*There’s a certain irony to publishing this market review after all that has transpired since April 2, the date that President Trump announced his expansive tariff policies. Indeed, many investors may feel like the first three months of the year are inconsequential given all that has happened in the last two weeks alone! Nevertheless, it’s helpful to take a broader and longer-term view towards markets, and we trust this quarterly review will help towards that end.
Stocks went into the beginning of 2025 with the bull market solidly intact, though valuations by many measures were beginning to look stretched. Indeed, The Fed appeared to have achieved the desired soft landing for the economy, and investors were still planning for additional rate cuts. That backdrop began to change under the new administration in Washington, as signs of a trade war emerged on Day 1 of the Trump administration. By late February, growth stocks were falling quickly, and some of the stocks primarily responsible for the success of the market in 2024 were declining substantially.
However, despite the turbulence, brights spots were found as trends reversed: growth stocks fell sharply while value rallied. Technology and communications stocks stumbled while basic materials, healthcare, and energy jumped. Once-suffering value and dividend strategies finally got a chance to shine, as did international stock funds. And on the fixed income side of capital markets, strategies with greater sensitivity to changes in interest rates got a boost as bond yields fell.
The Federal Reserve, however, notably stayed the course, opting to hold interest rates steady at both of its meetings. This was in part due to the fact that most economic indicators still showed signs of resilience: the jobs reports were solid, inflation was steady, and corporate earnings remained largely intact. Importantly, the Fed will keep a close eye during Q2 on these vital signs, as well as the impact of Trump-era tariff policies, as investors look for indications of what interest rates may do for the rest of 2025.
U.S. Equities
U.S. equities entered the year priced for perfection—trading about 1 1/2 standard deviations above their long-term average. The year started strong, with the S&P 500 reaching a new all-time high in mid-February. Yet despite a strong earnings season, changing rate expectations and prolonged tariff uncertainty pushed the S&P 500 down, as it corrected more than 10% in the second half of Q1 and posted a loss of 4.3% on a total return basis, its worst quarter since Q3 of 2022. The Magnificent 7 – Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla – which drove much of the market’s gains over the past two years, led the declines by falling nearly 15%. Value stocks outperformed growth; and large caps held up better than small caps, as evidenced by small caps losing nearly 9% for the quarter. Small caps have held a consistent losing streak compared to their large cap counterparts, but as shown by international equity returns in the next section (which far outperformed US equities after years of underperformance), they still have a part to play in a diversified and long-term investing approach.
International Equities
As alluded to above, international markets jumped, outperforming domestic stocks by ~10%, the strongest quarterly outperformance in over 15 years. China surged on AI breakthroughs, Europe gained on fiscal tailwinds, including an ambitious defense spending plan and the U.S. dollar posted its worst start in nearly a decade.
International developed stocks finished Q1 with gains of 6.4%, and much of this strength originated from Europe, where investor sentiment improved as governments revealed plans to increase spending. This prompted a shift from U.S. stocks towards Europe, as investors anticipated increased government spending would lead to stronger economic growth. Meanwhile, emerging markets posted a gain of just over 3% in Q1, rewarding investors who have stayed the course in this asset class.
Fixed Income
Two notable themes emerged in the bond market in Q1: falling US Treasury bond yields and wider credit spreads. The 10-year Treasury yield fell from a peak of 4.80% in mid-January to 4.15% in early March. It was a reversal from Q4, when the 10-year yield rose more than 75 bps due to renewed inflation concerns. Several factors contributed to the Q1 reversal, including rising policy uncertainty, the potential for tariffs, and concerns about slower economic growth. The combination prompted investors to move money into longer-maturity government bonds, which are viewed as safe havens. Bond prices rose as yields declined, and Treasury bonds provided diversification benefits in Q1, offsetting a portion of the stock market decline. Against this backdrop, the Bloomberg U.S. Aggregate returned 2.8%, providing the principal protection investors desire during turbulent equity markets, along with a solid dose of interest income.
