A Note About April 2nd
The events of April 2nd require some discussion before reviewing the first quarter of 2025, as the tariff announcements President Trump made on that day significantly exacerbated market concerns that were already beginning to surface in the months prior.
On April 2nd, President Trump announced tariffs which would turn back the clock on globalization and usher in an uncertain new era for global trade. New levies include a minimum rate of 10% and an overall weighted average tariff of 23%. This compares to a weighted average tax on imports of just 2.5% in 2024.
The April 2nd tariffs were significantly higher than investors had expected, and markets reacted by falling sharply. Over the two days following the tariff announcements, the S&P 500 lost -10.5%. Fortunately for diversified portfolios, bonds, gold, and to a lesser extent international stocks, held up much better and therefore declines at a portfolio level were considerably less.
The new protectionist approach has markets concerned because tariffs are expected to be inflationary and/or recessionary. There is a distinct chance that both of these things could occur simultaneously, resulting in stagflation. Stagflation, if it’s severe enough, has proven to be quite difficult to reverse.
Markets will undoubtedly be largely driven by news on tariffs in the near term. We are making some adjustments in our portfolios and will be watching to see whether the tariffs seem to be creating a global tariff war or whether they will be reduced from these initial levels. The markets will certainly be hoping for the latter.
Overview of the First Quarter of 2025
US stock market investors started to become anxious in the first quarter of 2025, contributing to volatility in US markets. After rising initially, the S&P 500 fell more than -10% from its peak during the first quarter (a feat that would be repeated in just two days in April).
In the end, the S&P 500, which had posted two strong years in 2023 and 2024, closed the first quarter with a total decline of -4.3%. This was not record-breaking by itself (the S&P 500 declined by -16.1% as recently as the second quarter of 2022) but combined with alarming headlines about tariffs and other far-reaching policy changes, it was enough to create widespread anxiety.
Investor concerns were reflected by corporate leadership and consumers alike. 259 of the companies in the S&P 500 mentioned tariffs in their January to February earnings calls for the fourth quarter of 2024. In March, the latest consumer sentiment survey from the University of Michigan declined to levels not seen since 2022 as consumers predicted inflation of 5% a year from now, driven by tariff concerns.
The University of Michigan report noted that the decline “reflects a clear consensus across all demographic and political affiliations; Republicans joined Independents and Democrats in expressing worsening expectations since February for their personal finances, business conditions, unemployment, and inflation.”
There appears to be a sense, among the majority in the country, that the tariff policies do not address their economic priorities. Poll numbers regarding President Trump’s ability to handle the economy, relatively high at the start of the quarter, have been falling, with specific concern that there is not enough focus on reducing inflation and too much on raising tariffs.
There remains the possibility that a reversal of the tariffs through negotiation would lead to a substantial recovery in the markets. However, the uncertainty caused by the haphazard rollout of the tariff policies seems to have already done some damage to future growth — to cite just one example in the first quarter, the number of newly announced mergers and acquisitions dropped to its lowest level since the financial crisis. One would presume that the longer the tariff negotiations go on the more damage will be done.
While many areas of the US stock market declined (although some were up), international stocks and bonds gained. In the sections that follow, we discuss the underlying drivers of these changes. In this quarter’s market commentary, we have included some updates through April 4th (in parentheses and italics). We run the risk of this commentary being behind the news no matter how often we update, but we wanted to include at least the initial reactions to these extraordinary events.
Stocks
In yet another example of how difficult it is to predict market movements in advance, tariffs impacted stock indices in unexpected ways. As tariff threats grew during the first quarter, international stocks rose while US stocks declined, suggesting that markets initially weighed the tariffs as being worse for US companies than for foreign ones.
For the first quarter, the MSCI EAFE index of developed market stocks gained +6.9%, while the Russell 1000 index of large US stocks declined -4.4%. This 11.3% outperformance of foreign stocks was partly due to yet another unexpected market reaction, which was that the US dollar fell on tariff concerns (it had been widely expected to rise if tariffs were implemented). In local currency terms the MSCI EAFE index only gained +2.9% but because of the dollar’s decline, in US dollar terms this resulted in the +6.9% increase.
