Summary

The first quarter of 2025 started off well enough, but it deteriorated badly as the quarter came to an end.  Between Election Day and Inauguration Day, the market had a lot of optimism about the new administration’s plan to aid “re-shoring” (bringing overseas manufacturing back to America).  President Trump during his first term paid careful attention to how the stock market interpreted his policies, so investors naturally assumed that he would be sensitive to stock prices this time as well.  So far, they have been disappointed.  The stock market peaked in mid-February and has moved sharply lower ever since.  Trump threatened our trading partners with large tariffs and then, despite the market’s negative reaction, followed through with them.  What really roiled the markets was that the actual tariff rates proposed were both larger than expected and seemingly without any evidence of a thought-out methodology.  Global financial markets – stock, bond, and currency – have reflected a movement away from the U.S. ever since[i].  US. stocks fell -4.6% during the first quarter[1].  Technology, retailing, and small cap stocks lost the most.

International stocks performed very well early on in the quarter and despite the tariff crisis still ended it with modest gains.  The developed market index (MSCI EAFE) gained 7.0% and the emerging market index (MSCI EM) rose 2.9%.  To some extent, foreign markets have been the beneficiaries of America’s more adversarial stance.  The U.S. prospered over the years from foreign investors parking their money in our stock and bond markets.  Now, having some concerns about our policies, many foreign investors are reducing their exposure here.  All in all, the value of diversification really proved itself last quarter as foreign stock and bond gains somewhat offset the drag from falling U.S stocks. 

U.S. bonds had a pretty decent quarter, rising 2.8% according to Bloomberg.  That said, they have become increasingly volatile in recent weeks as investors try to figure out what effect tariffs will have on inflation, interest rates, our trade deficit, and the value of the dollar.  After several years of outperforming government bonds, corporate bonds underperformed them in the first quarter as economic fears increased.  On the other hand, after over a decade of dismally underperforming dollar-based bonds, foreign bonds had an excellent quarter.  The weak dollar has really shaken things up.  Perhaps the biggest beneficiary of the weak dollar and doubt over U.S.  policy has been gold, because investors always need a safe-haven asset, and it doesn’t seem to be U.S. T-Bills anymore.  Gold rose close to 20% during the first quarter.

Activity

The first quarter was a wild ride, especially at the end.  Headlines were changing every day, many having a big impact on asset prices.  Early in the quarter the market priced in de-regulation, which means faster growth but higher interest rates.  That favors growth and cyclical stocks and higher-yielding bonds.  As it began to be clear that the agenda for Trump’s second term was going to be a lot different than that of the first term, markets had to make some big shifts.  Economic policy was not going to be conducted on the basis of whether or not the financial markets favored it; instead it was going to be more populist.  That said, there was no real playbook for how to model the inflationary or deflationary impact of a trade policy in which tariff rates seemed to change daily.  What we did know, however, was that the way the markets had initially positioned for a second Trump term was turning out to be completely wrong.  We had to pivot toward more defensive stocks, higher quality bonds, and portfolio protection in the form of gold and other alternatives that are not as sensitive to the economy.  We also needed to raise cash levels.  We are still making adjustments.  One notable change is that due to volatility, new funds are invested more gradually – in order to avoid buying too much on what might turn out to be an inauspicious day.

Outlook

Expect volatility.  President Trump’s goal seems to be to keep everyone off balance, and he is meeting that goal so far.  George H.W. Bush did not want to raise taxes in 1990, but a sharp rise in the deficit pushed the dollar down and interest rates up and forced his hand.  Bill Clinton wanted to make major changes to health care and social programs in 1994, but the bond market was not having it, so he had to abandon most of his plans[2].  Sometimes markets don’t let a president do what he would like to.  Usually, it doesn’t go well for the economy when presidents try to ignore markets.  I believe there is room for a stock rally if this president moderates his agenda, but right now he doesn’t seem anxious to do that.  Markets aren’t waiting – investors are “voting” for change by replacing the dollar with gold and the Japanese Yen, and they are trimming their stock and longer-term bond positions.

