By: Darren W. King | Wealth Management
Equity markets rallied to all-time highs at the beginning of the year on enthusiasm for Trump administration pro-growth policies and talk of American global financial market exceptionalism. This all came crashing down as the market entered correction territory on prospects for a global trade war and Trump tariff policy that have unsettled markets and have the potential to upend the global supply chain. Mag 7 mega cap and AI names have taken the brunt of the first quarter correction. The S&P 500 lost 4.28% in the 1st quarter. The Technology-heavy NASDAQ was down 10.28% in 2025, while the DOW Jones Industrial Average was down .86%. The Russell 2000 Small Cap Index finished the first quarter down 9.48%. International developed market equities, as measured by the Morgan Stanley Capital International Europe, Australasia, and Far East Index (MSCI EAFE), closed the quarter up 7.03% in US dollar terms and up 2.89% in local currency. The MSCI Emerging Markets Share Price Index closed the first quarter 2025 up 2.97% in US dollar terms.
The first quarter witnessed technology and growth shares underperform while value sectors posted a quarter of strong performance. S&P 500 sector results for 1Q2025: Energy 10.21%, Health Care 6.54%, Consumer Staples 5.23%, Utilities 4.93%, Real Estate 3.58%, Financials 3.48%, Materials 2.81%, Industrials -.19%, S&P 500 -4.28%, Communications Services -6.20%, Information Technology -12.65%, and Consumer Discretionary -13.80%. The first quarter saw sector rotation into value and defensive stocks while growth sectors, which have led the market over the last 2 years, drastically correct. The story of the first quarter was strong returns from areas of the market that had underperformed in the bull market and outperformance from international markets for the first time in many years. The market has reacted to the tariff surprise with a much more defensive posture.
Based on current consensus earnings forecasts, the forward 12-month P/E ratio for the S&P 500 is 20.5X, more expensive than the five-year average P/E of about 19.9X. Currently, the market is estimating 11.7% earnings growth on 4.2% revenue growth in 2025. However, we started the year expecting 14% earnings growth on 5.8% revenue growth as the inflationary and slower growth aspects of tariff policy are starting to be factored into 2025 earnings outlook. Profitability remains high for S&P constituents, with net profit margins currently at 12.1%, compared to 5-year average profit margins at 11.8%. Average equity strategists’ bottom-up price targets for the S&P 500 in 2025 are at 6,904.84, currently 27% higher than current trading levels. We expect forward price targets to move lower as companies provide more conservative forward guidance for 2025. After 2 years of S&P 500 returns greater than 20%; we see a continued broadening of equity returns out of technology and into other areas of the market that have not participated as dramatically in the equity rally. Strategic moves out of domestic large capitalization investing into international stocks took center stage in the first quarter as valuation discounts for international markets proved hard to ignore. With trade uncertainty and recession probabilities increasing, we expect valuation multiples to reset lower to more historic levels and will continue to assess portfolio shifts after the shock and surprise that the trade war has inflicted on capital markets.
During their March 2025 meeting, the Federal Reserve held rates steady at 4.25% to 4.5% and reiterated the same 50 basis points of interest rate cuts in 2025 that they communicated in December. After liberation day and China retaliatory tariffs, interest rates futures are now anticipating 100 basis points of fed cuts. The Fed also indicated a neutral rate around 3% as inflation expectations inch higher following tariff policy updates, while expectations for economic growth have slowed. The Fed estimates full year 2025 GDP to be 1.7% in 2025, revised down from 2.1% GDP growth estimates that were forecasted in December. Fed core inflation is estimated to end 2025 at 2.8%, higher than fourth quarter projections at 2.5%. Year-end 2025 unemployment estimates were revised to 4.4% from 4.3% in December. In short, while the labor market remains strong, uncertainty around the economic outlook has increased and recession probability odds have moved from near zero at the end of 2024 to higher in the near term. If current reciprocal tariff levels hold and more countries retaliate; 2025 could see a much more muted scenario. However, the Fed still sits in restrictive territory and has avenues to support the economy.
The 10-year treasury yield moved lower in 2025, starting the year at 4.57% and ending the quarter at 4.21%. Longest duration bonds outperformed shorter duration issues as yields fell across all maturities. 20+ year treasuries were up 4.59% in the first quarter, while intermediate treasuries were up 2.49%. In a risk-off trade, higher credit quality outperformed the lowest credit quality issues. Aaa rated bonds within the Barclays U.S. Aggregate Index were up 2.37% so far in 2025, while Baa rated bonds returned 2.28% during the same period. Despite market uncertainty, credit spreads have not moved appreciably and indicate a growth and inflation reset and not a full-blown recession in 2025.
The Bloomberg Dollar Spot Index finished the first quarter with the dollar having weakened 2.70% compared to our trading partners. International investors are forecasting slower growth and higher inflation in the US following the election. Light crude oil futures remained stable in 2025, with WTI oil futures minimally falling to $71.48 from $71.72 at the end of the quarter but have since collapsed to trade at $58.25. 30-year mortgage rates fell from 7.28% at the end of 2024 to 6.77% by the end of the first quarter, while 30-year treasuries fell 21 basis points from 4.78% at year-end 2024 to 4.57% at the end of the quarter.
