The first quarter of 2025 was marked by significant volatility in U.S. financial markets, driven by escalating trade tensions, policy uncertainty, and shifting investor sentiment. Despite a resilient labor market and robust corporate earnings, the imposition of new tariffs at the beginning of the second quarter and concerns over Federal Reserve independence deepened the market correction. However, a sharp rally has reversed more recent losses as the Trump administration backtracked on Federal Reserve independence and has seemingly become more conciliatory on trade policy. The S&P 500 and Nasdaq both experienced their biggest quarterly decline since 2022 as the large cap technology trade collapsed. For the quarter, the S&P 500 fell 4.3%, Nasdaq slid 10.4% and the Dow fell 0.9%. The yield on U.S. 10-year treasury bonds fell 37 bps to 4.21% as investors began to price in a decline in GDP growth expectations.
There was significant dispersion among sector returns in the first quarter, as investors continued to rotate out of large cap technology holdings and into traditionally more defensive market segments. Information Technology and Consumer Discretionary were the worst performing sectors, down 12.8% and 14.0%, respectively, as key Magnificent Seven components such as Apple (AAPL), Microsoft (MSFT), NVIDIA (NVDA) and Tesla (TSLA) suffered steep losses after years of outsized gains and significant multiple expansion. The technology trade was also hit hard by tariff concerns and, in the case of NVDA, export restrictions on key products. In contrast, traditionally defensive sectors such as Health Care, Consumer Staples and Utilities, saw gains between 4.1% - 6.1% during the quarter. The market rotation was also evident in factor style returns, where gains were registered by Low Volatility, Value, and Quality, while the Growth, Size, and Momentum factors all declined.
The first quarter of 2025 brought a dynamic mix of economic data that significantly impacted markets, reshaping expectations for monetary policy and the broader outlook for the U.S. economy. Investors entered the year cautiously optimistic, with hopes for a soft landing. However, as the quarter progressed, a series of data releases told a more nuanced—and at times conflicting—story about the state of the economy. January and February Consumer Price Index (CPI) reports surprised to the upside, with core inflation—excluding food and energy—remaining stubbornly high. Year-over-year core CPI in February stood at 3.6%, well above the Fed’s 2% target and slightly higher than expected. The March CPI report, released in early April, solidified the trend: services inflation remained sticky, driven by shelter costs and a reacceleration in medical services. The data sparked a sell-off in bonds, as traders rapidly repriced expectations for Federal Reserve rate cuts. What had been a consensus view of 2–3 rate cuts in 2025 was abruptly pared back to just one—possibly in late Q4. The unemployment rate hovered near historic lows, ending the quarter at 3.9%. The JOLTS data (Job Openings and Labor Turnover Survey) showed a modest decline in openings, reinforcing a narrative of gradual cooling without collapse, though much of the announced Federal workforce reductions have yet to appear in the data. The Bureau of Economic Analysis' advance estimate for Q1 GDP, released in April, indicated a 1.6% annualized growth rate—far below Q4 2024’s 2.3% pace. The deceleration was driven by weaker inventory investment and a slowdown in consumer spending, particularly on goods. Retail sales in February and March were underwhelming, hinting at some consumer fatigue amid high interest rates and lingering inflation pressures. However, services spending remained resilient, bolstered by travel, dining, and healthcare consumption. Consumer sentiment dipped in March, reflecting rising concern about persistent inflation. In regard to the U.S. economic outlook, our base case calls for the trend of slowing economic growth to continue in the first half of 2025 with GDP growth forecast to be below 1.5%, and we have also introduced the possibility of recession to our scenario analyses in acknowledgement that there are significant risks to economic growth due to the increasing possibility of unfavorable tariff policy outcomes. However, we would caution that economic scenario analysis is extremely difficult at the moment given the level of uncertainty involved, and are internally viewing them as guideposts rather than forecasts in this fluid geopolitical environment.
International equities are outperforming U.S. equities by the widest margin since Q2-2002, as investors took note of improved economic and corporate earnings prospects on the back of new stimulus measures in China and Europe, particularly Germany. International markets have continued to perform well into the second quarter despite the imposition of draconian tariffs on China and significant tariffs on key European exports such as autos and trucks. In contrast to the U.S., many developed and emerging market central banks have continued to cut interest rates as inflation reached their respective target levels, which has added to positive sentiment.
