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 Market Performance

The first half of the quarter was buoyed by optimism around the constructive elements of the Trump administration, including de-regulation and tax cuts. From Election Day through February 19^th, the S&P 500 experienced a 5.7% rally. The back half of the quarter brought noise on the policy front, in particular tariffs. The uncertainty around the end game and the potential impact on economic growth weighed on investors, consumers, and businesses. As a result, the index dropped 10% from the intra-quarter high. For the quarter, the S&P 500 declined by 4.3%, including a 5.6% tumble in March.

The tech-heavy Nasdaq, which drove much of the market gains in 2024, reversed course and fell by 9.6% for the quarter and 7.4% for the month of March. The Magnificent Seven (Alphabet, Amazon, Apple, Meta, Microsoft, Nvidia, and Tesla) declined by 15% over the first three months of the year after collectively returning 156% over the previous two years. Their might, roughly 1/3^rd of the weight of the S&P 500, dragged the other 493 constituents of the S&P 500 into negative territory, even though those stocks were up 0.4% on the year.

Mid and small caps didn’t fare any better. Mid caps were down 6% for the quarter and 5.5% for March. Small caps fell 9% and 6% over the same respective timeframes. Uncertainty over the economy and future trajectory of potential Fed rate cuts weighed on investor sentiment. Consumers, the engine of the economy, were spooked about the potential of a recession and the possibility of accompanying layoffs.  The Consumer Sentiment Index fell to its lowest level for three years, and the third lowest over the past decade and a half.

For the first time since 2010, international outperformed US stocks. The global foreign equity index was up 5% to end the quarter on the back of a weakening dollar and concern over domestic policies. Increases in spending on defense and infrastructure in Europe and strengthening fundamentals proved a tailwind for the sector.

Bonds were also a bright spot in a tough quarter. The Bloomberg US Aggregate benchmark was up 3% to start the year as the 10-year treasury yield fell from a high of 4.8% in January to a low of 4.1% to end March, as the flight to safety drove bond prices up and yields down.

Unknown Unknows Persist

Last quarter we discussed how even though we knew who would be helming the county, there was still uncertainty around how their objectives would impact the economy in the medium and long term. While that persists, new short-term concerns have surfaced much faster than expected, including escalating trade wars, questions about Fed independence and the dollar as a haven currency. Understandably, there is heightened concern about the path forward for the U.S. economy and how it will affect markets. And while there is no out-of-the-box solution, what investors can do is ensure that portfolios align with long-term objectives.

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Market Performance

The last month of the year saw investors pare back their winnings on fears of higher interest rates and rising economic uncertainty. The S&P 500 and Dow were down single digits, while the Nasdaq eked out a modest gain. Over the quarter they were up 2.4%, 0.5% and 6.2% respectively and 25%,13%, and 29% over the past 12 months. For the year, mega-cap tech stocks were one of the main drivers of returns with communication services and information technology both up over 35%. AI related optimism and robust economic growth proved to be tailwinds to the overall market.

Mid and small caps reversed the previous quarter’s outperformance and lagged the general market by about 5%. Enthusiasm over the election being in the rearview waned and was instead replaced with inflation jitters and concern over fewer than previously expected Fed rate cuts.

International equities also experienced a challenging end to the year. The broad-based developed market index fell by 2.3% in December and8% for the quarter but ended in positive territory for the year up 3.8%.Emerging markets held up better, but also experienced a year-end drop. After being flat in December and falling almost 8% from October through the end of the year, the index was up just over 8% over the previous 12 months. Much of the declines were due to a strengthening US dollar, rising political upheaval, and wars continuing on two fronts.  

Fixed income also had a weak end to the year with the10-year Treasury yield rising from 4.2% at the end of November to 4.6% at year-end, undoing the dip at the end of the summer that saw the benchmark bond metric falling to 3.8% by the end of September.

The central factor in all these results was rising long-term interests which hit valuations across the board and new information from the Federal Reserve. Despite the fact that the Fed lowered interest rates by 25basis points in December, they revised their expectations for 2025 showing fewer planned interest rate cuts, from four down to two. This signals that the Fed remains cautious about both the economy and inflation and will act on a meeting-by-meeting basis.

Overall, the economy continued to grow with both jobs and consumer sentiment showing renewed positivity. Higher consumer confidence typically means more spending, which should support the economy and add to corporate profits, creating a virtuous circle.

Known Unknowns versus Unknown Unknowns

Now that the nation has elected a president, the uncertainty of who will helm the country is now known. What is still unknown is what sort of legislation the incoming administration pass or attempt to pass. While tax cuts, tariffs and cost cutting seem to be at the forefront, how these will get implemented and the degree to which they will make an impact remains to be seen. In the short-term they are, on balance, positive for the economy and markets. However, in the long-term they could reignite inflation. While we’ve gotten a lot of answers about the next four years, these questions remain.

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Market Performance

Overall, the market seemed to shrug off the unprecedented political events of the summer with almost all sectors across asset classes positive. The three domestic major indices were up with the Dow leading the group at 8.7% gains as improving fundamentals and solid earnings growth supported lofty valuations. Foreign developed and emerging markets were also up between 7.25%and 8%. The former benefiting from a weaker dollar while the latter the beneficiary of the announcement of a major stimulus package in China.

Drilling down in the US markets, the rally continued to broaden with small and mid-caps outpacing larger companies. The small and mid-cap indices were up 10% and 7% on the quarter with lower borrowing rates and favorable sector weightings (financial and industrials over technology and communication services) providing a tailwind to performance.

Fixed income markets were strong throughout the quarter as falling interest rates and inflation continuing to ebb helped support returns over the summer. The US 10-year Treasury yields fell from 4.5% in July to 3.8%by the end of September, with short-term rates dropping considerably faster with the heightened expectation of continued Fed cuts.

Overall, economic data releases showed positive signs, as hiring and consumer spending remained robust, and inflation continued to wane. All this is a constructive backdrop for stocks and bonds alike.

What to Watch Out For

Although the macro environment paints a rosy picture, there continues to be concerns that could derail what has been a banner year for investments. The primary market risk domestically is a further economic slowdown in the months ahead. The Fed will likely monitor the labor market as an indicator. Conversely, if inflation starts to pick up, the central bank may have backed itself into a corner and have to reverse course; an outcome that would have been unthinkable several months ago.

Foreign risks remain as well, with the increasing conflicts in the Middle East and Ukraine dragging on into multiple years. The recent slowdown in China presents a problem to buyers and sellers alike.  

And finally, political tumult will undoubtedly increase leading up to the November election, and maybe beyond. But whichever party occupies the White House in January will struggle to implement many of its goals. As both candidates continue to flesh out their hopeful policies, the likelihood of a split government (one party controlling the executive branch, the other the legislative) seems to be the most probable outcome and the appetite for across-the-aisle bipartisanship to work on overlapping agendas seems to be lacking. While that may be frustrating from a civil standpoint, it’s counterintuitively positive for markets as it doesn’t allow the pendulum to oscillate too quickly, creating a reasonable near-term case for positive market results.