First Quarter 2025 - Ripple Effects

Market Recap

The first quarter of 2025 was highly volatile with divergent performance in each investment asset class.  US Large company stocks (S&P 500 Index) experienced a 10% correction before recovering temporarily to end the quarter down 5%.  US Small company stocks (Russell 2000 Index) ended the quarter down 10%.  The Magnificent Seven technology stocks (as a group) were down nearly 16% for the quarter.  In contrast to the U.S., many European and Asian markets rose sharply. Developed International stocks (MSCI EAFE Index) gained nearly 7% while emerging market stocks (MSCI EM Index) finished the quarter up 3%. US bonds (Bloomberg U.S. Aggregate Bond Index) gained 3% for the first quarter.

That only tells part of the story.  The quarter ended on March 31st, but even more volatility hit the markets with President Trump’s “Liberation Day” tariff announcement on April 2nd.  The magnitude of the tariff levies, as well as the methodology for calculating “reciprocal” tariffs, created significant uncertainty and subsequently caused extreme volatility in markets since the rollout.  I have authored several blog articles presenting our analysis on the rapidly changing dynamics of the market.  If you did not receive them and would like to be included in future publications, please let me know.  Due to the timely nature of the correspondence, we couldn’t mail paper articles.   

Investment Outlook

Globalization has represented a multiple decade paradigm shift in global economics.  The US ceded lower skilled manufacturing to cheaper labor emerging market countries and expanded high margin highly technical manufacturing, as well as the delivery of specialized services.  The result has been incredible growth in US wealth and economic power, while also lifting many emerging economies out of poverty.  The US benefited disproportionately and was cemented as the sole world superpower.  As a result of this wealth grab, US consumers went on a spending binge, buying up the world’s products, while using the strength of our investment markets to attract the rest of the world’s excess savings.  Enticed by our ability to borrow from the rest of the world cheaply, we expanded our spending even beyond our outsized means, and we have painted ourselves into a corner with extremely high national debt levels.  As a result of the hollowing out of US manufacturing, a large portion of our population, which don’t have the technological skills for the new economy or who live in areas that didn’t produce advanced high paying jobs, were left behind.  The wealth gap has grown to epic proportions with the rich getting exceedingly rich and the lower income folks being structurally impeded from closing the gap. 

The recent tariff policies have been put forth as a negotiation starting point, with no clear sign of what the ultimate objective is.  We are left to infer what we think the goal is, let alone the ultimate policy.  I believe that the most credible explanation is that the primary aim is to stop globalization and bring manufacturing back to the US.  This is posited as partly about jobs and partly to improve national security by reducing our reliance on products from other countries.  There is considerable debate as to whether this is the right goal, with opinions based largely on where you sit on the income spectrum. Families relying on manufacturing jobs, particularly in rural areas, are generally in favor.  Families secure in high paying jobs, predominantly in urban areas, are generally more concerned about the negative implications for future growth.  Regardless of your view on the goal, tariffs as a policy tool are unlikely to be purely a negotiating tactic that will be quickly reversed.  I believe this represents a change in the paradigm toward protectionism and anti-globalization.  While outsized “reciprocal” tariffs are likely to fade, it is increasingly likely that pervasive structural tariffs will be left in place with similar policy initiatives coming down the road.  There will be many economic and market implications in the years to come. 

Law of Unintended Consequences

The global economy is incredibly complex.  Disruptions in one small part of the globe can have unexpected ripple effects in seemingly unrelated markets.  In 1997-1998, the collapse of the currency of Thailand caused the Asian Financial Crisis, which had outsized effects on other Asian currencies, and ultimately on investment markets around the world, including the collapse of a large hedge fund called Long-Term Capital Management.  The collapse of Lehman Brothers bank triggered the 2008 Financial Crisis and ultimately the Global Great Recession. 

The shock factor of the tariff negotiations has been felt in all markets around the world, justifying the volatile reactions in a variety of investment markets.  There has been very strange trading behavior in the US Treasury Bond markets recently, raising some red flags.  During deep stock market selloffs, there is almost always a “flight to safety” as investors buy US Treasuries, bidding up the price of the bonds.  That didn’t happen this time.  The price of US Treasury Bonds actually declined (causing interest rates to rise).  Foreign investors were aggressive sellers of all US assets, putting the proceeds to work in non-US assets and Gold.  This is new.  The value of the US Dollar has been in a recent decline, causing even more eager money to flow into Gold as an alternative store of value.  Bitcoin has seen aggressive buyers, searching for a non-US dollar store of value.  The odd trading in the US Treasury market is what caused President Trump to back off on the reciprocal tariffs, for everyone except China, for 90 days.  That little trading oddity is a big deal in the investing world, and we are watching closely. 

This is all occurring in conjunction with an inflection point in the US debt situation.  The interest expense alone on our debt now exceeds what we spend on National Defense.  It will soon overtake Medicaid spending, with only Social Security and Medicare accounting for more of the budget.  Part of the globalization paradigm included foreign investors using the income from selling us goods to invest in the US stock market, and especially in buying US Treasury Bonds (our debt).  We depend on those buyers to be able to borrow cheaply and support our national debt.  Markets are now showing signs of concern about our credit worthiness.  If we don’t address our $2 trillion annual budget deficit, let alone our $36 trillion national debt, there will be further adjustments to the conditions we have grown accustomed to in the global economy.  I will be writing in more detail on this issue in future commentary.  Successful negotiation of trade deals with the rest of the world would alleviate much of the uncertainty overhanging markets today, but the ripple effect of unintended consequences bears monitoring.

Portfolio Positioning

We came into the year with a cautious outlook, broadly globally diversified, and heavily tilted toward lower valuation assets.  We have maintained a meaningful allocation to Gold, as a hedge against potential US dollar weakness.  This positioning has benefited portfolios, so far this year.  As a result of the heightened recession risk, we have recently sold out of our economically sensitive US small company position.  Despite sharp US stock market declines, US valuations are still far from cheap.  We will continue to look for opportunities to put the risk allocation to work when and where long-term valuations are attractive rather than chase short-term market movements. 

We thank you for your continued trust in our firm and we welcome any questions that you have. 

Cordially,

Shane M. Alsworth, MBA, CFP®, CLU®, CIMA®

The views and opinions presented in this article are those of Shane Alsworth only (disclosures below)

Sources: Morningstar/Ibbotson data, Ned Davis Research, BCA Research, Litman-Gregory, iMGP

For additional information, please visit our website at https://www.alsworthcapital.com/

*US large stocks (S&P 500 Index), US large cap growth (Russell 1000 Growth Index), US large cap value (Russell 1000 Value Index), US small stocks (Russell 2000 Index), (Developed international stocks (MSCI EAFE Index), Emerging Market stocks (MSCI EAFE EM Index), Core investment-grade bonds (Bloomberg U.S. Aggregate Bond Index), Floating Rate Loans (S&P/LSTA Performing Loan Index), US Dollar (DXY Index), Gold (Aberdeen Physical Gold ETF), Commodities (Bloomberg Commodity Index)

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