By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
Five years out from the market lows of 2020’s recession, the S&P 500 has had a remarkable 171% cumulative total return through the end of March. The start of 2025 has been rocky, however, with the S&P 500 down -4.3% in the first quarter and down -2.4% since the November election. The Bloomberg US Aggregate Bond Index has also experienced some turbulence but is positive 2.8% on the year and 1.9% since the election.
The primary buzzwords in the first quarter were “tariffs” and “uncertainty”, which are factors that almost always weigh down markets. Tariffs were the biggest culprit, because even though everyone expected President Trump to impose some tariffs, investors have been upended by their size and the lack of clarity leading up to their implementation. On April 2nd, the administration imposed baseline 10% universal tariffs on all imports and specific additional tariffs on roughly 60 countries with whom we have trade deficits. These tariffs were in addition to all existing tariffs, and if fully enacted they will amount to the largest tax increase in modern US history by far (see chart below). The expected tariff revenue will be around $100 billion greater than revenues earned from corporate income taxes.
Because tariffs are typically expected by economists to increase prices, cut profits, slow economic growth, increase global tensions, and reduce employment, we do not expect markets or the economy to keep up the pace of the last few years in the near term. The ways the tariffs could potentially pay off in the long run would primarily be by revitalizing our manufacturing sector and increasing tax revenues.
On the manufacturing side, it would take many years to significantly reduce our dependence on foreign supply chains, and doing so would likely still increase prices since American labor is so much more expensive than labor in the countries we currently import form. The effect of tariffs on employment is also unclear and debated. In theory, onshoring should promote new jobs, but a 2019 analysis from the Federal Reserve found that the tariffs from Trump’s first term negatively impacted manufacturing jobs because the boost from import protection was outweighed by the effects of retaliatory tariffs and rising input costs. The effect may be more positive this time around, but it is certainly a policy gamble, and the potential benefits would take time to pan out.
On the revenue side, it’s worth noting that tariffs were our country’s primary revenue source until the introduction of federal income tax in 1913. Since then, they have played a minor role, and our pre-2025 effective tariff rate of below 3% was the lowest among our top 10 trading partners. That number will increase ten-fold if the tariffs announced on April 2nd are fully implemented (see chart below), and on their own they will undoubtedly help decrease our enormous deficit.
Congress will likely need to respond to these tariffs by making their tax bill negotiations more growth-oriented, meaning they could add more tax cuts and incentives that end up partially offsetting that deficit reduction. Tariffs tend to disproportionately affect lower earners since more of their income goes towards spending on goods, but this effect would be less pronounced if the potential tax cuts targeted lower earners, as President Trump said he would like to do. At this point there is very little clarity on how tax reform will look. Additionally, if domestic manufacturing becomes less and less dependent on foreign supply chains, that tariff revenue could decrease and leave us less able to afford dramatic tax cuts.
Along with disruptive trade policy, there have been some small cracks in the employment situation and notable weakness in consumer confidence and housing. The Conference Board Expectations Index, which measures consumers’ outlook for income, business, and labor market conditions in the short-term, dropped to a 12-year low in March (see chart below).
A recession is still not our base case, but the odds have risen and the Atlanta Fed’s GDPNow forecast is predicting negative GDP growth for the first quarter. The Trump administration also admitted that there could be some pain before reaching their long-term goals of shrinking the deficit and reducing foreign reliance. This growth scare puts the Federal Reserve in the unenviable position of needing to consider rate cuts at the same time that PCE Inflation hovers stubbornly above their 2% target. The committee is currently in a “wait-and-see” mindset that is likely to rely more on hard data than soft data, and our guess is that they could be late on cutting rates if there is pressure on growth. Although expectations are constantly changing, markets are pricing in three or four cuts by the end of the year. If needed the Fed could also influence rates less directly by ending or further slowing down their balance sheet runoff.
