June 2025 US Stock Market Outlook: Has the Storm Passed?
Key Takeaways
- The US stock market is currently trading at only a 3% discount from its fair value.
- Investors should be market-weight overall, but consider an overweight position in value stocks.
- A minimal margin of safety exists when weighed against potential risks.
- The market appears calm for now, but heightened volatility is anticipated in the upcoming quarters.
June 2025 US Stock Market Outlook and Valuation
As of May 30, 2025, analyses indicate that the US stock market is trading at a modest 3% discount to fair value. Historically speaking, this position reflects a midpoint valuation—where the market fluctuates between higher and lower valuations about half the time. Given this context, while we maintain a market-weight stance, we strongly desire a more substantial margin of safety due to the increased downside risks we face ahead.
A striking moment occurred on April 4, 2025, when the price to fair value ratio fell drastically to a 17% discount. This prompted us to recommend that investors move to an overweight position, as the discount offered a significant safety net for long-term investors. Following a swift rebound, we adjusted our strategy back to market weight to secure those rapid, short-term gains.
Source: Morningstar Research Services, LLC. Data as of May 30, 2025.
Is This Just the Eye of the Hurricane?
In last month’s analysis, we noted the market was entering a period of relative calm. Recently, though, the US stock market has become uncharacteristically tranquil amidst looming risks. Yet, this seeming serenity might be akin to the eye of a hurricane, suggesting that a storm of volatility could be just around the corner.
Tariffs and Trade Negotiations
The ongoing saga of trade tariffs and negotiations remains a significant threat until conclusive agreements are reached. While discussions have commenced, the finish line feels far off. Legal challenges in the US regarding tariff legitimacy complicate matters, with potential appeals stalling progress.
Currently, understanding when these negotiations will culminate—and under what terms—is virtually impossible. Although some tariffs are on hold, new agreements are unlikely until deadlines loom. Such developments could dramatically sway market sentiment, particularly if adversarial nations seek to use strategic leaks to manipulate perceptions.
Economic Growth Slowing
The next few quarters may reveal distortions in both the economy and corporate earnings for several reasons. For starters, the first-quarter gross domestic product (GDP) report reflected a negative 0.3%. This downturn primarily stemmed from advanced purchases of foreign goods ahead of tariff implications, suggesting a more positive underlying growth trend.
Anticipated data for the second quarter’s GDP is set to show a 4.6% increase, though our team expects the genuine economic growth rate will continue to slow down as the year progresses. Moreover, issues surrounding supply chains and transportation disruptions may also lead to earnings miscalculations, risking disappointment among investors if earnings growth does not meet expectations.
Rising Yields Making Markets Nervous
Market sensitivities to Treasury yields have heightened, especially after a lackluster auction of 20-year US Treasury bonds. Should treasury yields weaken—most notably breaching the 5% threshold—it could trigger a recalibration of valuations across the US stock market.
The prospect of easing monetary policy appears limited in the near term. According to the CME FedWatch tool, no significant interest rate cuts are expected from the Federal Reserve until at least September.
Furthermore, worries extend beyond US borders, with Japanese long-term bond yields experiencing significant jumps. Such yields have raised questions regarding losses embedded in the balance sheets of Japanese banks and insurers—challenges compounded by an aging demographic and a staggering 260% debt-to-GDP ratio.
Outlook
As we look ahead, we should prepare for potential increased volatility as these issues unfold. Political uncertainties also create a wild card that might further disrupt market stability. If our assessments hold true, investors may want to keep a reserve of dry powder for an eventual move back into an overweight position once market valuations sufficiently align.
Positioning to Ride Out a Potentially Turbulent Market
Based on our recent valuations, we recommend the following tactical positions by style:
- Overweight value stocks, currently trading at a 14% discount to fair value.
- Market-weight core stocks, which hover at a 1% discount to fair value.
- Underweight growth stocks, trading at an 11% premium to fair value.
By capitalization, our recommendations are:
- Slightly underweight both large- and mid-cap stocks to enable an overweight position in undervalued small-cap stocks, currently at a 20% discount to fair value.
Although small-cap stocks hold substantial long-term potential, this position should not be viewed as a short-term play. Historical data indicates these stocks perform best when the Federal Reserve eases monetary policy, the economy begins recovering, and long-term interest rates decline—all factors that are currently not in play. Morningstar’s team projects a sequential economic slowdown, with long-term interest rates stabilizing between 4.25% and 4.75% since last November.
Source: Morningstar Research Services, LLC. Data as of May 30, 2025.
Sector Valuations and Takeaways
May saw the technology sector shine brightly, enjoying a robust 10.30% increase. However, this ascent now places it near fair value.
The communication services sector followed closely with a 9.59% rise, although it remains undervalued even after this performance. Companies like Meta and Alphabet have shown promise, yet still trade at significant discounts to fair value, indicating room for growth.
In contrast, the real estate sector crawled along with merely a 1.02% gain, maintaining a 10% discount to fair value. The energy sector continued to struggle, still markedly undervalued at a 14% discount, posting just a 1.58% rise.
Only the healthcare sector recorded declines, with a 4.96% loss in May, largely attributed to setbacks experienced by major players such as Eli Lilly and UnitedHealth.
Despite the consumer defensive sector being labeled as the most overvalued, the landscape looks a bit different when excluding the outliers like Costco, Walmart, and Procter & Gamble. Without them, the rest of the sector trades with a more manageable 6% discount.
Source: Morningstar Research Services, LLC. Data as of May 30, 2025.
In summary, while calm may reign today, the horizon suggests that investors should brace themselves for turbulence ahead. As circumstances evolve, ensuring a well-positioned portfolio will be key to weathering the storm.
