighting and the year-to-date return and their negative contributions. At this point, you can see a lot of those stocks have gone from being overvalued, other than Microsoft and Alphabet, which are now even further undervalued. And a lot of these stocks going from 1-star to 3-star or even 2-star and 3-star into 4-star territory. So we’re now seeing a lot more interesting opportunities now that they have taken this pretty broad selloff over the past couple of weeks.

And then this time, taking a look at the attribution analysis, I would just note that pretty much all of those stocks that are in the green for this year that are helping bolster the market to the downside are pretty much either all value stocks or at least they’re stocks that are considered by the market to be defensive and in that value category. Taking a look at these stocks, most of them still in that fair value category at this point with 3 stars, a few like Coke and Berkshire moving a little bit into a 2-star territory, CVS being really the only one at this point that we still see some upside potential from there.

And then lastly, just to finish up with this part, just showing a lot of these stocks that we think are most correlated with the AI trade, just how much these have fallen over the course of the year. A lot of these starting off the year in overvalued territory with 1 or 2 stars, and for the most part, all going to 4 and 5 stars after the selloff.

Just taking a look at how growth stock, I’m sorry, value stocks have performed as compared to the broad market: So you can see at this point over the past couple of weeks, on a relative value basis, value stocks have been moving up toward what we think the broad market valuation is trading at. And a lot of this is really just due to more growth stocks on a valuation basis coming down as opposed to value stocks moving up. But at this point, we still see, on a relative value as well as an absolute value basis, value stock category looking attractive. And then similarly for small caps, small caps on a relative value basis, not as undervalued as they were before. But again, that’s just much more because large-cap stocks have been coming down more than the valuations in the small-cap space. But again, we still think small-cap stocks look very attractive for investors today.

Just moving on to our sector valuations, just taking a look by sector, the percentage of stocks in each sector coming into the year is much more difficult to find undervalued opportunities. I believe it’s close to 25% of the market was 4- and 5-star rated. At this point, it’s well over half the market, and then you can see by those sectors that have sold off the most and they’re most undervalued where we see the most opportunities today. So at this point, communication services is the most undervalued sector—trading at a 32% discount. And that’s really across pretty much the entire sector. So again, Alphabet and Meta are by market cap, the two largest by market cap within the sector. I think they account for well over 40% of the market capitalization of the sector overall. Both those stocks have come down, look very attractive to us. But I’d note that even in the traditional communications and media space, we see a lot of opportunities in very strong high-paying dividend stocks that have narrow and wide economic moats for investors to choose from as well.

Some of the biggest differentials that we’ve seen thus far this year would be like the consumer cyclical sector. That’s now dropped to a 17% discount. It started the year at a 19% premium. That was really all just due to the movement that we’ve seen in Tesla. But then technology has now fallen to a pretty deep discount at 22%. That started off the year overvalued at a 7% premium. Most of that being taking the air out of that AI bubble. But even more of your traditional technology names have fallen as well.

Energy is a sector that we’d recommended to overweight at the beginning of the year. It was actually doing very well for most of this year. It was in the green I think up until last week. And in fact, I think it was last Friday that the energy sector by itself sold off 8% or 9%. So now that has become even more undervalued, trading at almost a 20% discount to fair value.

And the healthcare sector has also become more undervalued as well, dropping to a 12% discount from an 8% discount. But with healthcare, I’d also note that it’s even more attractive than that. For example, we think Eli Lilly, which is one of the largest market-cap stocks within that index, is significantly overvalued. I believe it’s a 2-star rated stock, and that does skew that price/fair value higher. So if you were to take that out of our price/fair value calculation, healthcare becomes even further undervalued, dropping by a couple more percent.