Given that indicators are pointing to late cycle conditions and stock valuations are still stretched, market returns will likely need to come from productivity-fueled positive earnings surprises. Artificial Intelligence (AI) promises to deliver substantial productivity growth, but it was primarily AI-related companies that dragged down markets in the first quarter as concerns surfaced that the US is over-investing in this theme.
While domestic technology stocks faltered, a falling US Dollar led international stocks to a quarter of exceptional outperformance. Their multiples are still trading at a significant discount to the S&P 500, though, and the effects of tariffs will play out differently for each country. We expect many countries to hit back with retaliatory tariffs, and in some cases non-monetary retaliations that could hurt US exports and our trading reputation on the global stage.
Investment Allocation
Our market convictions are generally the same as they were heading into the year, even with the tariffs and the first quarter rotation from growth to value. We lean towards high quality dividend growers and aim to avoid the concentration risks associated with large cap indices. The top ten names still make up 35% of the S&P 500 as of quarter-end, and we believe the valuation spread between the “average” stock and mega-cap stocks has room to narrow.
Small caps had an even tougher first quarter than large caps, and their valuations look quite attractive on a relative basis. However, small caps are known to be economically sensitive, and in the event that we do experience a material slowdown they could be hit the hardest. As such, we are favoring higher quality, resilient companies in this space.
The international space had an impressive run to start the year, but the question of how much to invest, and in which markets, is as tricky as it has been in decades because of the massive changes in foreign policy under the new administration. We believe that international is worth owning, but we’re cautious against overweighting it, and we rely on active managers who can pick winners in specific markets.
Our fixed income positioning has been driven by the opinion that we will see higher rates for longer, and that this is a good time to earn high income without needing to take imprudent risks. We are underweight duration and overweight quality vs the benchmark but tactically adjusting as rates and spreads move.
As has been the case for years, we continue to like alternative assets for the valuable diversification benefits they can provide in uncertain times. It has been a relief to see bonds hold up while equities have fallen recently, but in this strange environment they could easily become more correlated again.
First Quarter 2025 Commentary
By Daniel McGarvey, CFA on behalf of Stonebridge Financial Group advisors
Five years out from the market lows of 2020’s recession, the S&P 500 has had a remarkable 171% cumulative total return through the end of March. The start of 2025 has been rocky, however, with the S&P 500 down -4.3% in the first quarter and down -2.4% since the November election. The Bloomberg US Aggregate Bond Index has also experienced some turbulence but is positive 2.8% on the year and 1.9% since the election.
The primary buzzwords in the first quarter were “tariffs” and “uncertainty”, which are factors that almost always weigh down markets. Tariffs were the biggest culprit, because even though everyone expected President Trump to impose some tariffs, investors have been upended by their size and the lack of clarity leading up to their implementation. On April 2nd, the administration imposed baseline 10% universal tariffs on all imports and specific additional tariffs on roughly 60 countries with whom we have trade deficits. These tariffs were in addition to all existing tariffs, and if fully enacted they will amount to the largest tax increase in modern US history by far (see chart below). The expected tariff revenue will be around $100 billion greater than revenues earned from corporate income taxes.
Because tariffs are typically expected by economists to increase prices, cut profits, slow economic growth, increase global tensions, and reduce employment, we do not expect markets or the economy to keep up the pace of the last few years in the near term. The ways the tariffs could potentially pay off in the long run would primarily be by revitalizing our manufacturing sector and increasing tax revenues.
On the manufacturing side, it would take many years to significantly reduce our dependence on foreign supply chains, and doing so would likely still increase prices since American labor is so much more expensive than labor in the countries we currently import form. The effect of tariffs on employment is also unclear and debated. In theory, onshoring should promote new jobs, but a 2019 analysis from the Federal Reserve found that the tariffs from Trump’s first term negatively impacted manufacturing jobs because the boost from import protection was outweighed by the effects of retaliatory tariffs and rising input costs. The effect may be more positive this time around, but it is certainly a policy gamble, and the potential benefits would take time to pan out.