According to the Bureau of Labor Statistics, the March employment report showed 228K jobs gained during the month, well above estimates for 140K. Service sector employment was all but 12,000 of the job gains, as manufacturing job growth remained weak. The March jobs number reported unemployment at 4.2%, falling from 4.3% in July, but well off the cycle low unemployment rate at 3.5% in March or 2023. The labor force participation rate in March was 62.5%, up from the pandemic trough of 60.2% in April of 2020. For March, average hourly earnings rose 3.8% over the past year, below the recent wage inflation numbers that were averaging greater than 5% for most of 2023. In short, the March number provided temporary reassurance that the labor market is stable as we enter this period of uncertainty following news of the global trade war.
Retail sales in February increased .2% from the prior month, surprising economists who had predicted a much higher .6% increase. Annualized retail sales were up 3.5% over the past year, compared to the consumer price index’s measure of inflation up 2.8%. Seven of the report’s 13 categories posted declines for the month, with motor vehicle sales and spending on bars and restaurants particularly weak in February. Consumer sentiment and consumer spending habits have grown more cautious as consumers are tightening their belts on concern for the impact of the global trade war on future prices paid. However, the latest retail sales report remains positive for many categories, despite all the pessimism. Gasoline station sales were down .3% from the prior year as energy prices stabilized, providing a boost to consumer discretionary spending on other items. Department store sales were down 3.9% from the prior year. Building materials and supplies were down .7%. E-commerce and mail-order houses ended the 12-month period with a 6.5% sales gain. Auto sales were up 3.5% from the prior year. Restaurant spending was up 1.5%, furniture store sales were up 5.5%, health care spending was up 6.7% and clothing and accessories were up 1%. With consumer spending two-thirds of our economy, we are seeing consumption growth still rising above inflation and income gains surpassing inflation levels. Consumers are saving more with all the trade concern. With wage growth up 3.5% over the prior year, real disposable income also up 1.8%, personal income up 4.6%, and the personal savings rate ballooning to 4.6%; the income side of the equation is helping to defray some of the inflationary and higher financing pressures that we all are now expecting to see move higher in 2025.
The Trump administration’s “shock and awe” tariff policy have led to severe equity market selloffs across the globe. As of April 10th, the S&P 500 is now down 11% and back to levels last seen in May of 2024. With global effective tariff rates imposed by trading partners at around 4.6% as of 2023 estimates, markets were expecting reciprocal tariffs in that range. Baseline tariffs at 10% and Chinese tariffs at 104% are well beyond even the most bearish scenarios modeled by economists. Consensus economists’ estimate that the average reciprocal tariff rate imposed by the US to be 25%. However, reciprocal tariffs were paused for 90 days by president Trump on April 9, allowing further negotiation. The degree of impact to corporate earnings is very much uncertain. Whether reciprocal tariff rates will hold or whether the announced tariff rates will be used as a bargaining chip and negotiated away remains to be seen. Negotiated away and the market has discounted most of the bad news on tariff deals with trading partners coming in at a flat 10% rate. In worse case scenarios, we estimate a 10% S&P 500 earnings recession in 2025 with corporate earnings falling from $275 to $250 in 2025, and market multiples moving back to 10-year average P/E multiples of 18X. In this scenario, the S&P 500 has 10% more downside and 4,500 S&P 500 levels. This severe bear scenario is also consistent with historical recession-induced corrections in the 25% range. Our investment process remains consistent as we look for attractive entry points for profitable, high-quality, long-term investment ideas.
Within the fixed income markets, interest rate, fed policy, and market traders see three to four more twenty-five basis point interest rate cuts in 2025, with the Fed still indicating just two 25 basis point cuts. The issue is how much inflationary pressure will the trade war induce. That answer depends on whether countries retaliate following the Trump administration’s tariff announcement, or whether some of this will be walked back. The Fed quieted markets following the tariff announcements indicating the labor market, and economy are currently solid. Chairman Powell also indicated that Fed policy is currently restrictive and that they have avenues to become less restrictive if the economy needs support. As of April 8, 10 year investment grade corporate bond spreads to the treasury have widened by 40 basis points and have moved to August 2024 levels. In short, the bond market is still not pricing a recession but is pricing a stagflation scare, with stagflation indicating slower GDP growth with higher inflation. The corporate bond market is now offering yields greater than 5% for maturities greater than 7 years. We remained strategic and active in the bond market in January when rates peaked and also rebalanced many portfolios when the equity markets were at all time highs. For reference, the ten year treasury peaked at 4.8% in January and is now trading at 4.45% on April 9. Fixed income allocations have finally become a hedge to equity market weakness during this trade war correction.
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Click here to read the Q1 2025 Market Summary.
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Data Sources: Economic: Based on data from U.S. Bureau of Labor Statistics (unemployment, inflation); U.S. Dept. of Commerce (GDP, retail sales, housing); Institute for Supply Management (manufacturing/services). Factset (S&P 500 statistics); Performance: based on data reported in Bloomberg (indexes, oil spot prices, foreign exchange); News items are based on reports from multiple commonly available international news sources (i.e. wire services) and are independently verified when necessary with secondary sources, such as government agencies, corporate press releases, or trade organizations. All information is based on sources deemed reliable, but no warranty or guarantee is made as to its accuracy or completeness. Neither the information nor any opinion expressed herein constitutes a solicitation for the purchase or sale of any securities, and should not be relied upon as financial advice. Forecasts are based on current conditions, subject to change, and may not come to pass. Past performance is no guarantee of future results. All investing involves risk, including the potential loss of principal, and there can be no guarantee that any investing strategy will be successful.