Q1 2025 Investment Tally & Perspective

Economic Activity

Tariffs have stolen the show as the most important variable impacting markets and economies this quarter and into early April. As of the time of this writing, the U.S. has announced a 90-day pause in the ‘reciprocal tariff’ for many of the countries initially targeted. All prior tariffs remain in place, as does the 10% baseline outlined on April 2nd. Tariff rates for China, have been increased to 125%. According to Goldman Sachs, these changes will likely result in a 15.0% increase in the effective tariff rate this year, or close to $500 billion. This number will likely fluctuate in the future as negotiations continue and sectoral tariffs, which were excluded from the April 2nd announcement, get implemented. For proper scale, consider U.S. GDP amounts to $29 trillion, and for fiscal 2025 the IRS is projected to collect $2.7 trillion in income taxes. Outside of the direct cost of tariffs, there are also retaliatory tariffs, and the impact of increased uncertainty on business investment and planning. The April 2nd announcements have resulted in GDP forecasts getting revised lower.

First quarter GDP growth, as estimated by the Atlanta Fed’s GDP Now tracker, is expected to be -2.8%. The bulk of this is due to trade distortions from elevated imports, likely from front-running expected policy change. Excluding net exports and inventory changes, Q1 GDP would be expected to grow 1.6%. Still, this is masking a troubling weakness as personal consumption expenditures (PCE), the measure of the mighty U.S. consumer is only contributing 0.18% to that figure. PCE contributed greater than 1.3% to GDP for each of the last four quarters.

Retail sales and services appear to be slowing down, coupled with a back-to-back jump in the monthly personal savings rate – both potentially showing exhaustion and/or hesitation from U.S. consumers. The U.S. labor market continues to hold steady which is encouraging.

Outside of the U.S. there have been important developments, particularly in Europe. The potential ceasefire between Ukraine and Russia, and its implications on energy prices has been received positively. More importantly, after years of half measures, the latest moves by the Trump administration seems to have finally created urgency in the European Union to invest in defense. Germany, in recent periods, has been a fierce advocate for austerity due to its history with hyperinflation. However, in March the country approved a 1 trillion euro spending package to be split evenly between defense and infrastructure. This was even more meaningful as the package required an amendment to the ‘debt brake’ in Germany’s constitution. While this spending may occur over many years, it is still significant relative to Germany’s GDP of 4.3 trillion euros. Spending plans are occurring on the Continent outside of Germany as well, with many NATO members looking at increasing the percent of GDP spent on defense.

Monetary Policy

The U.S. Federal Reserve has been in a holding pattern, which has generally been an easy place for them to be given inflation’s descent towards their target, and a still robust economic picture. However, we are likely to see more tension in their decision making going forward. The administration’s tariff policies will likely induce higher inflation to some degree. It may also change consumers and businesses’ expectations for long-run inflation. A recent University of Michigan consumer confidence survey showed five-year inflation expectations reaching levels not seen since the 1990’s. The Fed has been concerned that inflation expectations could become a self-fulfilling prophecy, and all else equal, would likely hold rates steady, or potentially raise them to fight this development. On the other hand, any growth slowdown could warrant the Federal Reserve cutting interest rates.

While this dilemma is often discussed, it’s clear the Fed’s opinion leans towards a one-time bump from tariffs and they suspect any inflation uptick would be short-lived. They are likely to hold rates steady until they see convincing evidence of economic weakness. While this seems sensible, we suspect that if it weren’t for these inflation concerns, the Fed may have already been cutting rates today. Cutting rates once the economy has downward momentum is not ideal, and we will be watching closely as the Fed reacts to incoming data.

Valuation and Sentiment

While valuations have been adjusting lower, we are still in line with historical averages. According to FactSet, the forward P/E ratio (a common guide for equity valuations) for the S&P 500 is 19.4x. For reference the 10-year and 5-year averages are 18.3x and 19.9x, respectively. Sentiment, however, is very poor. Looking at the American Association of Individual Investors survey, the percent of respondents who are bearish outnumber the bulls by over 40 percentage points, versus bulls outnumbering bears by 20 points closer to the election. This level of negative sentiment is on the outer bounds of extreme. Since 1987 there have only been 11 weeks with readings more bearish than this. Typically, sentiment is viewed as a contrarian indicator, meaning it pays to do the opposite. The 11 episodes were clustered in late 1990, early 2009, and the fall of 2022. After these periods, forward 1-year, 5-year, and 10-year returns have exceeded 15%.

