As you may know, the stock market has experienced significant volatility in recent weeks due to uncertainties surrounding the administration’s tariff policy — its duration, potential retaliation from other countries, and the risk of a U.S. recession. The following investment commentary reflects the first quarter of the year, prior to these recent developments. Please know that we are closely monitoring the situation and understand the stress it may cause. Challenging times like these highlight the importance of our core investment principles, particularly global diversification and asset allocation, and reinforce why adhering to your financial plan is crucial.
After a strong start to the year, a reversal over the last six weeks of the quarter dragged U.S. stocks into negative territory for the three-month period. Other sub-asset classes had a significantly better quarter, especially international stocks and certain alternative investments. Concerns over tariff policy weighed on U.S. stock prices, as did the realization that the very accommodative fiscal policies enacted since the onset of COVID-19 were being re-evaluated by the Trump administration. Bond prices rose over the quarter, as interest rates dipped based on the belief that economic growth will slow and inflation could remain elevated well into 2025. Volatility increased in the first quarter; however, this generally represents a return to normal after the relative calm of the past two years.
International stocks (MSCI All Country World Index ex-U.S.) significantly outperformed U.S. stocks (Russell 3000). Prospects for increased fiscal spending by Germany and China helped fuel the outperformance by international stocks; however, geopolitical conflicts around the globe and the uncertain effects of U.S. tariff policy on foreign country economies pose potential challenges to international stocks over the remainder of 2025. Developed markets companies (MSCI EAFE) held the overall leadership mantle, although emerging markets (MSCI EM) companies also posted solid gains. In U.S. markets, none of the capitalization-weighted indices escaped with a positive quarterly return, but large-sized (S&P 500) companies did outpace their small-sized (S&P SmallCap 600) and mid-sized (S&P MidCap 400) counterparts. Small companies experienced a particularly pronounced whiplash – shifting from outsized gains post-election to the most precipitous drop in the quarter.
Bonds (Bloomberg US Aggregate Bond Index) performed in their more traditional role as a ballast to stock market turmoil, returning positively over the quarter. Interest rates gyrated over the quarter, ultimately ending generally lower on expectations for more muted economic growth in the coming quarters. The outlook for Federal Reserve policy has coalesced around a holding pattern – as the Fed is likely to wait to cut rates further until more marked signs of lower inflation emerge.
Alternative assets increased during the quarter, boosted by solid contributions from commodities (Bloomberg Commodity), natural resources stocks (S&P Global Natural Resources), and global real estate (FTSE EPRA/NAREIT Developed).
“The key to making money in stocks is not to get scared out of them.”
– Peter Lynch
Human nature often nudges us toward minimizing the volatility of outcomes in our activities: looking both ways before crossing a busy street, not eating every wild plant you come across on a nature walk, tightly securing that car carrier the first time you take a child home from the hospital. Investing is an activity where the volatility of potential outcomes is well known: the tradeoff between risk and return is ever-present when making decisions. However, that does not necessarily mean that learning to live with market volatility is easy! Legendary fund manager (and author of several classic investing books) Peter Lynch serves as a calming voice by distilling the essence of stock market investing down to don’t get “scared out” of doing it.
Now, this is not necessarily an argument for throwing caution to the wind and holding all your money in stocks. Rather, it’s confirmation that volatility in the stock market is a feature of the investing ecosystem, not a bug. To reap long-term rewards, investors must be prepared to handle the inevitable bouts of volatility and declines that crop up. Since 1950, the S&P 500 Index has experienced 39 declines of 10% or more (generally defined as a correction). Eleven of these instances have morphed into bear markets (greater than 20% downturns). Those figures average out to a market correction every other year and a bear market every seven years, meaning that market drops are normal occurrences along the investment path.
Our current environment of market gyrations to start 2025 is nothing out of the ordinary. Coming off the returns of 2023 and 2024 (two years of being up 20%+ in the S&P 500 Index), the turbulence of this year is not shocking. Stock prices don’t go up forever, and when a substantial amount of expected future return is realized sooner than anticipated (as in the past two years), it’s only rational that fluctuations following that period of strong returns serve as a release valve before a bubble emerges.
Multiple factors contributed to the significant run-up in stock prices since the end of 2022. Huge amounts of government spending, coupled with extensive borrowing at low interest rates (corporate bond issuance and residential mortgage refinancing, for instance) accelerated economic activity and helped boost corporate profits. Productivity and technology gains also helped fuel the advance through productivity enhancements. As a result, heading into this year, stocks were highly valued by historical standards (as measured by price-earnings ratio) – leaving them susceptible to some mean reversion.
Of course, volatility can be exacerbated by actual and proposed public policy and world events. There is little doubt that the inconsistency of the Trump administration’s tariff policy has contributed to market fluctuations, as has the market realization that the COVID-era level of fiscal spending (promulgated by both parties) is untenable. Just as annual stock returns of 20%+ cannot happen in perpetuity, $2 trillion annual budget deficits cannot continue unabated. At some point, spending and tax policy will have to adjust and America will pay the piper. As those details get worked out, the turbulence of this year could stick with us for some time, a sharp contrast to the relative smooth sailing of the past few years. While we don’t expect a market drop like those experienced in 1999 or 2008 in the near term – due to still-solid economic fundamentals – some bumpiness as policies shift into place is a high-likelihood event.
In the first quarter of the year, we conducted some larger-scale trading activity in client accounts. The primary goal of this trading was to return to a neutral stock allocation, relative to benchmark weighting. With the economy still generally healthy and no overwhelming consensus view for what the remainder of 2025 holds, we feel that a neutral allocation is currently warranted. This is NOT an all-in or all-out decision; your portfolio performance is primarily based on the overarching asset allocation selection we arrive at together, and this return to neutral allocation represents a modest yet meaningful adjustment. Our examination of key economic and market data is continuous; if we determine later in 2025 that a different approach is more attractive based on our analysis, we will not hesitate to make additional adjustments.
Beneath the top-line asset allocation, we regularly express our views on market sectors through tilting at the sub-asset class level. Some adjustments in the first quarter reflect those views. We are amending the composition of our stock sleeve from a 75% U.S. / 25% international mix to 80% U.S. / 20% international. This is not a broad change – but rather a slight leaning-in to the belief that the U.S. is slightly better positioned than the rest of the world for the remainder of the year.
Additionally, our domestic multifactor (value, momentum, and quality components) fund was swapped out in favor of a pure momentum fund. While most of our U.S. stock allocation will remain in a cap-weighted approach (small/mid/large indices), adding the momentum fund (alongside our long-standing dividend ETF) as another tilt gives exposure to a singular factor that we believe will be additive to portfolios.
Amid the ups and downs of market volatility, our commitment to the Planning Alternatives core investment principles has not wavered. The tried-and-true tenets – asset allocation, global diversification, cost sensitivity, and marrying an investment strategy with a comprehensive financial plan – help mitigate some of the inherent risk of stock investing and keep investors from getting “scared out” of markets.
Please contact us with questions regarding any of these items, or just to chat!