So at this point today, the only sectors that we actually still see as being overvalued are consumer defensive and utilities. Now I would note utilities is pretty broadly overvalued across the board. Not a lot of individual name opportunities there. The independent power producers are specifically the most overvalued stocks within that category. They’ve been hit pretty hard, but we still think that they’re overvalued and have further to fall from here. Then lastly, just to round it out here with the consumer defensive sector: This is what I consider to be more of a barbell valuation. So what we see there is the three largest stocks by market cap in that sector, Procter & Gamble, Costco, and Walmart. We think those three companies’ stocks are overvalued. I believe Walmart and Costco are both 1-star-rated stocks; Procter & Gamble being a 2-star-rated stock. So if you were to take those three stocks out of our calculation, the rest of the consumer defensive sector looks very attractive to us. Some of the names that held up best this past quarter have been the tobacco names, the food names, stocks that we’ve had as 4- or 5-star rated. Also just good solid value stocks as well as high-dividend-paying stocks as well that we see a lot of opportunities for investors in today’s marketplace.

I’m not going to run through all of these names. These are our sector directors’ best picks by sector. International Flavors & Fragrances and Nutrien, both being new picks, a number of new financial-services picks as well. Just a note here: By sector, technically Broadridge falls in the technology sector. Global Payments falls within the industrial sector, but they are covered by our financials analyst team, so that’s why they’re included in here. And then Federal Realty is a pick that’s been in and out a couple of times just depending on its valuation, but makes a return to appearance this quarter. A number of new picks in the industrials sector. Adobe having gotten attractive enough to now make one of our technology picks. And then lastly, Brown-Forman, Campbell’s—two new picks to the consumer defensive sector—Pfizer being added in healthcare, and then Eversource Energy being added in the utilities sector.

Taking a look by economic moat: Moat stocks are looking really attractive here. In fact, they are now the most attractive part of the market. So at the beginning of the year, these were, at best, pretty fully valued if not getting to be overvalued. The mega-cap names like Apple, Alphabet, Amazon, Microsoft, Nvidia, all getting hit hard, very hard thus far this year, bringing valuations down to very undervalued levels in that large moat sector. But even the mid and the small also looking attractive, and seeing a lot of value among the moat names in the value category as well. So I do think now is a good time: Scour your portfolio and look for those areas where you can swap out of those companies that do not have an economic moat into those companies that we believe have long-term durable competitive advantages.

And as always, I like to provide a screen. Using Microsoft tools, you can look for those companies. So in this case I screen by large-cap stocks with wide economic moats and either a medium or low uncertainty. And then just do a reverse ranking here from the most undervalued on up. Similar, doing the same thing for mid-cap stocks, and then lastly for small-cap stocks. And then with small-cap stocks, I’d just note here that there aren’t enough small-cap stocks with a wide economic moat to flush out this list. So in this case, I add narrow economic moat rated stocks as well.

Taking a look at the mega-cap stocks, and just going to flip through these—people can come back later because I want to make sure I have enough time for Preston and Michael—but just looking at their performance, these are now the updated list of undervalued mega-cap stocks. Some good strong names coming into this list like Meta, Amazon, and Pepsi. And then here’s the performance of those names that we identified at the beginning of the year as being overvalued mega-cap stocks, kind of a split decision here. Half of them have fallen, half of them have kind of held their gains. So again, a lot of these now having fallen out of the list and a couple of new names coming into the list for the rest of the year.

And just to wrap things up with our fixed-income outlook: Bonds have held their own. We’ve actually seen a decline in long-term interest rates. So that’s helped bolster the Morningstar Core Bond Index, up well over 3% year to date. Now we’ve been recommending for a while now to be underweight investment-grade and high-yield corporate bonds, and that’s actually played out. What we’ve seen over the past couple of weeks is that corporate credit spreads that we thought were way too tight for the amount of risk that you take in investment-grade and high yield have blown out over the past couple of weeks. High yield moving out 111 basis points to 438 over, and investment grade having widened 32 basis points to 111, I’m sorry, actually high yield widened 148 to 438. At this point, I still think that there’s probably more downside risk than upside potential. So I still prefer US Treasuries and structured finance bonds over the corporate credit risk at this point in time.

And I didn’t get a chance to update these slides, but I think just intuitively you can look and see where the corporate credit spread is for investment grade and high yield and see that, on the long-term basis, even with as much as we’ve widened over the past week, they’re still at near historically tight levels for both of these indices.

So with that, I’d like to turn the baton over to Preston to provide us with his updated economic outlook.

Preston Caldwell: Thank you, Dave. So needless to say, tariffs have radically altered our economic outlook, with tariff rates blasting up to levels not seen in a century. This will set in motion a cascade of supply-and-demand side shocks, all acting to weigh on the rate of economic growth.