The Investment Outlook

By our eyes, it appears that the U.S. economy has entered a quagmire rooted in economic and business uncertainty. This unexpected and unwanted development was self-inflicted (a la changing tariff policies). There are multiple examples where foreign countries impose higher tariffs, provide state sponsored support, or some other advantage to local businesses over U.S. enterprises. We also agree that given political dynamics, Presidents are only allowed a small window to make meaningful changes. However, given the administration’s broad and higher than anticipated tariff policy we are unsure if the benefits will outweigh the costs. Today’s market is filled with uncertainty and while some paths lead to grim outcomes, there are others that offer off ramps to an improved future.

The Fed is balancing potential inflation pressures from the new tariff policies versus further cuts in interest rates to avoid having the economy decline into a recession. As tariffs transition from an unknown to a known factor, businesses and investors will adjust to a changed world of trade. The Fed is data driven and odds favor upcoming data that justify the Fed cutting short-term interest rates in the second quarter with further cuts in the second half of the year.

After two strong years of rising stock prices, the decline in asset values has been discomforting for investors and advisors. Yet, with the drawdown being quite pervasive, and assuming a deep recession is avoided, attractive valuations are now more widespread making the math used to project potential returns point higher – stated differently, risk/reward assessments look more attractive. Investors have rotated funds from the more-pricey Magnificent 7 into areas with more modest valuations; only time will tell if this market rotation is a long-term trend, or whether technology re-establishes its market-leading growth when positive market forces once again gain traction.

Currently, indiscriminate selling pressure from hedge funds and other highly leveraged investors that need to pay down their borrowed funds have driven prices sharply lower. Rapid declines feed on themselves until the debt/loans have been paid down sufficiently. As these occasional declines play out, they raise the human emotion of fear until the forced selling has run its course. Markets then typically turn higher as fear recedes and the seeds of greed become planted.

During the past year or more we have maintained a defensive investment strategy that has served us well. There are multiple variables pulling the investment outlook in opposite directions. The recent price decline has been sharp, investor sentiment is poor, and downside risks are at the forefront of everyone’s mind. These variables provide support for positive future returns. Alternatively, the economy was weakening throughout the first quarter and the administration has greatly increased tariffs from the beginning of the year. A recession cannot be ruled out, and if one were to occur, we suspect more downside for equities is possible. With this backdrop, we continue to prefer defense, and will be on the lookout for opportunities to turn aggressive should the outlook improve, or valuations become more compelling.

Investing in Uncertain Times

With the announcement of “Liberation Day” last week, businesses and consumers were handed another bout of political uncertainty and market volatility. According to Goldman Sachs, the result is an increase to a 15% effective tariff rate, up significantly from 2.3% in 2024. After watching a 10% market decline in a week, a natural reaction for an investor might be to retreat to cash. Though easier said than done, we encourage our clients to maintain a long-term perspective and, with history as our guide, remember that what’s in today’s news does not reflect the long-term outcomes you will achieve by staying invested. Continue reading for some tips to navigate through uncertain times.

• Downturns are normal, and the recovery can be quick – historically, US stocks have experienced three downturns of 5% or more per year, a correction (defined as a loss of 10%-20% from the high) once per year, and a correction of 15% or more every 3 years. And, according to data from Bloomberg, the recovery time for a 5%-10% downturn in the Dow Jones Industrial Average is three months, while the time to recovery from a correction of 10%-20% is eight months.
• Focus on time in the market, not timing the market – while it can be tempting to try and sell out of stocks during downturns, timing it right has proven to be difficult. Some of the best days in the market have come after the worst and sitting on the sidelines during a recovery can significantly impact performance. According to a study by Bloomberg and Fidelity, a hypothetical investor who missed the five best days in the market since 1988 would have reduced their long-term gains by 37% through 2023. Missing the ten based days reduced their long-term gain by over 54%.
• Invest consistently – dollar cost averaging is a strategy that involves investing a fixed amount at regular intervals, regardless of market conditions. It reduces the impact of volatility by averaging the purchase price of investments over time. Sticking with a plan such as dollar cost averaging means you will be able to buy stocks at some of the best prices – that is, when things seem to be the worst.
• Maintain an emergency fund – as part of our planning approach, we have stressed the importance of keeping an adequate emergency fund. This ensures that you will not be forced to liquidate long-term investments, possibly at unfavorable prices, to cover unexpected expenses. We have stressed to clients that anything invested in stocks should be viewed with a time horizon of five years or greater.

Market volatility is an inherent aspect of investing, but it does not have to derail your financial journey. While we do not recommend making large changes to one’s portfolio during these times, it is important to note how it makes you feel for when the market does recover. If uneasy, it is possible your risk tolerance has changed and your exposure to stocks needs to be reduced. As noted earlier, downturns are a normal part of investing.

As always, please contact us if we may be of assistance in any manner.