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First Quarter Review: The technology sector lost steam in the first quarter, leading to a decline of 4.3% for the Standard and Poor’s 500 Index. The Russell 2000 Small Cap benchmark fell 9.5%, while the MSCI World ex-US International Index rose 5.4%. Gold jumped 19.0% and the Bloomberg Commodity Index returned 8.9%. The Bloomberg Bond Index almost fully reversed its fourth quarter decline by gaining 2.8%. In our year-end letter, we wrote “investors will need to be reassured that the hundreds of billions of dollars in A.I. capital investment is being put to productive use.” Investors were put on alert in late January when DeepSeek, a startup in China, gained attention for being less expensive to build and less energy dependent, but as powerful as leading AI models. This news was one of the catalysts for the 15.7% decline for the Magnificent Seven in the quarter. Given their market domination, the S&P 500’s much more moderate decline was an indication of healthy rotation into other sectors. The Value component of the S&P 500 posted a slight gain of 0.3% in the quarter.
Tariffs: Any expectations of continued market resiliency were dashed on the second day of the new quarter. As President Trump spoke in the Rose Garden after the April 2nd market close, S&P futures rose over 1% as investors anticipated the previously signaled 10% global tariff rate. However, the tone changed immediately when President Trump revealed hyperaggressive “reciprocal” tariff rates which were based upon calculations of our trade partners tariffs that were devoid of economic principle. The 10.5% decline for the S&P 500 over the next two trading days was the fifth largest percentage two-day decline since 1950.
The rationale is an “America First” strategy where manufacturing is re-shored and trade deficits disappear. This will require the faith to make investments that could span decades, while first surviving an immediate economic shock. Tariffs are stagflationary and economists quickly increased the probability of a U.S. recession to 50% while also raising their inflation projections. The Federal Reserve is sidelined as it waits to determine which of its dual mandates, price stability or maximum sustainable employment, will require their support. Beyond the economic damage being inflicted each passing day on global companies and small businesses, there are indications of increasing financial stress in the capital markets. Historically, a crisis leads to a flight into the U.S. dollar as the global reserve currency and into the safety and liquidity of U.S. Treasuries. The exact opposite occurred, with the dollar index declining almost 6% (with Gold up 10%) from April 2nd through April 21st and the Ten-Year Treasury yield rising 0.4% to 4.41%. This capital flight caught the attention of the administration, particularly Treasury Secretary Bessent, and reportedly influenced the announcement of the 90-day reciprocal tariff moratorium shortly after they became effective. There are far too many nuances and variables in global trade flows to capture in this review, but it is noteworthy that foreign entities, both government and private, hold over $8 trillion in U.S. government debt, or more than 30% of the debt outstanding. In addition, the U.S. will need to roll over $9 trillion of debt in 2026 just as rising interest costs add to the burden of our fiscal deficit. Starting a global trade war would not be an ideal strategy for the world’s largest debtor nation.
Investing: We appreciate your composure as you process the continuous news flow. We are always diligent in matching your asset mix to your personal situation, and we continue to monitor and adjust your portfolio allocation on the margin as appropriate. This is not the time to make assumptions about the future and make dramatic portfolio moves. Large one-day moves cluster together, particularly in bear markets, and it can be exceedingly detrimental to be “out of the market” on positive days. The range of potential economic and capital market outcomes is historically wide today. This environment leads us to repeat our mantra of diversification, quality, and a margin of safety. Barring relief through successful negotiations (especially China) or a challenge through the courts, a high tariff world would likely engender new investment trends and asset relationships, lower global growth and perhaps end the era of “American exceptionalism” during which the U.S. “punched above its weight” and drew asymmetrical investment from around the world. We may be at the start of an extended cycle of outperformance by overseas markets, both developed and emerging. We expect companies in their forthcoming earnings calls to withhold future guidance, which should add to share price volatility. We will assess individual companies based upon our estimate of the value of the franchise, the position in their industry, and our confidence in management. Longer term bonds offer uncertain value for the reasons discussed above.
Our team will continue to leverage our collective experience and respond on your behalf to whatever investment environment we are presented with. As always, we thank you for your trust and welcome a discussion specific to your portfolio.