So we’ve reduced our real GDP forecast by 0.7 percentage points in 2025 and 0.9 percentage points in 2026. This is accompanied by some catch-up in ‘28 and ‘29, but there will be some permanent damage. So the level of real GDP in 2029 is still down by 1.1 percentage points compared with our prior forecast.

Now there’s plenty of room for uncertainty. Our expected GDP growth rates skirt just above recessionary territory, but we do see the probability of a recession at around 40% to 45%. On the other hand, we could see more of a slow burn where the deleterious consequences of tariffs for economic efficiency steadily drag on growth over the next five to 10 years without provoking an abrupt slowdown.

On inflation, the US has nearly beaten back inflation. It dropped from 6.6% in 2022 to 2.5% in 2024, but tariffs will breathe new life into inflation starting with goods prices but likely flowing into the rest of the economy with a lag. Our inflation forecast rises by 0.6 percentage points in 2025 and 1.3 percentage points in 2026. And then after that, inflation should drop off as the slack created by very weak GDP growth creates disinflationary pressure.

Once all the tariffs announced as of April 2 take effect, we estimate the average US tariff rate will stand at a staggering 25.5%, up 23 percentage points from 2024. We expect the average tariff rate to still stand at a hefty 18% at the end of 2025. Now, some exemptions are likely, of course, there’s little more that Trump relishes more than being in a position to dole out imperial favors. We could even see a total about face. Certainly rumors of that seem to be moving markets up this morning, the notion that maybe we’ll see a substantial rollback of tariffs. But conversely, escalation is also possible with retaliation following retaliation with Trump having threatened to add another 50% tariff on China, which would amount to a de facto embargo.

So look, in our prior forecast, we got this wrong, frankly. Up until the last week, we had viewed tariff threats as largely saber-rattling designed to push through other geopolitical goals. This was the case during Trump’s first administration, and for the first few months of his second term, this pattern continued to play out, seemingly. Tariffs were implemented on Canada and Mexico for a few days but quickly rescinded after he deemed concessions had been made around border security and other issues. But on April 2, Trump’s rhetoric was purely mercantilist. That is, he is determined to use tariffs to quash the US trade deficit and revive thereby the country’s manufacturing dominance to its historic heights. And as he reminded us last week, he’s harbored this vision since the 1980s. And crucially, in contrast to his first administration, he’s now surrounded by personnel who bow to this vision. So we now think most likely high tariffs are here for the long haul. We see tariffs probably coming down only gradually over several years after the cumulative toll of economic pain and potential election losses compels a shift in policy.

A normal recession is precipitated by an abrupt contraction in aggregate demand. 2008 is a classic example, but like the recent pandemic recession, the tariff surge is really more of a mix of demand- and supply-side shocks. Now the direct impact of the tariffs is a supply-side shock, representing the hit to economic efficiency from cutting off foreign trade. In general, deviating from the free market equilibrium diminishes the productive capacity of the economy. But unlike the pandemic shock, when people could eventually return to work, this hit to the supply side is permanent if the tariffs aren’t removed. So there’s really, in light of that permanence, no scope for countercyclical policy, whether physical or monetary, to offset the impact of such a permanent supply-side shock.

Aggregate demand will also contract. Partly this is because the tariffs represent a large tax increase hitting private-sector incomes unless the tariff revenue is totally recycled into new tax cuts and government spending. But perhaps the bigger demand side factor, though, is the surge in uncertainty that we’re seeing in the associated deterioration in financial conditions, which could lead to firms and households cutting back their spending. Of course, uncertainty also exacerbates the supply-side contraction. The lack of clarity makes it hard for businesses to plan and adapt to a new tariff regime. And so, because of this, we may even see little domestic supply response to make up for lower foreign imports.

So putting this all together, we expect the supply shocks to predominate, and that means that the net impact of the tariffs is moderately inflationary over the next couple of years. To the extent that this is wrong and the demand shocks outweigh the supply shocks, they could be, this could be much less inflationary and more recessionary. But one thing we do know is that the demand and the supply shocks will act in concert to reduce real GDP.

