Quarterly Recap Q1 2025

SUMMARY

• In Q1, ‘Value’ and ‘Defensive’ beat ‘Growth,’ which has continued early in Q2.
• We still believe medium-term US earnings trends will remain solid.
• We look to the upcoming earnings season for direction in reinvestment.

In a vacuum, the first quarter of 2025 appeared to continue the seesawing between ‘growth’ and ‘value’-oriented themes that we’ve seen over the past year. Specifically, most ‘value’ and ‘defensive’ market segments (with the notable exception of US Small Cap) led the way, after trailing ‘growth’ markets in the fourth quarter of 2024.

However, like most things in the investment world, these returns cannot simply be viewed in a vacuum. With the benefit of the context of the first two weeks of the second quarter, the first quarter can now be seen as a precursor to the market’s shift into a more defensive investment style. We believe this shift is primarily due to uncertainty surrounding tariffs, which is creating significant downward pressure on global markets. It will not be until we start to see first quarter earnings that we can truly assess whether this uncertainty has manifested into tangible deterioration in corporate fundamentals. In the meantime, we can still garner insights from these returns.

US Sectors: In Q1, Defensives and Value at the Top

Table 2 (below) shows US sector performance. In a reversal of the fourth quarter, technology-related themes in Consumer Discretionary, Technology and Communication Services were the only sectors with returns below the S&P 500. From a fundamental standpoint, we still have conviction in the largest of these growth companies. We believe they are still producing strong cash flow and have large installed user bases. Within these sectors, the area we are less convicted in is the smaller market-capitalization companies.

Moving to the highest performing sectors, US energy was the best performing sector after three consecutive quarters of negative returns. However, in our view, this uptrend may be short lived given more recent happenings. Over the first two weeks of the first quarter, we have seen a large drawdown in oil prices, spurred on by OPEC+ production hikes. This weakness in price could hurt the US energy business model, especially if rising prices elsewhere eat into their margins.

Health Care, Consumer Staples, Utilities, and Real Estate were also among the top performing sectors. We consider these sectors to be ‘defensive’ sectors, and their strong performance could point to the market’s concern over the health of the US economy. Our house view is that these sectors are not the best positioned given current macroeconomic conditions. Specifically, we have concerns on these companies’ margins, as their input costs rise due to tariff and their ability to pass on these costs to customers may be close to capacity. We will look to US earnings season for the first quarter to help evaluate the fundamentals of these companies and help bridge the gap between market performance and our views.

International Stocks: In Q1, International Rallies, Led by China and Europe

Moving to Table 3 (below), each international market in our global universe outperformed the S&P 500 for US investors. Europe and China were the best performers. For Europe, there are two takeaways from this rally, in our view. First, the market could be hoping fiscal stimulus announced by Germany makes its way across the continent, spurring on their more value centric equity markets. Second, again with the context of the past two weeks, global investors could be moving away from dollar denominated investments, due to tariff uncertainty.

For China, the rally in equities has followed a similar trend as more traditional value-oriented market. From a valuation perspective, it can appear to be more value leaning, but, when looking at its sector breakdown, there is a lot of technology exposure. In our view, this separates it from other international markets in its reaction to a reflationary environment. Regardless of sector composition, we remain reluctant to invest in China due to concerns around foreign investor protections, opacity around economic data, and their posturing in the geopolitical theater.

Currency returns in this quarter may have been the biggest sign of what was to come in the first weeks of the second quarter, in our view. Most developed international currencies rallied relative to the dollar, which we again attribute to concerns about US tariffs. More commodity-focused countries, such as Emerging markets and Canada, saw flat to slightly negative currency movements, due to weakness in commodity prices this quarter.

Looking Forward: Watching Earnings Carefully for Potential Future Reinvestment Opportunities

Recapping past market returns can be a tricky exercise, especially when you add severe market volatility to the mix. While tariff uncertainty loomed over the first quarter, it has fully taken hold of the second quarter, through two weeks. We have spent recent Strategic Views (see here and here) discussing this uncertainty, the tariffs causing them, and our views on potential market scenarios that could result. As a quick refresher of our conclusions from these pieces, we are comfortable currently maintaining reduced risk levels in both our longer-horizon and particularly in our shorter-horizon balanced portfolios. To varying degrees depending on the time horizon of the portfolio, we have trimmed both US equity exposure as well as credit and interest rate sensitivity.

Note: As mentioned last week, in addition to further risk management contingencies, our scenario analysis also incorporates equity re-investment as well as divestment plans. As we stated in our Outlook, corporate America is unbelievably adept at quickly adjusting to unexpected macro impacts and protecting earnings and margins. As such, we must be patient and diligent when it comes to analyzing these markets and their earnings. It is still our house view that intermediate-term earnings trends will remain stronger in the US than internationally. With that being said, if earnings season shows signs that US earnings are beginning to falter and/or international earnings are beginning to rally, we will adjust the portfolios accordingly.

Risk Discussion: All investments in securities, including the strategies discussed above, include a risk of loss of principal (invested amount) and any profits that have not been realized. Markets fluctuate substantially over time, and have experienced increased volatility in recent years due to global and domestic economic events. Performance of any investment is not guaranteed. In a rising interest rate environment, the value of fixed-income securities generally declines. Diversification does not guarantee a profit or protect against a loss. Investments in international and emerging markets securities include exposure to risks such as currency fluctuations, foreign taxes and regulations, and the potential for illiquid markets and political instability. Please see the end of this publication for more disclosures.