June 2025 US stock market outlook: Has the storm passed?

Key takeaways

• The US stock market is trading at only a 3% discount.
• Market-weight stocks overall, but overweight value.
• There is a minimal margin of safety as compared with risks ahead.
• The market is calm for now, but heightened volatility is expected in the coming quarters.

June 2025 US stock market outlook and valuation

As of May 30, 2025, according to a composite of our valuations, the US stock market was trading at a 3% discount to fair value. Historically, that was close to the midpoint, where half the time the market trades at a higher valuation and half the time at a lower valuation. While we remain market weight at this valuation, we’d prefer to see more of a margin of safety in light of the higher-than-average downside risk potential.

For example, the price/fair value fell as low as a 17% discount to fair value on April 4, 2025. At that level, we recommended that investors move to an overweight position as we thought that the discount was more than enough margin of safety for long-term investors. Following this especially rapid rebound, we moved back to a market weight as valuations closed in on fair value to lock in those quick, short-term gains.

Is this just the eye of the hurricane?

Last month, we noted that heading into May, we were entering a period of relative calm. Over the past month, the US stock market has become especially sanguine about the heightened risks it will have to face this year. Yet, this calm appears to be more like the eye of the hurricane as opposed to the passing of a single storm.

Tariffs and trade negotiations

The on-again/off-again drama regarding trade tariffs and trade negotiations will remain an outstanding risk until negotiations are concluded. Trade negotiations have reportedly begun, yet finalized agreements don’t appear to be anywhere near fruition. Furthermore, legal wranglings within the US have questioned the validity of the tariffs and will be caught up in appeals courts over the short term.

At this point, it’s nearly impossible to determine when trade negotiations will be completed and what the terms of those negotiations will be. While the worst of the tariffs have been paused, we suspect it won’t be until those deadlines approach that new agreements may be finalized. Until then, as news emerges regarding the progress and substance of trade negotiations, these headlines could have an outsize positive or negative impact on markets. For example, other countries could make selective leaks to the media to try to destabilize US markets in order to try to obtain negotiating leverage.

Economic growth slowing

Over the next few quarters, we suspect that the economy and corporate earnings will be distorted by several factors. First, the reported gross domestic product for the first quarter of 2025 was negative 0.3%. Yet, the negative print was due to a significant amount of purchasing of foreign goods prior to the implementation of the tariffs. Excluding the impact of these purchases, the real underlying fundamental rate of economic growth would have been positive.

Second-quarter GDP is poised to be skewed to the upside as this effect is reversed. The Atlanta Fed GDPNow estimate for second-quarter GDP is 4.6%, yet Morningstar’s US economics team expects the real underlying fundamental rate of economic growth will slow from the first quarter. Furthermore, our US economics team projects that the rate of real economic growth (excluding heightened imports before the tariffs) will continue to slow sequentially over the remainder of 2025.

Second, we suspect that supply and transportation dislocations will result in numerous disruptions and may lead to accounting adjustments and thus distort earnings. Assuming our economic forecast comes to fruition and the resulting surge in imports causes dislocations, a slowing earnings-growth rate could disappoint investors and lead to a downward recalibration in market valuations.

Rising yields making markets nervous

Following a weak auction on 20-year US Treasury bonds, there is heightened sensitivity to Treasury yields. If US Treasury yields were to weaken, especially if they were to breach 5%, we expect it would likely lead to a downward adjustment in valuations across the US stock market.

An easing monetary policy does not appear to be in the cards in the near term. According to the CME FedWatch tool, the market is not expecting the Federal Reserve to cut the federal-funds rate anytime soon. It’s not until the September meeting that the market is pricing in a higher than 50% probability for the Fed to cut rates.

And it isn’t just the US bond market that has investors concerned. Yields on long-term Japanese bonds surged higher. The Japanese 40-year bond yield increased almost 120 basis points this year to 3.70% before coming back down to 3.07%. As yields rose and bond prices fell, many investors began to question the amount of embedded losses on the balance sheets of Japanese banks and insurance companies. With the oldest demographic among the developed markets and a debt/GDP ratio above 260%, many investors are questioning how long the Japanese markets can withstand higher interest rates.

Outlook

Over the next few quarters, we wouldn’t be surprised to see higher-than-usual volatility as these variables play out. Additionally, geopolitical risk does not appear to be abating and could add another wild card to the table. If we are correct, and the stock market suffers another selloff, investors may want to keep enough dry powder to move back to an overweight position once valuations warrant such, as we saw at the beginning of April.

Positioning to ride out a potentially turbulent market

Based on our valuations, by style, we advocate that investors:

• Overweight value stocks, which trade at a 14% discount to fair value.
• Market-weight core stocks, which trade at a 1% discount to fair value.
• Underweight growth stocks, which trade at an 11% premium to fair value.

By capitalization, we advocate that investors:

• Slightly underweight both large- and mid-cap stocks to fund an overweight in small-cap stocks.
• Overweight small-cap stocks, which trade at a 20% discount to fair value.

While small-cap stocks remain significantly undervalued, an overweight position here should not be viewed as a short-term trade because it may take a while before market sentiment shifts to a positive view on small caps. Historically, small-cap stocks do best when the Federal Reserve is easing monetary policy, the economy is viewed as bottoming out and poised to start to rebound, and long-term interest rates are declining.

That is not the current environment. Today, the outlook for monetary policy is especially cloudy. Morningstar’s US economics team expects that the rate of economic growth in the US will slow sequentially, and long-term interest rates have largely been range-bound between 4.25% and 4.75% since last November.

Sector valuations and takeaways

Technology was the highest returning sector in May, up 10.30%. Following this surge, the sector is now trading near fair value.

Communication services was the second-highest returning sector in May, rising 9.59%. Yet even after this run, it remains the most undervalued sector. Although Meta rose almost 17%, it remains a 4-star-rated stock at a 16% discount, and Alphabet rose 7% in May, and this 5-star stock trades at a 28% discount to our fair value.

Rounding out the three top-performing sectors, consumer cyclical rose 8.86% last month. However, 40% of this gain was generated by Tesla, which surged 18% in May. Tesla accounts for almost 19% of the sector index’s market capitalization, and as such, its price movement and valuation can heavily skew the sector average. At this point, the valuation of the consumer cyclical sector is back to nearly fairly valued.

Laggards in May included the real estate sector, which only rose 1.02%. The sector valuation was unchanged at a 10% discount to fair value as the return was matched by an equivalent increase in fair values. Similarly, the energy sector remains significantly undervalued at a 14% discount to fair value as the sector only rose 1.58% last month.

The healthcare sector was the only sector to become more undervalued, declining 4.96% in May, making it the only sector to register a loss. Losses from Eli Lilly and UnitedHealth accounted for the preponderance of the sector’s decline.

The consumer defensive sector remains the most overvalued, yet that valuation is skewed into overvalued territory by 1-star-rated Costco, 1-star Walmart, and 2-star Procter & Gamble. These three stocks account for 31% of the market capitalization of the sector index. Excluding these three stocks, the rest of the sector trades at a more reasonable 6% discount to fair value. The utilities and financial-services sectors are the next two most overvalued sectors. In these sectors, overvaluation is more widespread, and few stocks are rated 4- or 5-stars.

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