Just to provide a little more historical perspective, the US average tariff rate stood at about 2.5% in 2024. The first round of Trump tariffs back in 2018 and 2019 only increased the average tariff rate by about a percentage point. But again, with everything announced on April 2, the US tariff rate will explode to about 25%--the highest in over a century, since 1905, in fact. And even our projected year-end 2026 tariff rate of 15% would be the highest since the 1930s. Now, the difference with back then is that the US and global economy are vastly more interconnected now. The US imports as a share of GDP averaged 3.7% in the 1930s but stood at 14% in 2024. So this is truly an unprecedented event.

So we know very clearly that Trump’s agitation with tariffs stems from a long-standing grievance against the US current account deficit. I’m going to use the terms current account deficit and trade deficit somewhat interchangeably. Technically the current account deficit is the trade deficit plus the balance on foreign income flows, but the trade deficit is the primary driver. So I’ll use these terms somewhat interchangeably.

Now what’s interesting is that, from an economic theory standpoint, the direct impact of tariffs is extremely unlikely to make a dent in the trade or current account deficit. So this is counterintuitive, but it’s a logical consequence of basic accounting identities. That is, the current account deficit equals the net inflow of foreign capital. So because this is an accounting identity, it’s not merely a theory, it holds with certitude. So if the flow of capital is inelastic with respect to the exchange rate, this is why the capital, this blue line on this chart is a vertical line, then an increase in tariffs cannot improve the current account deficit. Because what happens is the foreign-exchange market reaches a new equilibrium by exchange-rate appreciation, and also some combination of retaliation from foreign countries because, if you have an increase in foreign tariff rates on US exports, then that will obviously discourage US exports and keep the current account deficit relatively unchanged from that perspective if imports and exports are both going down.

But to the extent, even if retaliation is not anything like a 100%, we would expect foreign-exchange appreciation to, foreign exchange, the US dollar to appreciate to the exact degree required to keep the current account balance unchanged. This is if capital inflows do not shift, which as a base case, we wouldn’t expect. So again, that’s the only assumption we’ve made here is the inelasticity, or lack of sensitivity, of capital flows with respect to the exchange rate.

Now interestingly, we haven’t seen appreciation in the US dollar. The US dollar actually is down 3% year to date. Now partly this could be because markets are anticipating a very high degree of retaliation from US trading partners, but I do think that retaliation is unlikely to be measure for measure. So this lack of appreciation is something of a puzzle. And I think an explanation could be that the tariff chaos is so degrading confidence in US markets that it’s actually stemming the flow of capital into the US.

So ironically, this contraction in capital flows could actually achieve Trump’s goal of making a dent in the trade deficit, albeit not by his intended route and not by a route that is desirable for the US economy by any means because, while a small measured reduction in capital flows into the US could represent a healthy rebalancing of the global economy, a panic and sudden stop could have calamitous consequences.

So to the extent that we do get more exchange-rate appreciation, that could blunt some of the inflationary ramifications of the tariffs, but we’re not seeing that for now. Another factor that’s going to mediate the inflationary consequences of the tariffs is what happens with fiscal policy. So right now, we’re estimating that the tariff revenue in 2025 will amount to a fiscal contraction of about 1.8% of GDP. And we’re only expecting that to be partially offset by new tax cuts and spending because we had already included extension of the TCJA, the 2017 TCJA in our baseline forecast. So the fact that that’s proceeding is no change to our forecast.

So tax cuts will probably only be enhanced slightly, just given that Congress has a lack of clarity around the permanence of these tariffs and the associated revenue. So altogether, our expectation for the federal deficit has been reduced by 1.5% of GDP compared to our prior forecast, which is a substantial fiscal shock. Now, to the extent that we do get additional tax cuts coming from the tariff revenue, then that could better prop up near-term GDP growth, albeit at the cost of higher inflation.

Just turning to some of the near-term data briefly. So it’s likely that real GDP growth in the first-quarter 2021 will be driven down by this jump in imports that we’re seeing. The Atlanta Fed is projecting a 0.8% decline in real GDP for the first quarter of 2025. And sorry, the annotation on this top chart is incorrect. The GDP now projection refers not to the fourth quarter of 2024, but the first quarter of 2025. And so that now cast is, it shouldn’t be taken as a signal that a recession is beginning right now because the reading, the projection that GDP will decline is driven by a fall in net exports driven by a surge in imports, which is ultimately driven by companies racing to stock up on imported goods to the extent they can before tariffs go up.

