First Quarter Market Recap
In the first quarter of 2025, the global stock market exhibited wide-ranging performances across regions and asset classes. The S&P 500 entered correction territory, dropping more than 10% from its mid-February high as investor sentiment weakened amid trade tensions and policy uncertainty. Stocks ended the quarter down nearly 5%. In contrast, many European and Asian markets rose sharply. Germany’s market (MSCI Germany Index) gained nearly 19% following a fiscal policy shift toward increased defense spending that boosted market confidence. Chinese stocks (MSCI China Index) rose nearly 17%, driven by government stimulus and advancements in artificial intelligence. China’s meaningful weight in the emerging-market index lifted emerging markets by 2.9% (MSCI Emerging Markets) in the period.
In the U.S., large-cap stocks (S&P 500) fell nearly 5%, outperforming small-cap (Russell 2000), which fell nearly 7%. Large-cap growth stocks finally lagged this quarter as investors rotated into value and foreign stocks amid economic uncertainty. Large-cap value stocks (Russell 1000 Value) gained nearly 3%, widely outperforming large-cap growth’s (Russell 1000 Growth) nearly 8% decline. The equal-weighted S&P 500 was slightly positive, outperforming the cap-weighted index, signaling the decline of Magnificent 7, which comprised one-third of the S&P 500 index at the start of the year. The Bloomberg Magnificent 7 Index was down 16% in the quarter.
Within fixed-income, both credit and interest-rate-sensitive sectors posted gains. The 10-year Treasury yield experienced significant volatility, ending slightly lower from 4.57% to 4.36%, and investment-grade core bonds (Bloomberg U.S. Aggregate Bond Index) rose just over 2%. Credit-sensitive bonds such as high-yield held up well, gaining 1.5%.
Investment Outlook and Portfolio Positioning
Heading into the year, we expressed caution that elevated stock market valuations—especially for U.S. technology companies—combined with policy uncertainty, could leave the market vulnerable to volatility. This is what transpired over the first quarter.
After hitting new highs on February 19, U.S. stocks suffered their first “correction” since 2023. The narrative around U.S. stocks started to shift in late January, beginning with the release of DeepSeek—a Chinese-built artificial intelligence model seen as a direct threat to U.S. tech companies’ AI dominance. The selloff in U.S. stocks was exacerbated in early February amid tensions around trade, tariffs, and policy uncertainty.
As we entered the second quarter, President Trump announced a comprehensive set of higher-than-expected tariffs on April 2 during “Liberation Day.” These included a 10% baseline tariff on all imports and significantly higher tariffs for certain trade partners, such as 54% for China and 20% for the European Union. These tariffs, in aggregate, would result in the effective tariff rate on all imports rising to 24%, putting it at a 125-year high.
In response, equity markets suffered sharp declines, with the S&P 500 Index experiencing its second correction of the year, dropping roughly 10% in the two days following the announcement. European and Asian stock indexes also fell meaningfully. The U.S. dollar weakened against major currencies, and longer-term interest rates fell over fears of an economic slowdown.
Leading up to “Liberation Day,” economic conditions in the U.S. were reasonable, with relatively stable fundamentals. Corporate earnings continued to surprise to the upside, GDP was still expanding (albeit more slowly), the labor market remained in decent shape with historically low unemployment, and consumer spending remained relatively steady.
Tariff Policy and Implications
President Trump’s tariff policies reflect a protectionist agenda aimed at protecting U.S. industry. The administration views tariffs as a tool to make American manufacturing more competitive, addressing the hollowing out of manufacturing that occurred over recent decades. While free trade agreements were beneficial for corporate profits, they resulted in manufacturing job losses and negative consequences for many American communities. Globalization made it easy to substitute domestic workers for cheaper foreign labor.
In a barrier-free world, companies logically shift production to countries with comparative advantages. China’s manufacturing is more efficient and cost-effective than America’s. The administration believes tariffs can help rebuild the domestic manufacturing base lost to globalization by incentivizing factory construction and job creation. While certain industries critical to national security should be restored—such as key healthcare supply chain components—producing low-cost retail goods domestically would likely be prohibitively expensive. Tariffs represent one tool to drive reshoring, partly justified by the fact that all major U.S. trading partners apply higher tariffs to American goods than the U.S. applies to theirs. The Trump Administration’s advocacy for “reciprocal tariffs” aims to enforce “fair trade” by addressing this imbalance.