Under the current policy-driven uncertain conditions, high-quality fixed income appears increasingly attractive. Starting yields—historically strong indicators of forward returns—remain at 15-year highs, offering compelling income potential and downside protection if recession risks materialize later this year. High-quality bonds typically exhibit lower volatility than equities, providing a more stable source of return for investors in uncertain economic conditions. Since the Fed began its rate-cutting cycle in September 2024, the outlook for cash yields has deteriorated relative to bonds, as market rates move lower in response to growth concerns. As additional Federal Reserve rate cuts come into focus, bond investors stand to benefit from capital appreciation and higher income than money market funds provide.
We remain selective within our portfolio’s fixed income allocation, focusing on higher quality, more liquid, and resilient investments. Defensive sectors and large, systemically important banks with strong capital positions continue to offer value. Government-guaranteed mortgage securities (Agency MBS) are particularly attractive, as their spreads over Treasuries remain near historical highs, making them a liquid alternative to corporate credit. As always, fixed income portfolio duration should align with client cash flow needs, with a neutral benchmark anchoring.
As we move further into the second quarter, several factors will influence the trajectory of U.S. financial markets. The introduction of sweeping tariffs in early April has led to increased market volatility. These measures have raised concerns about inflationary pressures and potential disruptions to global supply chains. The IMF has revised its global growth forecast for 2025 downward to 2.8%, citing the negative impact of U.S. trade policies. The U.S. growth forecast was also reduced to 1.8%. The Fed is expected to maintain a cautious approach, closely monitoring economic indicators before making further policy adjustments, despite the Trump administration’s desire for immediate rate cuts. While some analysts anticipate potential rate cuts later in the year, the timing remains uncertain. Increased uncertainty has led investors to seek safe-haven assets, including gold, which we remain overweight as prices reach record highs. In addition, the U.S. dollar weakened significantly, reflecting concerns over the country's trade policies and economic outlook.
Our global equity portfolio remains overweight large-cap U.S. stocks relative to foreign equities, though we anticipate increasing our international exposure as relative growth and valuation prospects are improving after more than a decade of U.S. outperformance. The weakened dollar, which increases returns for dollar-based investors, should also provide some earnings cushion to U.S.-based companies with significant international revenues. We continue to favor high-quality companies with stable growth prospects and have become more cautious in our sector allocations, reducing our overweight exposures to both Information Technology due to still high valuations and reduced growth prospects and Financials, where we reduced some of the highest beta companies in the portfolio. We remain committed to companies positioned for capital investment and long-term growth. Despite the resilience of the U.S. economy, we are closely monitoring tariff policy and its impact on economic growth and corporate earnings, and believe investors should prepare for heightened uncertainty and remain focused on quality, diversification, and resilience across both equity and fixed income portfolios.
Author:
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Bruce Schoenfeld Principal Investment Analyst First American Trust |
Bruce is the Principal Investment Analyst responsible for investment research coverage of various asset classes and equity industry sectors. Bruce has more than 25 years of experience as an equity analyst and portfolio manager. He joined First American from 3P Associates, LLC, an investment and strategic management consulting firm he founded. He previously served as Director of Research at BlueStar Global Investors and as an analyst and portfolio manager focused on emerging markets for Delaware Investments, Artha Capital and Caisse de depot et placement du Quebec, Canada’s second largest pension fund.
Co-Authors: |
Jason Nerio SVP, Director of Investment Research & Strategy First American Trust |
Jason Nerio is the Director of Investment Research and Strategy at First American Trust. Mr. Nerio has more than 25 years of investment research experience. He is responsible for formulating investment strategy and serves as a leading member of the investment committee which monitors and manages the firm’s allocation strategies for over $1 billion in client assets.
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Scott Dudgeon, CFA Director, Equity Research First American Trust |
Scott Dudgeon is the Director of Equity Research at First American Trust. Mr. Dudgeon is a Chartered Financial Analyst (CFA) and has more than 25 years of investment research experience. He also serves as a leading member of the investment committee and has a proven track record for outperforming the markets for our clients. He has been with The First American Family of Companies for 16+ years.
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