Commentary – Of Pianos, Mattresses, and Light Switches – Why it is Especially Challenging to Manage Assets in this Environment

I believe that the Trump Administration believes that the trade deficit that America has had for decades is a result of other countries taking advantage of America’s generosity, and that it isn’t fair.  I believe that America consciously and purposefully ran a trade deficit.  We were buying influence and giving the world an incentive to choose capitalism over Soviet or Chinese-style command economies.  I believe that this influence came in handy for America after September 11th, when the U.S. called in favors and nearly everyone responded (even those that had misgivings).  That said, capitalism has certainly won the economic war and revisiting our global commitments might have been in order.  In his first term, President Trump complained that most European nations were not living up to their agreed-to defense financial obligations.  Despite this, not much changed.  Europeans knew they were not spending enough, but they also understood that they were also helping America to project its power more easily into the Middle East and Asia.

This is the political backdrop for what has occurred in the financial space since Trump has come back into the Presidency.  The United States had a legitimate gripe, but is it pursuing that gripe constructively or destructively?  Did it consider all the implications of blowing up the status quo? The Trump Administration resented tariffs placed on American goods as well as the non-tariff barriers many countries imposed.  However, like its non-nuanced view of global geo-politics, it also had a narrow economic view.  The United States of America in the 2020s is very largely a service economy.  It runs a trade surplus in services with almost every country on Earth.  In addition, the U.S. has its own tariffs and non-tariff barriers.  This is why trade disputes are typically negotiated.  It was thought to be understood that nobody really benefits from blowing up the whole framework of international trade.

The global economy is exceedingly complicated.  It is very arduous and time consuming to try to change, which is why there are typically a lot of negotiations.  One option Trump had was to treat the process of restructuring trade and political relationships like moving a Steinway grand piano out of a third floor studio – carefully, and with a lot of people and ropes and things.  Another option was to treat it like getting rid of an old mattress – open the window and toss it out.  Evidently, he is choosing the latter.  Global investors have been trying to cope with this ever since.

Truthfully, we don’t know whether this bold experiment will ultimately prove to be successful, or modestly successful, or mostly unsuccessful, or disastrous.  It is too soon to tell.  That said, markets are always trying to anticipate future results.  It would have been possible to announce the tariffs on April 2nd with a meticulous explanation as to why each country was assessed the amount it was.  When that didn’t happen, markets made a downward revision to anticipated future returns.  Two days later, the administration revealed a mathematical formula (with Greek letters!) to justify how much each country was tariffed.  Unfortunately for them, most economists can do math with Greek letters, and they were not impressed.  Side note – one can write a formula using Greek letters to explain the basic premise of American football (you need to advance the ball at least ten yards every four plays), but that doesn’t make it especially complicated.  So the reveal, which was basically that we tariffed each country roughly by the percentage of our trade deficit with them, blew a hole through America’s credibility and made markets go down even more.  When the 90-day reprieve was announced on April 9th, markets rejoiced to the tune of nine percent in less than three hours, but that still left us considerably short of where we began, and we still have the tariff deadline looming ahead.

All of this makes portfolio management very challenging.  Typically, when an investment analyst makes a forecast, he or she is trying to assess how fast the economy is going to grow, to what extent interest rates are going to rise or fall, and most importantly what the interplay will be between the economy and interest rates.  Think about this as being like a dimmer switch in your dining room – based on new input one nudges one’s expectations up or down a bit.  If necessary, you have to replace a less suitable asset with a more suitable one.  Now think about how tariffs impact a forecast.  A 5% tariff increase affects a company’s profit margins; maybe they pass it on to their customers, maybe they have to absorb it themselves, but they want to keep the business so they pay it.  A 25% tariff, on the other hand, is probably too large to absorb.  If they can’t pass most of it on, they have to consider foregoing the import and telling their customer to get it from somebody else.  Recently, the Trump Administration and China have raised tariffs on each other to over 100%.  That is a “FORGET IT” level.  Nothing (except tiny components) gets bought or sold at that tariff level.  Economies start to go south very fast when trade grinds to a halt.  That’s not a dimmer – that is an off switch!  A portfolio in a “dark” room is going to have to be a great deal different (more conservative) than a portfolio in a lighted room. 

