Insights

Quarterly Commentary

1Q 2025

Though it seems like ancient history, we start this report by reviewing the first quarter of 2025. Optimism around deregulation and tax cuts carried US stocks higher into February, before giving way to increasing concerns about the new administration’s policies and their impact on the economy. Concern translates to caution, which became evident as consumers and businesses slowed their spending and investing plans as the quarter progressed.

The S&P reached an all-time high on February 19^th, then fell 10% in just 16 days. Leadership flipped – large tech slumped, and financials were the only sector to sustain gains over both Q4 2024 and Q1 2025.

After years of underperformance, foreign stocks fared much better. European stocks, especially those in the defense sector, rose amid expectations for increased government spending as the US appeared to be backing away from commitments to NATO and Ukraine.

The bond market rallied as inflation worries took a back seat to the weakening economic outlook. The yield on the 10-year Treasury note peaked at 4.8% in early January and declined to 4.2% by the end of March. After assuming a normal upward slope last year, the spread between 10-year and 2-year bonds widened slightly to 0.34%.  

April Tariffs

The extent and scale of the tariffs introduced on April 2^nd came as a shock. US stocks fell 10% in two days, and markets elsewhere declined almost as much.

Why the reaction? Our top reasons:

1. 1. Tariffs are a tax increase on businesses and/or consumers. Investors were hoping a Trump election meant taxes would be going down.
2. 2. Tariffs generally shrink the global economy through increasing prices and lowering volumes. Getting a slightly larger slice of a smaller pie isn’t likely to deliver the promised economic gains. There may be good reasons to do this selectively (for national security, for example), but that doesn’t change the math.
3. 3. The US is playing a risky hand. We have started a trade war with nearly all the countries of the world, while each of them is only focused on a trade war with one country – the US. Goodwill can turn bad. Anger over tariffs and other unfriendly policies has already curtailed tourism in the US, hurt overseas sales of US brands, and triggered the liquidation of some US assets.

Handwringing

Within a few hours of the announcement, opponents of the new tariffs were asking: what can be done to halt the new policy? The US Constitution grants Congress the power to lay and collect taxes and tariffs. But over the course of almost one hundred years, Congress delegated its power over tariffs (like so many other things) to the president. Last week, the president cited one such delegation, the International Emergency Economic Powers Act of 1977 (IEEPA), declaring that America’s trade deficits are a “national emergency,” and that other countries’ trade policies pose “an unusual and extraordinary threat” to the US. Trump is the first president to use the IEEPA to impose tariffs, until now it was used by presidents to hurt the bad guys by freezing bank accounts or seizing mega yachts. Lawsuits challenging the tariffs have been filed - the courts will decide.

There may be other legal grounds for overturning the new tariff policy. During the Biden administration, the Supreme Court’s conservative majority employed a legal doctrine known as “major questions” to strike down executive branch actions they deemed to be overly ambitious. In this thinking, the courts presume that Congress does not grant the president or executive agencies control over issues of major economic or political significance, such as the authority to cancel up $400 billion in student loans (2022), or, perhaps in this case, the power to enforce a new worldwide tariff policy that is causing unprecedented uncertainty and upheaval.

Members of Congress could seek to reclaim control over tariffs. House approval is unlikely, and if vetoed by the president, passage by a two-thirds majority would be even more unlikely.

Perspective

After a rumor and then denial, the President did in fact place a 90-day pause on tariffs greater than 10% this week. China was the exception – its tariff was increased to 125%. Relieved investors went on a buying spree, pushing up US indexes by 9% on Wednesday. Half of that gain dissipated the next day.

Regardless of the eventual outcome, the Trump tariff sell-off will join Black Friday (1929), Black Monday (1987), the Great Financial Crisis (2008) and the onset of Covid (2020) in the pantheon of epic market collapses. Of the four antecedents, only 1987 saw a quick recovery without a recession - it was a structural market failure (portfolio insurance) rather than caused by economic implosion or a global pandemic.

We may one day regard the President’s actions as accelerating trends that were already underway – the deglobalization of trade and the rise of regional alliances as the US role of policeman recedes. We won’t know how much damage has been done to the US/global economy for at least a few months.

Strategy

It seems more likely than not that the US will go into recession this year. The impact of decisions by individuals and businesses to pull back on spending and investing is magnified as it spreads through the economy. Higher costs and supply chain disruptions affect some businesses more than others.  

The odds of a global recession are somewhat lower, particularly in countries where fiscal stimulus can counter the drag of a trade war. Europe appears advantaged in this way.

The upside scenario is that most of our trading partners respond by reducing protectionist policies, which elicits a positive response from the US. Alternatively, congressional or judicial pressure could influence the President’s course.

We are focused on capital preservation while maintaining market exposure in this unusual environment.