Now actually in principle, if you think about it, that should be fully offset by an increase in other components of GDP, whether that be inventories or other kinds of expenditures because if you think about it, the goods, they come off the dock, they register as imports, and then they have to go to a warehouse, they have to go somewhere, and they should show up in terms of GDP in those other areas. But that offsetting impact isn’t yet showing up, owing to measurement error, which is why these quarter-to-quarter estimates can be so volatile, because of that measurement error component. But it eventually will. So we’ll eventually either see some upward revisions to the first-quarter estimate if it turns out to be negative or we’ll see a rebound in the second quarter.

So the recession isn’t here yet, but we do see some of the underlying components of GDP also slowing. So it looks like real consumption growth is likely to slow to around half a percentage point in the first quarter. Even prior to the tariffs, we had cited consumer exhaustion as likely to provoke a deceleration in growth in 2025. And now with the tariffs, we’re expecting a very sharp slowdown in GDP growth. We think that the bottom in terms of year-over-year growth rates will come sometime between the fourth quarter of 2025 and the second quarter of 2026 at around zero to 0.5%. If we were to get a negative reading year-over-year for real GDP growth, that would be unambiguously a recession. Although again, it’s a somewhat subjective decision-making process for declaring a recession.

Labor markets, I won’t go into this in detail unless you want to, just going into today or into the tariff announcements, labor markets had looked relatively in balance. Now in terms of what we’re expecting from the Fed, the market has altered its expectations for the federal-funds rate a good deal. We’ve kept our expectations more or less unchanged. We’re expecting three rate cuts this year, three rate cuts next year, and two rate cuts in 2027. So we’re roughly in line with what the market’s expecting right now.

Obviously, I do see a chance that the primary impact of the tariffs is more recessionary, which would call for more-aggressive Fed action. But again, there’s that scenario I called out where we don’t have a recession and we just have more of a slow stagflationary burn, which would call for more restrictive monetary policy. So balancing all that out, we haven’t altered our trajectory for the federal-funds rate a good deal, but on net, it does look like the federal-funds rate will come down in order to support the economy and maintain healthy economic growth.

So with that, I’m going to turn it over to Michael to continue the presentation.

Michael Field: Thank you. So from one bloodbath to another, looking at Europe. So I’ve been saying for a while now that Europe has been getting into better shape, certainly in comparison with the US. Our inflation rate was down, or is down, almost to the targeted level. Interest rates are down to 2.5%, the lowest in the Western world. And GDP growth, that gap between the US and Europe has kind of slowly been narrowed. And if you add to this as well, the recently announced German infrastructure fund, it’s going to add about EUR 500 million into the German economy, which to put that into perspective, the Inflation Reduction Act in the US was worth about $900 million and was spread out of a population of about 4 times the size of Germany.

So a lot of positives happening in the Europe, but that’s the good news, and the bad news is all of that is out the window at the moment with this tariff threat hanging over all of our heads. Ultimately, should we by some miracle manage to get out of this unscathed and the situation to fix itself in the short term, then there’s nothing to say we couldn’t kind of resume that path of growth and improvement in Europe. The backdrop for European equities is kind of outperformance at the beginning of this year, but like Preston mentioned, the longer the situation goes on, the more it gets baked into forecasts and the more damage we take as a result.

So, valuation. Now, how does Europe look? So this is the first time since I’ve been producing this report that we’re really struggling to keep a pace with markets or that market movements on a day-to-day basis are enough to shift the picture. And this number has indeed changed since we’ve gone to print. So the number now is about 0.87 for Europe. So that’s saying there’s about 15% upside from here, and that kind of changes the picture. That puts us in perspective with the bargain territory that we’d seen about two years ago. The real difference with markets now, though, is that there’s a real threat, a direct threat that we all know about, hanging over our heads that’s causing this opportunity to arise.

