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There are three major themes for investors to keep an eye on as we enter the second half of 2025, according to Vanguard economists.

One of them is tariffs, which could have a longer-term effect on stocks, beyond 2025, explained Roger Aliaga-Díaz, chief economist, Americas, and global head of portfolio construction at Vanguard, and Kevin Khang, Vanguard senior international economist.

“Tariffs will not only impact the global economy this year but also set longer-term changes in motion,”Aliaga-Díaz said.

1. Tariffs and their long-term effects

The economists said the uncertainty around tariffs and the anticipation of slowing global trade had the effect of accelerating imports and led to a buildup of inventory before tariff announcements.

“Thanks to the substantial frontloading of imports in the U.S. during the first quarter, the realized effective tariff rate, which is the average-weighted tariff actually paid by importers, has remained well under 10% so far. However, tariff frontloading and policy uncertainty will eventually subside, and we do expect the effective tariff rate to climb to around 13% by the end of 2025,” they wrote in recent commentary.

But longer term, stated Aliaga-Díaz and Khang, tariffs could be a catalyst for broader changes in the global economy.

“For example, the European Union’s commitment to increase defense spending could boost the region’s economy for the next few years and become a kernel of homegrown productivity in the longer term,” they wrote. “In China, efforts to shift from an export- and investment-driven economy to a consumer-driven economy will be crucial. And in the U.S., a spotlight is being shined anew on the importance of fiscal discipline.”

2. Interest rates should remain above inflation

The second major theme involves interest rates, explained the Vanguard economists. There are trends in motion that will likely keep interest rates above the rate of inflation for the foreseeable future.

The Federal Reserve’s summary of projections, or dot plot, predicts rates at 3.4% in 2027 and 3.0% over the longer-term, supporting this view.

Aliaga-Díaz and Khang contend that the neutral rate, the rate at which supply and demand is in balance, will be much higher than it was pre-pandemic, when it ranged from 1% to 2.50% in 2019 and early 2020.

They argue that inflation is anticipated to remain above the Fed’s 2% goal in the short-term, which is also reflected in the dot plot as PCE inflation is targeted at 2.1% in 2027 and 2.00% longer term.

“However, of more enduring relevance is the U.S. fiscal deficit. At 6% to 7% of GDP, it is historically high for a peacetime and non-recessionary environment,” they wrote. “Worse yet, the deficit picture is likely to deteriorate over time given aging demographics. If left unchecked, those persistent deficits become a source of excess demand and inflationary pressures.”

So, they suggest that if the Federal Reserve is committed to its 2% inflation goal, then it is likely that the U.S. is entering a period of “persistently higher real interest rates.”

3. Rising importance of portfolio diversification  

The Vanguard experts believe that investors will move toward greater global portfolio diversification due to several factors.

One of them is the high valuations of U.S. stocks — or more specifically, the major technology and growth firms, which have dominated the markets in recent years. This could lead to more volatile, as we saw in the first quarter, and investors seeking less expensive and volatile options.

Another is AI. While AI has been the dominant force in the market in recent years, it has mostly boosted big tech firms. But history shows that transformative technologies eventually benefit companies far beyond tech.

“The next winners in the AI race could be those value companies that benefit from the technology breakthroughs, as opposed to the growth companies that created the technology in the first place. From a historical perspective, railroads in the 19th century and technology, media, and telecommunications companies in the 1990s provide some of the most salient examples of this concept,” they wrote.

In addition, there could be a trend toward more international diversification, given the fact that U.S. equities are still overvalued, among other reasons.

“In the last 15 years, U.S. equities and the U.S. dollar have moved in lockstep, with both outpacing their international counterparts—a double whammy for global diversification,” Aliaga-Díaz and Khang wrote. “But that has left both U.S. equities and the U.S. dollar overvalued relative to a broad range of fair-value estimates.”

With international investments now expected to generate higher returns than they have in the past, the case for international diversification is even more compelling, they said.

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