Navigating Market Risks in the Second Half of 2025: ETFs to Consider

After sliding nearly 19% between mid-February and early April, the U.S. economy reversed course, rebounding about 24% since early April. While many economists expect the U.S. market bulls to continue with their momentum going into the second half of the year, underlying risk factors still remain, making it prudent for investors to increase exposure to defensive funds.

According to Goldman Sachs, as quoted on CNBC, mounting policy risks and macro conditions are set to keep equity markets on edge. Below, we mention a few factors that contribute to market uncertainty and weigh on investor sentiment, setting the stage for an uncertain second half of 2025.

Tariffs Add Fuel to Investor Uncertainty

Inflationary pressures, intensified by the tariffs proposed by President Donald Trump, continue to be a major headwind for the U.S. economy. According to Greg Daco, chief economist at EY, tariff-driven inflation could reaccelerate inflation, leading to income erosion and a potential slowdown in consumer spending, as quoted on Yahoo Finance.

Per analysts at JPMorgan, as quoted on Reuters, expectations of tariff-driven stagflation have been a key factor behind their downward revision of GDP forecasts to 1.3% in 2025, down from their previous estimate of 2%. Stagflation is an economic condition marked by the combination of slowing growth, rising inflation and high unemployment, occurring simultaneously.

The unpredictability of the Trump administration’s tariff policy was highlighted last Friday, when the President called off trade talks with Canada, moments after confirming a deal with China, testing investor confidence.

Volatility Ranging From Geopolitics to Recession

JPMorgan analysts continue to see a heightened risk of a recession, forecasting a 40% likelihood of a recession in the second half of the year.

While the ceasefire between Israel and Iran was seen as a positive step toward stability in the Middle East, underlying geopolitical tensions persist, and market sentiment remains fragile. Persistent uncertainty surrounding Iran’s nuclear ambitions and renewed escalation in the Russia-Ukraine war, with Russia recently launching its most extensive aerial attack since the conflict began, put a strain on market expectations and kept geopolitical risk structurally high.

Fed Uncertainty and Mounting Debt Pressure

Concerns over U.S. debt levels, coupled with leadership and political uncertainty of the Fed, add pressure to investor confidence. The $4.2 trillion tax-cut proposal from Trump, alongside elevated spending plans, is projected to significantly expand federal debt.

An increasing number of investors had been anticipating a Fed rate cut in July. However, with the central bank maintaining a cautious tone, a September cut now appears far more likely. Per the CME FedWatch tool, markets are anticipating a 93.2% likelihood of a rate cut in September compared to a 78.8% likelihood of the rates remaining unchanged in July.

According to Reuters, President Trump’s comments about Federal Reserve Chair Jerome Powell, hinting at a possible Fed leadership shake-up, remain a significant source of investor unease.

Labor Market Frictions

Immigration bottlenecks and aging demographics threaten to slow labor force growth and add another layer of uncertainty to the economic outlook. According to economists at Barclays, as quoted on Reuters, the combined impact of both is expected to create significant and lasting headwinds to labor force growth and overall economic activity.

Barclays economists estimate that potential job growth could decline to around 60,000 per month over the next six months, dragging economic growth down to 1.4-1.6% through next year, from the current 2%.

ETFs to Explore

Institutional investor sentiment remains subdued, with investors remain broadly cautious despite the markets rebounding. In such an economic environment, preserving capital and cushioning volatility is key for investors.

Investors should adopt a defensive approach as it's better to be cautious than unprepared. With ETFs offering the additional benefit of instant diversification and tax efficiency, investors can use ETFs to increase exposure to defensive funds.

Investing in these sectors not only shields portfolios from downside risks and safeguards investments during market distress but also offers gains when the broader market trends upward. These sectors provide dual benefits, protecting portfolios during market downturns and offering gains when the market rises.

Value ETFs

Vanguard Value ETF VTV, iShares Russell 1000 Value ETF IWD and iShares S&P 500 Value ETF IVE, having a Zacks ETF Rank #1 (Strong Buy) or 2 (Buy), could be appealing options. Characterized by solid fundamentals, such as earnings, dividends, book value and cash flow, these stocks trade below their intrinsic value, representing undervaluation.

Gold ETFs

Investors can also consider funds, such as SPDR Gold Shares GLD, iShares Gold Trust IAU and SPDR Gold MiniShares Trust GLDM, increasing exposure to the yellow metal. Across extended investment periods, gold preserves its purchasing power, outpacing inflation.

Additionally, a safe-haven investment during a challenging period, gold remains a secure choice amid economic and geopolitical instability.

Quality ETFs

Investors can look at funds like iShares MSCI USA Quality Factor ETF QUAL, Invesco S&P 500 Quality ETF SPHQ and JPMorgan U.S. Quality Factor ETF JQUA. Amid market uncertainty, quality investing emerges as a strategic response, providing a potential buffer against the potential headwinds.

Investment Strategies to Follow

In addition to the funds mentioned, investors can also implement investment strategies, such as buy-and-hold and dollar-cost averaging (DCA). Both stand out as effective strategies to create portfolio momentum and build wealth in the long term, ignoring short-term price fluctuations.

The investment strategies remove emotional behavior from investing, preventing investors from overtrading and making impulsive decisions like panic selling during downturns or overbuying in a rally, which can harm their portfolio. This is especially relevant in the current economic landscape.

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This article originally published on Zacks Investment Research (zacks.com).

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