The methodology behind the tariffs is primarily based on trade deficits, with countries running larger trade surpluses with the U.S. subjected to higher tariffs. This approach seems to be a blunt tool aimed at reducing trade deficits rather than truly reciprocating tariff levels imposed on U.S. goods. For some countries, it appears mathematically difficult to reach a trade balance with the U.S., suggesting these tariffs might serve as a negotiation tool rather than a permanent fixture.
Meanwhile, the Fed finds itself in a challenging position. While the tariffs threaten growth, the likelihood of tariff-induced inflation complicates the Fed’s ability to respond with rate cuts. Fed Chair Powell has indicated that current economic data does not warrant rate cuts, and the Fed remains hesitant to ease too quickly, wary of appearing politically influenced or risking premature loosening.
Global Stocks
The narrative around U.S. stocks shifted in late January with the release of DeepSeek, a large language model from China that threatened U.S. tech dominance in AI. This contributed to the rotation out of U.S. large-cap growth stocks, which lagged U.S. large-cap value stocks significantly in Q1.
Meanwhile, European equities gained 10.5% during the first quarter, their widest quarterly outperformance gap versus U.S. equities in four decades. A weaker U.S. dollar—down nearly 4%—provided a meaningful tailwind for unhedged foreign assets.
Fiscal stimulus from Europe, particularly Germany’s proposed €500 billion infrastructure investment fund alongside increased defense spending, marks the country’s largest fiscal package in decades. This is expected to boost euro-area GDP growth by an estimated 0.5% to 1% in 2025. Additionally, the European Central Bank has adopted a more accommodative stance, with further rate reductions anticipated through mid-2025.
The biggest risk to Europe’s resurgence comes from U.S. tariffs, particularly those targeting the automobile sector, which comprises 7% of the bloc’s GDP.
Equity Volatility
Recent market corrections should be viewed in a historical context. Since 1950, the market has experienced 34 corrections of 10% magnitude, yet only about a third escalated into bear markets exceeding 20% losses. While today’s concerns around higher interest rates, government layoffs, and shifting trade policies add to uncertainty, the broader economic backdrop remains relatively stable.
In periods of market stress, the two-part decision of market timing (when to sell, when to buy back) is generally a losing proposition. Markets are not in full meltdown, and we are typically biased to be buyers during equity declines. Historically, the stock market’s largest daily gains don’t occur during bull markets but during bear markets, with nine of the 10 largest daily gains over the last 75 years happening during recessions.
Fixed-Income
Treasury yields remained elevated in Q1, with the 10-year yield holding above 4.2% as markets reassessed the timing of potential Fed rate cuts. Credit markets performed well, supported by strong corporate earnings and stable fundamentals.
The Fed continues to balance inflation risks with signs of slowing growth. While early-year expectations pointed to multiple rate cuts in 2025, persistent inflation led the market to scale back its rate-cut projections. The Fed is expected to hold rates steady through mid-year, with potential for two to three cuts in the second half, assuming inflation moderates.
Corporate bond markets remain well-supported by solid earnings growth, strong balance sheets, and manageable refinancing needs. Investment-grade credit spreads have stayed tight, while high-yield bonds continue to benefit from low default risks (trailing 12-month default rate was a healthy 0.25% at the end of February).
Investment Implications
Ongoing market volatility is driven by uncertainty around tariff policy. If tariffs remain in place or escalate, they will negatively impact consumers and business investment, potentially pushing the economy into recession. Conversely, any de-escalation could quickly stabilize markets.
At the portfolio level, our fixed-income exposure continues to favor shorter-dated, high-quality bonds earning yields above the benchmark. In this uncertain environment, we prioritize attractive absolute returns over trying to predict interest rate moves.
During the quarter, we increased U.S. stock allocations. While U.S. equity valuations have compressed, they remain elevated versus global peers—and for good reason: future earnings visibility is stronger in the U.S. Additionally, Europe continues to lag in AI infrastructure development and faces ongoing geopolitical challenges in 2025 as de-globalization progresses.
Closing Thoughts
Tariffs and trade policy have injected significant uncertainty into financial markets, and the volatile environment will likely continue until there is more clarity. While many economies were in relatively good shape prior to “Liberation Day,” the tariff announcement has raised the probability of recession.
The current market environment is volatile and tough to predict with confidence. More than ever, it’s important to stay disciplined and avoid reactive portfolio shifts. This challenging environment reinforces the importance of diversification, patience, and a clear investment process.
As always, we appreciate your trust.
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