Market Commentary | Q1 2025
Over the past three months, one thing has been clear: investor sentiment has shifted markedly towards uncertainty and caution. Many people are feeling unsettled, wondering how long the current period of tumult and disruption will last. Meanwhile, markets are doing what they always do – they look ahead, digest new information, evaluate shifting sentiment and surprise policy moves, and then adjust prices in the present.
While dramatic shifts in tariff policy and trade relations have shocked many investors, the stock market has behaved in a fairly rational manner. We say this not as a balm for falling stock prices, but simply as a reminder that the market is trying hard to forecast an inherently unknowable future. Some analysts have put forth scenarios that predict continued resilience in certain industries, a soft landing, and policy reversals or exemptions that help avoid deeper disruption. Others expect prolonged trade tensions, elevated inflation, or slower economic growth in the US and internationally. No particular outcome is guaranteed or is likely to unfold exactly as predicted, and yet the market is tasked with pricing a variety of future scenarios.
Market behavior this past quarter reflects heightened uncertainty – not a full-scale break in confidence about our economic future, but an ongoing recalibration in light of a more complicated picture that includes this week’s antagonistic rollout of new tariffs.
Looking Back at Q1
In January, on the heels of strong market growth in 2024, many investors were feeling confident that the US economy was on strong footing and a new Republican administration would provide additional tailwinds for the business environment. So far, the story has played out quite differently.
Tariff-related headlines buffeted US equity markets throughout the first quarter. US stocks rallied to start the year, but began their retreat following the imposition of new tariffs on Mexico, Canada, and China in February. March offered little relief, with the US administration announcing new tariffs on steel, aluminum, and autos. Meanwhile, shifting expectations around the severity of Trump’s April 2 tariff announcements drove swings in market prices and ultimately triggered a significant pullback this week.
Prior to the declines in US stocks this week, the first quarter saw a market in which our client portfolio performance ranged from slightly positive to slightly negative. The value of diversification was on display this quarter as declines in US stocks were offset by gains in international equities, real estate, and bonds.
- US Large Cap Stocks, as measured by the S&P 500 index, declined by -4.3% during the quarter. This included a decline of -10% from their highpoint in mid-February and was led by even larger declines in tech stocks colloquially known as the Magnificent 7. Tesla lost well over a third of its value in Q1 alone, with Nvidia and Alphabet/Google each losing close to 20%.
- US Small Cap Stocks, as measured by the S&P 600 index, declined by -8.9% during the quarter. Smaller companies often have less pricing power to temper the impact of tariffs, and while they can provide faster growth during economic booms, they also tend to be more sensitive to economic slowdowns.
- International Stocks, as measured by the EAFE index, saw price growth during the quarter of +6.9%. Fiscal stimulus and new infrastructure spending were key drivers of this growth.
- Broad US Bonds, measured by the Bloomberg Aggregate Bond Index, grew by +2.8% during the quarter and provided a welcome source of stability. Additionally, expectations solidified that the Fed would cut interest rates this year, which helped bond prices move higher while still providing portfolios with ongoing interest income.
- US Real Estate, measured by the FTSE NAREIT index, also grew during the quarter with a price increase of +2.9%. Real estate was also aided by expectations of lower interest rates in the future that would bring mortgage rates and borrowing costs down.
Diversification in Action: International Stocks Outperform
One of the most noteworthy stories in Q1 was the outperformance of international equities. The confrontational approach from the new US administration galvanized European policymakers, with President Trump’s policies (ironically) leading to US declines and European exceptionalism, at least in the short term. The real boost has come from the fact that the fiscal response from EU countries has been swifter and more significant than many investors expected.
European Commission President Ursula von der Leyen announced a proposal for approximately €800bn of spending to boost the bloc’s defense capabilities, while Germany announced a new €500bn infrastructure spending plan.[1] Further, Eurozone interest rates were cut twice during the quarter, with an additional 60 basis points of cuts expected by markets over the remainder of 2025. While the future remains uncertain, market prices in Q1 are already reflecting this decisive shift towards higher spending and infrastructure investment in Europe.
Despite lagging U.S. stocks in recent years, we have intentionally maintained an allocation to international equities – knowing that leadership rotates and global diversification adds resilience. History has shown that exposure to stocks in developed countries and emerging markets has provided benefits at different moments in the market cycle. Looking ahead, we may see an even larger diversification benefit in the future if and as economies globally become less aligned. In the short term, we are trimming some of the recent gains in these stocks as part of our regular rebalancing process and expect this allocation will continue to provide ballast to our client portfolios during this volatile period in the market.
Markets Price Possibility, Not Certainty
Even with the rollout of new tariffs and the layoffs of thousands of federal employees, there is no guarantee that the US economy will slow significantly or enter a recession. That said, the probability of this outcome has increased in recent weeks. Over the course of the first quarter, Wall Street’s optimism for a pro-growth agenda and tax cuts has been replaced by rising concerns about the potential impact of a new global trade war.
We are already looking ahead to Q1 earnings reports, which will begin in a few weeks. This will be an opportunity for companies to highlight their first quarter results, which may not be significantly impacted by new tariffs or policies yet. Currently, the estimated year-over-year earnings growth rate for the S&P 500 is +7.3%, which would mark the seventh-straight quarter of earnings growth.[2] Further, companies will try to strike a balance between adjusting profit expectations downward based on new tariff and supply chain impacts while also telling investors they are prepared to navigate this new landscape. While volatility may persist, Q1 earnings could offer a dose of reality and help to ground investors in tangible results rather than a theoretical future.
The speculative nature of markets leads to overreactions, both on the upside as well as the downside. A new economic report or a rumor about an upcoming tariff announcement can send the market scurrying higher or lower, and it can feel disorienting, especially when media coverage amplifies the swings. However, this constant recalibration is also what makes markets efficient over the long term. Eventually, fundamentals reassert themselves. Quality companies with solid earnings, sustainable business models, and prudent management continue to grow. Investors who maintain a steady diversified strategy, rather than chasing headlines, are often best positioned to see long-term benefits.
Stay Grounded, Stay Diversified
This is a new chapter for the market and our interconnected global economy, but it does not require an entirely new approach. At North Berkeley, we believe client portfolios should be built with thoughtful diversification and maintained with regular rebalancing rather than reactive market timing. Further, we pair our portfolios with long-term financial planning, allowing our clients to assess their financial security in a more personalized way. This quarter offered a timely reminder of the benefits of this philosophy.
While every period of disruptive transition feels unique – which they are in various ways – we have confidence that financial markets and the global economy have successfully navigated many crises, transitions, and economic and political cycles throughout history. With hindsight, we can see that in each of those times, remaining invested led to financial rewards over the long run.
The market’s job is to price a multitude of futures; ours is to help our clients remain grounded through them all.
Resources
[1] Germany votes for historic boost to defence spending. BBC
[2] Earnings Insights 03/28/2025. FactSet
