Market Review
What a roller coaster quarter! The benchmark S&P 500 index closed the 1st quarter down 4.6%, following a 2.1% gain the prior three months and after initially rising almost 4.5% to yet another all-time high in mid-February. After that high, the index then pulled back by over 10% before staging a solid bounce into quarter-end. Fourth-quarter corporate earnings beat analyst forecasts by over 7%, growing a little more than 13% year-over-year. Revenues surprised to the upside by around 1%, growing over 5% versus the prior year. Analysts project that earnings grew by around 6.5% during the 1st quarter and will grow around 10% in 2025, with double-digit earnings growth in each of the next three quarters. The Federal Reserve (“the Fed”) left their policy rate unchanged at each of their two meetings during the 1st quarter after cutting that rate twice during the 4th quarter. Fed Chair Powell noted in comments that uncertainty around the economic outlook has increased, though the odds of a recession remain quite low, and the central bank remains attentive to the risks to both sides of its dual mandate to promote both low and stable inflation and maximum employment.
The Economy
The U.S. economy expanded at a slightly above-trend 2.4% pace during the 4th quarter, after consensus began the quarter calling for a below-trend 1.4% growth rate. Per the Federal Reserve Bank of Atlanta’s GDPNow model estimate, 1st quarter economic activity will pull back by almost 2%, as US companies pulled forward imports ahead of potential tariffs. First-quarter inflation readings on the central bank’s preferred Core Personal Consumption Expenditures Deflator remained near post-pandemic lows. The Fed’s post-meeting statement in March indicated that labor market conditions remain solid, with the number of job openings and job seekers fairly balanced. Economists anticipate the U.S. economy will grow a slightly above-trend 2.2% during 2025, which would mark a roughly 1% slowdown versus each of the prior two years. The unemployment rate stands 0.7% above the cycle low of 3.4%, and remains quite low by historical standards. Longer-term interest rates fell by 0.2%-0.4% during the quarter, which may be marginally stimulative for the U.S. economy.
Equity Markets
The S&P 500 topped only three sectors during the first three months of 2025 after topping five during the final three months of 2024. Communication Services (down 6.4%), Consumer (down 6.9%) and Technology (down 12.8%) sectors all lagged that broader market for the quarter, and between the three of them, they comprise 56% of the index’s market value. Consumer spending remains solid overall, but moderated compared to a robust holiday season. Investors see a potential drag on consumption due to tariffs potentially arriving on the heels of the cumulative inflation in recent years. Communication Services and Tech faced two related headwinds, as investor concern over eventual returns on capital-intensive investments in infrastructure to support artificial intelligence (A.I.) efforts met with news that a Chinese firm had allegedly developed a sophisticated A.I. model using comparatively less advanced computer chips and at substantially lower cost than their Western counterparts. There was something of an “aha” moment, however, with the revelation that the Chinese A.I. model was trained by using Western A.I. models. Energy (+7.2%) led all sectors, as investors saw the new administration as more friendly on a regulatory front and more likely to approve new infrastructure to support domestic energy markets supporting A.I. data centers and a more robust power grid overall. Healthcare (+6.1%) topped all sectors except Energy, as investors sought stability in a more uncertain macro environment. Financials (+3.1%) finished third among sectors, because investors anticipate a less restrictive regulatory environment for the sector and for mergers and acquisitions overall, which could help drive investment banking activity. Real Estate (+2.7%) also benefited from investors looking to own stable business platforms. Given the sector’s dividend focus, it tends to perform well when longer-term interest rates are stable or falling. Industrials (down 0.5%) trailed the top four sectors by a good bit, boosted by their role in building our US energy and power grid infrastructure but pulled down by headwinds from potential retaliatory tariffs on U.S. goods shipped abroad.
Long-Term View
Businesses and investors can handle negative news. In fact, investors want to own businesses whose management teams show the resiliency to improvise and adapt to overcome challenging backdrops. Those two groups can handle positive news, as long as investors can avoid becoming irrationally exuberant and getting too aggressive in the face of that news. Both businesses and investors, however, struggle to deal with pending news. Will the U.S, institute tariffs? The markets have seen such measures announced, then rolled back or delayed. Which countries will be covered? Which goods will be covered? What goods or industries might be exempted? Will other countries around the world institute tariffs on U.S. goods? To be sure, the market narrative has been filled with such questions, which very much embody “pending news”. Successful businesses plan well, and then execute well. Pending news makes both aspects challenging for management teams. Businesses commit their valuable capital to generate long-term returns. Expensive initial investments can produce returns that far exceed the initial outlay. Management teams deal in probabilities in terms of potential outcomes for those investments, but pending news makes those probabilities difficult to determine, meaning decisions and the ensuing activity get delayed. Amidst pending news, it makes sense—as ever—for investors to block out short-term noise and focus on the long-term plan they have in place. Veteran seafarers say to look at the horizon during choppy seas to avoid seasickness. That’s good advice for investors, too.