On the revenue side, it’s worth noting that tariffs were our country’s primary revenue source until the introduction of federal income tax in 1913. Since then, they have played a minor role, and our pre-2025 effective tariff rate of below 3% was the lowest among our top 10 trading partners. That number will increase ten-fold if the tariffs announced on April 2nd are fully implemented (see chart below), and on their own they will undoubtedly help decrease our enormous deficit.
Congress will likely need to respond to these tariffs by making their tax bill negotiations more growth-oriented, meaning they could add more tax cuts and incentives that end up partially offsetting that deficit reduction. Tariffs tend to disproportionately affect lower earners since more of their income goes towards spending on goods, but this effect would be less pronounced if the potential tax cuts targeted lower earners, as President Trump said he would like to do. At this point there is very little clarity on how tax reform will look. Additionally, if domestic manufacturing becomes less and less dependent on foreign supply chains, that tariff revenue could decrease and leave us less able to afford dramatic tax cuts.
Along with disruptive trade policy, there have been some small cracks in the employment situation and notable weakness in consumer confidence and housing. The Conference Board Expectations Index, which measures consumers’ outlook for income, business, and labor market conditions in the short-term, dropped to a 12-year low in March (see chart below).
A recession is still not our base case, but the odds have risen and the Atlanta Fed’s GDPNow forecast is predicting negative GDP growth for the first quarter. The Trump administration also admitted that there could be some pain before reaching their long-term goals of shrinking the deficit and reducing foreign reliance. This growth scare puts the Federal Reserve in the unenviable position of needing to consider rate cuts at the same time that PCE Inflation hovers stubbornly above their 2% target. The committee is currently in a “wait-and-see” mindset that is likely to rely more on hard data than soft data, and our guess is that they could be late on cutting rates if there is pressure on growth. Although expectations are constantly changing, markets are pricing in three or four cuts by the end of the year. If needed the Fed could also influence rates less directly by ending or further slowing down their balance sheet runoff.
Given that indicators are pointing to late cycle conditions and stock valuations are still stretched, market returns will likely need to come from productivity-fueled positive earnings surprises. Artificial Intelligence (AI) promises to deliver substantial productivity growth, but it was primarily AI-related companies that dragged down markets in the first quarter as concerns surfaced that the US is over-investing in this theme.
While domestic technology stocks faltered, a falling US Dollar led international stocks to a quarter of exceptional outperformance. Their multiples are still trading at a significant discount to the S&P 500, though, and the effects of tariffs will play out differently for each country. We expect many countries to hit back with retaliatory tariffs, and in some cases non-monetary retaliations that could hurt US exports and our trading reputation on the global stage.
Investment Allocation
Our market convictions are generally the same as they were heading into the year, even with the tariffs and the first quarter rotation from growth to value. We lean towards high quality dividend growers and aim to avoid the concentration risks associated with large cap indices. The top ten names still make up 35% of the S&P 500 as of quarter-end, and we believe the valuation spread between the “average” stock and mega-cap stocks has room to narrow.
Small caps had an even tougher first quarter than large caps, and their valuations look quite attractive on a relative basis. However, small caps are known to be economically sensitive, and in the event that we do experience a material slowdown they could be hit the hardest. As such, we are favoring higher quality, resilient companies in this space.
The international space had an impressive run to start the year, but the question of how much to invest, and in which markets, is as tricky as it has been in decades because of the massive changes in foreign policy under the new administration. We believe that international is worth owning, but we’re cautious against overweighting it, and we rely on active managers who can pick winners in specific markets.
Our fixed income positioning has been driven by the opinion that we will see higher rates for longer, and that this is a good time to earn high income without needing to take imprudent risks. We are underweight duration and overweight quality vs the benchmark but tactically adjusting as rates and spreads move.
As has been the case for years, we continue to like alternative assets for the valuable diversification benefits they can provide in uncertain times. It has been a relief to see bonds hold up while equities have fallen recently, but in this strange environment they could easily become more correlated again.
Stonebridge Financial Group
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