Global Market Review and Outlook

Total Returns
Source: Factset

Life moves pretty fast.

FERRIS BUELLER

Global capital markets were whipsawed in the first quarter of 2025, with strong initial sentiment giving way to rising political and economic uncertainty. The S&P 500 hit an all-time high in February as the market rode the tailwinds of the “Trump bump,” driven by the prospect of strong economic growth, artificial intelligence (AI) leadership, falling inflation, deregulation, and lower interest rates. Cracks in the narrative appeared in late January with the announcement of China’s inexpensive but effective DeepSeek AI model, which threatens U.S. AI dominance and casts a shadow over the related capital spending boom.

From the outset, the new administration set the tone for meaningful fiscal policy change, issuing 109 executive orders in the first quarter, more than any president since the 1950s. These orders relate to a broad range of issues, including government spending, international trade, and immigration. In early March, U.S.-imposed tariffs went into effect on Mexico, Canada, and China. As investors weighed the implications of policy and tariffs on inflation, economic growth, and the global balance of power, sentiment shifted toward uncertainty, pressuring markets.

By quarter end, the U.S. equity market as measured by the S&P 500 declined 4%, experiencing a 10% fall from the high-water mark in February to the March low. While economic hard data is still coming in strong, the outlook has weakened. It is important to remember the U.S. economy is approaching any potential setback from a position of strength with healthy consumer debt ratios and a structurally tight labor market.

Developments in Washington took center stage in the quarter and trade policy has been, and remains, a major source of economic and market focus. President Trump’s initial announcement of new tariffs on imports from Canada, Mexico, and China was magnified on “Liberation Day,” April 2 (early in the second quarter), when broad-based tariffs were announced on countries around the world. As of the writing of this letter in mid-April, we know that markets reacted strongly to the magnitude of the April 2 announcement, resulting in some of the largest market swings in the history of the stock market over the next few trading days. The bond market response over these days was surprising as interest rates rose while the stock market fell. While it is impossible to discern exactly why, explanations range from investors questioning the safe-haven status of the U.S. dollar to the unwinding of leveraged trades by hedge funds.

On April 9, the Trump administration issued a 90-day pause on many of the imposed tariffs, with the exception of China, where tariffs were raised to 145%. With the pause in place for most countries, the ultimate timing, scale, and effect of these tariffs are unknown at this time. As for China, it has placed retaliatory tariffs on the U.S., and both sides seem to be dug in on their positioning with consequences that extend beyond economics to global power dynamics. Geopolitical tensions are running high as allies and allegiances are in motion.

Fortunately, the economy in the U.S. entered 2025 on solid footing. In March, real GDP grew at an annualized rate of 2.4%, while the Consumer Price Index (CPI) rose 2.4% year-over-year, reflecting moderate inflationary pressures close to the Federal Reserve’s 2% target. Meanwhile, the labor market remains in good standing, with the unemployment rate just above 4% and close to full employment. While consumers’ finances feel stretched due to the accumulation of price increases, wage gains continue to outpace inflation, resulting in positive real wage growth, a key factor in maintaining consumer resilience. Importantly, corporate balance sheets are sound, and margins are close to record high levels. All in, the economic environment enabled corporate earnings growth last quarter of 18% year-over-year for the S&P 500, the highest rate since 2021.

The economic outlook for the rest of 2025 is becoming increasingly murky as policy takes shape. Already, recent consumer and corporate confidence, which increased following the election and was high coming into the first quarter, has faded as uncertainty weighs on survey results. When confidence declines, big decisions such as spending and hiring are delayed, slowing economic growth. Earnings growth in S&P 500 companies for 2025 was expected to be approximately 13% going into 2025; that estimate has now declined to 8%. Companies are beginning to report first-quarter results, and while numbers are strong looking backward, CEOs are expressing challenges in setting future earnings expectations.

In response to the evolving fiscal setting, Federal Reserve (Fed) Chairman Jerome Powell, in his address to the Economic Club of Chicago last week, acknowledged potential inflationary pressures and moderated expectations for economic growth from tariffs. If the scenario of elevated inflation and slowing growth occurs, the Fed’s ability to lower interest rates to respond may be limited, as its toolkit is designed to address only one of those things at a time, and the policy that supports one hurts the other. An increase in inflation could force the Fed to delay the pace and timing of rate reductions. Elevated rates would keep borrowing costs for both consumers and businesses high, which could further pressure economic activity. It’s a complex environment for the Fed, which since the Great Financial Crisis has been a key market support.

The activities of the first quarter and, even more so the start of second quarter, have been characterized by market stress. While unsettling, market corrections are normal occurrences and often take place during times of uncertainty, such as we are experiencing today with new and evolving policy. Pullbacks allow valuations to reset, excesses to moderate, and expectations to recalibrate. If the appropriate conditions exist, drawdowns often can present more attractive entry points for high-quality assets. Over the last 45 years, the average intra-year drawdown has been 14.1%. Even so, the S&P 500 has posted positive annual returns in 34 of those 45 years.

The factors dictating the path forward are fluid. In the long run, businesses are nimble and corporations find a way to navigate changing circumstances and come out stronger. Congress is currently working on a fiscal package to extend the Tax Cuts and Jobs Act and potentially add growth-oriented policies to its upcoming legislation, which could prove stimulative. Whether Congress is able to deliver “one big beautiful bill” remains to be seen, and margins in the House and Senate are both narrow, but the next few months will prove informative in what may take shape in the way of economic tailwinds.

Outside the U.S., international markets are also in a period of transition as they react to the changes in U.S. policy and support. Europe has instituted major spending increases targeted to both defense spending and economic growth. Long-term structural changes in Europe’s economy would be hard to institute and seem unlikely, but we are watching closely. China, which has a large population and was a driving force in world growth for decades, has been challenged in its economic growth since COVID, but it has a vast manufacturing workforce and wields geopolitical clout. While international equities have lagged for years relative to their U.S. counterparts, it is noteworthy that valuations in international securities are lower than those in the U.S., and international stock indices have higher dividend yields than their U.S. markets counterparts. These characteristics may prove attractive, at least for a period, especially if the world economic climate is less predictable.

Fixed-income assets have not been immune to market volatility but have been relatively stable in the current environment. Corporate bond spreads, extra compensation above the risk-free rate to own corporate bonds, widened to levels in line with long-term averages. If the economy moves into a recession, we expect these spreads to widen further. The good news for investors is that real above-inflation returns are available in the bond markets. Where appropriate, we continue to look to high-quality assets within fixed income to provide stability in portfolios.

While there is a constant flow of tweets and headlines, we believe trying to navigate the market based on the news of the day is a fool’s errand. Rather, we are committed to building durable portfolios designed to meet your long-term goals. We remain prudent in our approach and are patient stewards of your capital.

Please reach out if you would like to discuss. We wish you an enjoyable spring!