Domestic Equities Market Commentary – 1Q 2025

After holding onto gains through the first two months of the quarter—the S&P 500 hit an all-time high in mid-February—domestic equity markets finally succumbed to the uncertainties surrounding Trump policies, especially the looming trade war and DOGE-related layoffs, and their impact on economic growth and inflation. Cracks in the AI-growth theme added to the quarter’s troubles, especially among the Magnificent 7. This quarter’s decline breaks the large cap market’s five-quarter winning streak and has pushed most market indexes into correction territory. Fixed income markets posted modest gains, as the flight to safety trade overwhelmed the typical negative response to inflationary fears. Without the support of the Magnificent 7, the S&P 500 lost -4.3% in the quarter. Indeed, nearly all of the S&P’s decline can be attributed to the mid-teen’s percentage drop in these stocks. Thus, the Magnificent 7-heavy sectors of Consumer Discretionary, Information Technology, and Communication Services underperformed, while the more defensive Energy, Health Care, Utilities, Consumer Staples, Financials, and Real Estate sectors outperformed.

The Russell 2000 Index, having hit its all-time highs last November, continued to slide amid declining earnings expectations, falling -9.5% for the quarter. Only Utilities posted a gain, while several sectors posted double-digit losses. Information Technology was hit particularly hard, with semiconductor and software names responsible for most of the sector’s decline.

Value investing returned to the fore in the quarter, with Value outperforming Growth by over 12% among large caps and by over 3% among small caps. Here too, it was the growthy Magnificent 7-heavy sectors of Information Technology and Consumer Discretionary lagging, while the value-oriented Financials, Health Care, and Energy sectors performed well. In the small cap realm, the relative performance gap was driven by strength among the Value-oriented Financials, Utilities, and Real Estate sectors, as well as weakness in Growth-heavy Information
Technology. Among smaller companies, style factors favored quality this quarter, with larger size, higher ROE, and lower beta among the best performing factors.

The outlook for the US economy has become more uncertain. There is still a non-trivial list of positives. Earnings for 2024 finished the year strong, and current earnings projections are showing good growth in 2025. The labor market is still in a good place, as the unemployment rate remains low and non-farm payrolls are steady. ISM survey work supports growth in Services, still the majority of our economy, although the Manufacturing survey did slip back into contraction territory. Corporate balance sheets remain healthy, providing ample firepower for share buybacks, dividends, and acquisitions. Personal balance sheets also remain strong, although a declining stock market has hurt personal net worth, and credit card delinquencies have been on the rise.

Yet, Trump policy uncertainties have started to impact business and consumer sentiment, with CEO and business confidence surveys falling and consumer confidence dropping to its lowest level since the pandemic. Indeed, with tariffs and layoffs certainly on the rise, a cutback in spending only makes sense. While one could argue that tariffs, if used prudently, could help the US economy, it is the sledgehammer approach to their application that creates the most risk in the near term. Chinese advances in AI, at lower costs, have also created concerns over this key component of economic growth and spending expectations. The GDP outlook, though still positive, has been trimmed back, while inflation readings have remained stubbornly above the Fed’s 2% target. Further near-term Fed rate cuts have also been put on hold given the uncertain outlook.

First quarter earnings reports are key, perhaps more so than in any recent quarter, as management guidance and outlook statements will give us a first look at how Corporate America and consumers are experiencing and reacting to the impact of Trump policies, especially the trade war. Whereas the only certainty would seem to be more market volatility, investor sentiment has turned so negative that a relief rally can’t be ruled out.

While we attempt to give our best prediction on the economic outlook, our primary charge remains finding companies that can best lead us through the economic mine field, coming out the other side in an improved competitive position. We have found that such companies possess similar quality traits, including leading market positions, experienced management teams, and solid financial characteristics. Our experience gives us confidence that our quality portfolios will continue to outperform in the long term.