(This trend continued in the first two days after the April 2nd tariff announcements as foreign stocks outperformed US stocks)
In the US, growth stocks including Alphabet (Google), Apple, and Nvidia fell more than the overall market. Overall, the Russell 1000 Growth index declined -10.0% in the first quarter, while the Russell 1000 Value index gained +2.1%.
(In the first two days after the tariff announcements, this trend continued, albeit to a smaller extent, as value company stocks declined a bit less than growth stocks)
During the first quarter, small company stocks fell more than large company stocks. This was yet another unexpected result, as many market observers had suggested small company stocks would be more insulated from a trade war since they have less revenue from overseas. However, the overall risk of recession, which falls hardest on the smaller companies, seems to have been the greater consideration. Small cap stocks as measured by the Russell 2000 index fell -9.5%.
(In the first two days after the tariff announcements, this trend moderated, and small company stocks declined approximately in line with large cap stocks)
Bonds
The Federal Reserve opted to keep interest rates steady at its January and March meetings. However, the market began to anticipate that interest rates would decline in the future. The interest rate on the 10-year US Treasury bond fell from 4.58% to 4.23% (further declining to 4.00% as of April 4th).
The decline in interest rates led to gains for bonds. The Bloomberg US Aggregate Bond Index increased +2.8%. Shorter term bonds, which are less sensitive to interest rates, gained a bit less but were still up +1.6% (as measured by the Bloomberg US Aggregate Bond 1-3 Year Index).
Finally, the strongest performing bonds were foreign bonds that benefitted from both declining interest rates and the declining value of the dollar. For example, the iShares 1-3 Year International Treasury ETF rose +4.4% in the quarter.
Commodities
Amid concerns about softening growth in many countries, the price of oil declined slightly. At the start of the year, WTI crude was $72.44 per barrel and by the end of the first quarter it had fallen to $71.87 (by the end of April 4th, oil had dropped sharply to $61.99).
Gold, on the other hand, had another extremely strong quarter. Gold has benefitted from being considered a “risk off” asset, and from strong demand. The Chinese central bank continues to build up its gold holdings, which set a record in February as gold approaches 6% of the Chinese central bank’s foreign reserves holdings. Gold spot price rose +19.3% during the first quarter (although it pulled back a bit in the days after April 2nd).
Looking Ahead
Last quarter, we noted that strategists were “mostly expecting the 2023 and 2024 rally to resume in 2025.” We also noted that “of course, strategists are usually wrong about this sort of thing.” That’s why this Looking Ahead section always tries to stay humble. Our crystal ball is no better than anyone else’s. At Plum Street Advisors we try to stay focused on looking ahead to potential risks, rather than predicting returns.
Currently, inflation risk seems to be re-emerging. Inflation was well on its way back down toward its 2% target in 2024, but it has hit a floor recently, and if tariffs stay anywhere near their new levels, inflation is likely to escalate.
The US market also seems to have some unique risks at the moment (other than the previously-mentioned tariff risk). The S&P 500 contains 500 stocks – but just five of them (Apple, Microsoft, Nvidia, Amazon, and Meta) make up 25% of the value of the index. Growth in these stocks has been spurred on by the artificial intelligence boom, as has the value of many other stocks, and a pullback in the tech sector is another serious risk in the US market. By contrast, the MSCI EAFE index of international stocks is much more diversified. The top 5 stocks make up just 7% of the index, and they range from technology to consumer goods to pharmaceuticals.
As we continue to identify emerging risks, we will also continue to adjust the diversified portfolios to address these risks. Inflation-protected bonds can help protect against inflation, for example, while international stock holdings can help reduce concentration risk. In the long run, holding a well-considered diversified portfolio of various stocks, bonds, and commodities avoids having to try to use a crystal ball to out-guess the market. It certainly has been helpful so far this year.