MARKET RETURNS: It’s not lost on us that the market turbulence over the first few trading days of Q2 has rendered Q1 performance commentary outdated. While prices remain volatile, year-to-date through April 7: foreign stocks have been more resilient than U.S. stocks, bonds have produced positive returns, and certain alternative investments remain comfortably in positive territory.
For the first quarter, global equities were down moderately as the drag from U.S. stock prices outweighed gains overseas. The S&P 500 finished the quarter with a mid-single-digit decline despite a strong start to the year, making an all-time high as recently as February 19. Shares of domestic small and midsize companies fared slightly worse. Value stocks beat growth around the globe, low volatility outperformed within developed markets, and momentum and quality were mixed across regions. Fixed income posted positive returns, with U.S. bonds slightly ahead of foreign. Cash equivalents continued to generate consistent mid-single digit returns as the Fed maintained its policy rate. Gold prices extended their rally, surpassing $3,000 per troy ounce for the first time.
LOOKING FORWARD:
Tariff Shock: The White House announced the following tariffs on April 2:
-
- 25% on foreign autos effective immediately
- 10% baseline effective April 5
- reciprocal at 50% of USTR’s calculation of overall barriers to US trade effective April 9
These changes would bring the U.S. effective tariff rate to its highest level since the early 20th century, causing a major economic shock as the administration attempts a meaningful re-ordering of global trade. Although tariffs were a fixture of campaign trail rhetoric, investors chose to take Trump seriously rather than literally and few expected a move of this magnitude.
The market reaction has been severe as investor expectations adjusted to reflect a higher probability of recession. Major stock markets traded down double-digits over the ensuing two days. Selling pressure appeared indiscriminate in a broader de-risking of equity exposure. Intermediate interest rates fell, boosting prices for high-quality bonds. A depreciating U.S. dollar provided a marginal tailwind for foreign assets and commodity prices, though the negative implications for growth tended to dominate.
Strategic policy objectives include reducing trade imbalances, bringing manufacturing back onshore, and generating revenue for the federal government. Key questions remain around the effectiveness of these measures toward achieving those goals, domestic political and business community resistance, response from trading partners, and practical implementation considerations. We see three potential scenarios from here:
-
- most tariffs are removed due to political or legal considerations or because they were an empty threat
- tariffs are reduced as trading partners come to the negotiating table
- tariffs remain as announced
While President Trump focuses on stock market performance as a gauge of success, the trade issue appears to be a higher priority for his administration.
The economic and market implications are highly dependent on which scenario materializes. Tariff removal would likely trigger a stock market rally and a return to the economic status quo, albeit with a hit to sentiment. Markets appear to be pricing a more moderate tariff regime currently, with lower equity valuations, slower growth, and higher inflation. Keeping tariffs at the announced levels would probably trigger a global recession and further equity downside.
Monetary policy is likely to remain on hold pending further clarity. The potential for slower growth and higher inflation puts the two components of the Fed’s dual mandate (price stability and maximum employment) at odds. An uptick in inflation could necessitate rate hikes, while a recession-induced increase in unemployment could require cuts. Meaningful fiscal stimulus appears unlikely due to deficit spending and the associated increase in the national debt in the aftermath of the pandemic.
The Long View: Remaining disciplined is critical during times of heightened volatility and uncertainty. Drawdowns are an inherent aspect of stock market investing, with a -10% correction occurring about every 16 months and a -20% bear market materializing around every five and a half years on average (based on S&P 500 data going back to 1942). Time horizon is one of the most significant advantages an investor can possess, with the probability of achieving gains reaching nearly 90% five years out (based on S&P 500 data since 1928).
Each stock market pullback comes with its own drivers and “this time is different” narrative – arguably the four most dangerous words in investing. Catalysts tend to include wars, political upheaval, the bursting of speculative bubbles, public health crises, etc. These events can be extremely concerning as they’re playing out yet tend to present buying opportunities in hindsight. Warren Buffet once said “be fearful when others are greedy and greedy when others are fearful” – sage advice but very difficult to put into practice. It’s our job to help clients enforce this discipline.
Diversification is a rare “free lunch” in investing and a cornerstone of our portfolio construction process. It’s been a difficult philosophy to defend over the past couple years as a narrow group of stocks drove back-to-back 25%+ gains for the S&P 500, well ahead of most other asset classes. Yet balancing risks in a broader portfolio can yield benefits in uncertain times, whether that means owning foreign assets to hedge currency fluctuations, owning smaller U.S. stocks for insulation from trade tensions, owning bonds to protect against a slowdown in economic growth, or owning inflation-sensitive assets to preserve purchasing power.
Conclusion: We’re monitoring developments closely and working to identify opportunities presented by each potential scenario. If recession appears likely and equity valuations contract further, we can increase risk incrementally at more attractive levels. That could also be a chance to harvest losses and make any strategic adjustments more tax-efficiently. If positive developments lead to a relief rally, clients taking distributions could opportunistically increase their cash buffer to insulate from further volatility. Whatever transpires, our goal is to ensure portfolios are positioned optimally to achieve clients’ goals.
We wish you well and are here to support you during these unsettled times!
Index Descriptions:
S&P 500 Index TR is a market capitalization weighted index which represents the broad market for large company U.S. stocks. Returns reflect the reinvestment of dividends.
The MSCI EAFE Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developed market stocks excluding those from the U.S. and Canada. Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.
The MSCI EM Index NR USD is a market capitalization weighted index which represents the broad market for large and mid-sized developing market stocks. Returns reflect the reinvestment of dividends and foreign withholding taxes and are translated into U.S. Dollars.
The Bloomberg U.S. Agg Bond Index is a market capitalization weighted index which represents the broad market for taxable investment grade U.S. dollar-denominated bonds. Returns reflect the reinvestment of interest.
The US Treasury Bill Auction Avg 1-month is an index comprised of short-term U.S. government-issued investments with yields collected weekly and can be considered a proxy for cash.
The opinions expressed in this article are for general informational purposes only and are not intended to provide specific advice or recommendations for any individual or on any specific security. All opinions expressed herein constitute the judgment of the author(s) as of the date of the report and are subject to change without notice. The material has been gathered from sources believed to be reliable, however Opes cannot guarantee the accuracy or completeness of such information, and certain information presented here may have been condensed or summarized from its original source. This information may contain certain statements that may be deemed forward looking. Please note that any such statements are not guarantees of any future performance, and actual results or developments may differ materially from those discussed. Opes does not provide tax or legal advice, and nothing contained in these materials should be taken as such. As always please remember investing involves risk and possible loss of principal capital. Advisory services are only offered to clients or prospective clients where Opes and its representatives are properly licensed or exempt from licensure. No advice may be rendered by Opes unless a client service agreement is in place.