Obviously, the value of any income stream changes dramatically when its tariff rate changes from 40% to 10%, as happened on Wednesday April 9th.  There was an intraday rally of almost 9%.  It is very hard to model for something like that.  How does an investor respond to this kind of volatility?  If you are an investor not domiciled in the United States, you can’t possibly anticipate what the U.S. President might say or do next, so you protect yourself by selling dollar-based assets.  You reduce exposure to the “suddenly-not-so-safe” haven of U.S. bonds and stocks and increase your weighting of alternative safe havens like gold (up 26.5% year-to-date) or the Japanese yen (+10.5%). This is what we have seen lately.

For the last decade or so prominent investors have used metaphors like “cleanest dirty shirt”[3] to illustrate the point that however concerned one might be about America that every other country as an investment option was considerably worse.  American asset outperformance became so taken for granted in recent years that “American exceptionalism”[4] was widely used in investment circles.  These notions are being called into question now.  Again, I don’t know how this is all going to be resolved, but I do know that I can’t put the same valuations on U.S. assets that I did in the “TINA” (There Is No Alternative) Era.  U.S. assets will necessarily carry lower premiums over foreign assets than they did from 2012 to 2024.  It doesn’t mean they won’t produce nice gains, but as a whole they should underperform non-US bonds and stocks.  Alternatives like gold and commodities are going to have to be a larger part of portfolios as well. 

In all probability, the world has now entered a new era.  The word “uncertainty” has been bandied about frequently in recent weeks.  The Trump Administration has an ambitious agenda to shake up global trade and politics and make them more friendly to American interests, but that is exceedingly difficult under even the best circumstances.  It will require a level of diplomacy that is so far not in evidence.  I am not speaking from personal conviction here, I am simply conveying the message of the markets, and so far that message has not been very favorable.  As the rally on April 9th demonstrates, there is room for asset prices to improve dramatically if tariffs are abandoned, but I have no thought that going through all of this for nothing would be regarded by markets as positive either.   Because of the increased levels of both volatility and uncertainty, we at Trademark believe we have to exercise more caution, at least in the short term, than we have had to in recent years.  We take our responsibility as manager of your assets extremely seriously.  Over the past decade, stock market sell-offs have provided very good “buy-the-dip” opportunities.  I am not as confident that this is the approach to take this time.

 [1] S&P 500 large company index, according to Standard and Poors.  The NASDAQ Composite fell -10.3% and the Russell 2000 small cap index sank -9.5% according to Nasdaq.com.

[2] This prompted James Carville, Clinton’s political strategist, to opine that if he were ever resurrected, he’d like to come back as the bond market because then he could intimidate everyone.

[3] PIMCO’s Bill Gross, November 2012

[4] A laudatory phrase from 19th century French political philosopher Alexis de Tocqueville.

[i] A large part of the problem, as many in the market have stated, was that wasn’t clear why we needed to end the era of American market exceptionalism.  If you look at a chart of relative performance, the U.S. was by far the largest beneficiary of the status quo over the last fifteen years or so.  There is no economic policy that guarantees that absolutely everybody will do better.  Clearly, many industrial jobs were lost during this time period (though far more were lost between 1985 and 2000).  Congress sent money to the states many times to try to alleviate the economic pain of those who lost their jobs, but some states simply pocketed it or cut taxes (which, while nice, does nothing to help someone who isn’t earning any money).

In any event, we have begun a policy of blaming and punishing our trading partners for taking jobs we gave U.S. corporations tax incentives for moving under the Reagan, George H.W. Bush, and Clinton Administrations.  Needless to say, those countries aren’t happy about it.  So far, those industries most exposed to tariff concerns have fared worse than those that largely do business domestically, but even energy, which Trump promised specifically to help, has seen losses over 15% as global demand falls.

DISCLOSURE

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