What’s interesting is if we look at the performance of European equity markets, it’s on the chart on the left-hand side here, European equity markets had been outperforming global equities in US equities indeed. Year to date, they still are, but the performance had been quite marked until a couple of weeks ago. Europe had been up around 10% year to date, and that’s tailed off a little bit. As with other markets, it’s taken some hit as a result, and that’s kind of reflected in valuation. So the only good part of this is valuations have fallen and created even more opportunities for us. And again, this chart on the right-hand side has shifted downward a little bit since we’ve gone to print on it. But the message remains that Europe has still got a lot of upside at the moment. It’s still worth a look from an investment perspective, but relative to other markets, for example, like the US, there actually is a little bit more upside in these markets currently.

Style boxes then. And we kind of paint a similar picture to the one that David talked about in the US. Obviously, the general market is trading at a reasonable discount, and that’s interesting for that reason alone. But if you dig a little deeper into value and mid-cap and small cap, for instance, you’re going to get a lot more upside, particularly with small cap in Europe. And I think the one difference I would point out between the US and Europe, and you can see it on this chart, is that the discrepancy between small cap and the general market and indeed mid-cap and the general market is even more marked in Europe than it is in the US. So you can get even more upside in those areas than we pointed out in the US, for instance.

What’s happened in the first quarter is just trying to take stock of everything that’s happened, especially over the last few weeks, and it’s influenced those numbers, too. So you can see I mentioned that the European market had, at one stage, been up 10%. Now that’s tracked back to kind of more low- to mid-single-digit gains, but you can see that those movements over the last quarter have been kind of, there’s been a large disparity between the sectors that have moved, ultimately. So there’s been a clear flight to safety, the likes of utilities, consumer defensives. Financials, to some degree as well, has seen a large uptick over the last few weeks at the very least. And indeed over the last 12 months as well, you’ve seen it of compounding some of those gains. So it’s very much sector-driven, certainly over the short- and the longer-term picture there.

So, that’s what happened. But what’s happening now? How do markets stand today? And if you’re looking at Europe, which sectors should you be looking at? So the good news is there’s not a single sector in Europe that’s currently overvalued, but if you look at, if you want the cheapest sectors in Europe, certainly, for those brave enough among us to invest, you can see consumer discretionary is offering a whopping 30%-plus upside from here. And then that’s followed by the likes of tech and indeed healthcare in Europe, as well, which are still offering 20%, 25% upside. So some good value to be had within those sectors as well.

For those more defensive-minded of you, and this is kind of one of the key differences I’d point out from some of the charts that David presented earlier as well, the defensive sectors in Europe are actually still offering pretty good value as well. If you look at consumer defensives, for instance, and indeed utilities, despite those gains that I mentioned that they’ve attracted over the last quarter and indeed the last year, those sectors are still pretty attractive at this point. There’s pretty decent upside potential from there. If you want to go even deeper into that, into terms of stocks on the consumer discretionary side, homebuilders are obviously very attractive at the moment, being dragged down by the fears for the general economy. Luxury names, Kering, the owner of Gucci, for instance, there’s quite a handful of luxury good stocks in Europe that are offering pretty good value at the moment. And it’s our view, the view of the analysts, that these stocks are more price-immune than the market has given them credit for.

And then further down that list is indeed auto. So the very front line of tariffs within Europe, the likes of Volkswagen, BMW, etc., all of those stocks are flashing up as very attractive at the moment. And again, it’s our analysts’ contention that there’s sufficient upside despite all those fears that you can invest safely in those stocks with a view to the long term.

Consumer staples then, brewers, for instance, Heineken and tobacco stocks, British American Tobacco. And then on the more consumer staples side, household goods side, the likes of Reckitt Benckiser, another UK stock. I’ll give you one more just in healthcare then because I mentioned it, the likes of GSK has recently come into kind of contention for an attractive name as well, but there’s a lot more to come where that came from.

Dziubinski: All right. Well, we will end there. I’d like to thank Dave, Preston, and Michael for their time today, and thank everyone for joining Morningstar’s second-quarter 2025 US Stock Market Outlook webinar.

Now be sure to check the attachments tab at the bottom of the screen to register for Michael’s upcoming webinar and for the annual Morningstar Investment Conference. We’ll see you next time.