2025 Q1 Thoughts

Market Recap

Global stock markets displayed wide performance dispersion across regions and styles over the year’s first quarter. After making a new all-time high in mid-February, U.S. stocks (S&P 500 Index) suffered their first 10% correction since 2023 before recovering to end the quarter down 5%. Smaller-cap U.S. stocks (Russell 2000 Index), which tend to be more volatile than their larger-cap counterparts, declined further, ending the quarter down 10%. Large-cap growth stocks (Russell 1000 Growth Index), which have led the market higher for several years, finally lagged this quarter as investors rotated into U.S. large-cap value (Russell 1000 Value) and foreign stocks (MSCI EAFE) amid economic uncertainty.

In contrast to the U.S., many European and Asian markets rose sharply. Developed International stocks (MSCI EAFE Index) gained nearly 7% while emerging market stocks (MSCI EM Index) also fared well, finishing the quarter up 3%.

Interest rates experienced significant volatility throughout the quarter, fluctuating amid shifting inflation expectations, Federal Reserve policy signals, and broader market uncertainty. Overall, the 10-year treasury rate declined from 4.57% at the start of the year to end the quarter at 4.36%. The decline in rates benefited investment-grade bonds (Bloomberg U.S. Aggregate Bond Index), which gained 3%. High-yield bonds (ICE BofA High Yield Index) also ended in positive territory, gaining just under 1%.

Performance in the first quarter was a great reminder of the benefits of diversification. Unexpected losses in U.S. stocks (growth stock in particular) were offset by gains in U.S. large-cap value stocks, foreign stocks, and investment-grade bonds.

Investment Outlook and Portfolio Positioning

Heading into the year, The Gardner Group expressed caution that elevated stock market valuations, especially for US technology companies, combined with policy uncertainty, could leave the market vulnerable to volatility. Indeed, this is what transpired over the first quarter of the year.

After hitting new highs in on February 19th, U.S. stocks suffered their first “correction” since 2023, when the S&P 500 index declined a total of 10% through March 15th. The narrative around U.S. stocks started to shift in late January, beginning with the release of DeepSeek, a Chinese-built Artificial Intelligence model that is seen as a direct threat to U.S. tech companies’ dominance of the AI industry. The selloff in US stocks was exacerbated in early February amid tensions around trade, tariffs, and policy uncertainty.

President Trump further shocked investors on April 2 (what he declared “Liberation Day”) by announcing a comprehensive set of much higher than expected tariffs. These included a 10% baseline tariff on all imports and unexpected and significantly higher tariffs for certain trade partners, such as 54% for China and 20% for the European Union. These tariffs in aggregate, if implemented and maintained, would result in the effective tariff rate on all imports rising to 24%, putting it at a 125-year high.

In response to Trump’s announcement, equity markets suffered sharp declines, with the S&P 500 Index suffering 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 plummeted over fears of an economic slowdown.

While it is prudent to monitor risks, particularly if economic conditions worsen, it is too early to classify this market downturn as a crisis. Long-term investors should maintain perspective, recognizing that market cycles of fear and relief are natural, and history has consistently rewarded patience and disciplined investing.

Leading up to “Liberation Day,” economic conditions in the U.S. were reasonable, and the overall economic backdrop was relatively stable. Despite ongoing volatility and concerns about slowing growth, we still see some supportive underlying economic fundamentals. For example, corporate earnings have continued to surprise to the upside, with many companies exceeding expectations and maintaining strong profit margins. GDP is still expanding, albeit at a slower pace, reflecting a resilient economy even in the face of higher interest rates. Meanwhile, the labor market remains in decent shape, with unemployment at historically low levels and key sectors such as construction, healthcare, technology, and professional services still adding jobs. Furthermore, consumer spending has remained relatively steady and businesses have yet to signal widespread distress.

That said, the consistently ever-changing tariff landscape is clearly weighing on consumer sentiment, adding to overall uncertainty. Consumer and investment sentiment has declined recently, and we are closely monitoring potential headwinds and signs that could cause us to become more defensive. Specifically, there are some soft data points, such as consumer confidence, that have weakened materially. Consumers drive about 70% of U.S. economic activity, making their sentiment an important factor to monitor.

To put it simply, the stock market hates uncertainty. And uncertainty around trade and tariffs will continue to be a headwind for U.S. stocks.

Closing Thoughts

It goes without saying that tariffs and trade policy have injected a big dose of additional uncertainty into the financial markets, and we understand that such developments can be worrying. There are still many lingering questions, including what potential retaliatory measures will come from countries hit with tariffs, whether the announced tariff levels will remain in place or possibly be lowered, and what their ultimate impact will be on the financial markets. Until there is more clarity, the volatile environment will likely continue.

Currently, it seems like stock prices are at least reflecting some of the bad/unexpected news regarding tariffs. While many foreign and U.S. economies were in relatively good shape prior to the Liberation Day, Trump’s tariff announcement has led us to raise the probability of a recession. We are actively assessing a range of economic outcomes and their impacts on the markets.

At the portfolio level, our fixed-income exposure continues to favor our positions in shorter-dated bonds, most of which is high-quality and earning yields comfortably above the benchmark. It remains anyone’s guess where Treasury yields are headed next, and in this uncertain environment, we are maintaining our bird-in-hand approach, prioritizing attractive absolute returns over trying to predict the timing and magnitude of interest-rate moves.

Within our global equity allocation, we remain diversified across U.S. and foreign stocks, and across growth and value stocks. The benefits of diversification were apparent in the first quarter, and our analysis suggests there continue to be opportunities in areas outside of U.S. large-cap growth stocks, like U.S. large-cap value, European, and emerging-market stocks, where valuations are more compelling.

The current market environment is noisy, volatile, and frankly, too tough to call with confidence. More than ever, we believe it’s important to stay disciplined and avoid making reactive portfolio shifts. This is a challenging environment, but one that reinforces the importance of diversification, patience, and a clear investment process.

With all the volatility, unknown, and concern that has seeped into the market since Q2 started, The Gardner Group appreciates your trust even more. Please call if you have further questions.