2025 1st Quarter Market Commentary
Top Headline for Q1: Stock Market Correction
In the first quarter of 2025 we had a broad pullback in the U.S. equity markets with the S&P 500 Index moving (briefly) into “correction” territory – a peak-to-valley drop of 10%. The drop happened quickly with the market falling 10% in 20 trading days – the 5th fastest correction since 1950. The drawdown story becomes more clear if you look at performance by sector. The pullback was, in fact, driven mainly by technology which is the largest sector within the S&P 500. In Q1, the technology sector (XLK) and consumer discretionary (XLY) both finished down over 10% whereas every other sector was essentially flat or positive for the quarter. There is no question that the “Mag 7” led the decline much like they led the rise (see table below for recent drawdowns).
Looking forward, equity market pullbacks generally represent buying opportunities. If we use the previously mentioned example of the prior four fastest 10% declines in the S&P 500 since 1950 and two others that tied this latest decline in 20 trading days, forward looking returns after the declines look quite favorable. After the decline, the average forward looking 1 month return was 2.9%, the average 3 month return was 8.2%, the average 6 month return was 15.0% and the average 12 month return was 19.9%. While history doesn’t always repeat itself, it does show that historically, these types of “panic selling” events sometimes have been overdone.
In summary, we believe it pays to use market declines as an opportunity to rebalance. Since 1928 the S&P 500 has averaged around 8% per year. However, if you strip out the 10 best trading days in each year, you'd only average -13% per year. Similar results have appeared for the last 10 years. For example, the index has averaged 12% since 2015 but if you strip out the 10 best trading days each year, you'd average -10% per year. While it is tempting to try and time the market, history shows that you want to be invested when those 10 best days happen.
General Market Update
US Equities: As mentioned above, the S&P 500 Index fell 4.27%. This marked the first down quarter for the S&P 500 Index since the 3rd quarter of 2023 and only the 6th negative quarter since January 1, 2020. The Nasdaq Composite finished the quarter down 10.26% and the Russell 2000 small cap index was down 9.48%. Overall, Q1 demonstrated “risk off” behavior as investors shifted away from growth names into more defensive industries such as Utilities, Real Estate and Health Care.
International and Emerging Market Equities: International equity markets proved to be one of the beneficiaries of capital leaving the U.S. market. More mature (developed) nations saw substantial capital inflows leading to a rise in the Schwab International Equity ETF (SCHF) of 6.92%. Emerging markets also fared well, despite tariff uncertainties, with the Schwab Emerging Markets ETF (SCHE) up 3.53%. Q1 marked one of the largest gaps in performance that we’ve seen between U.S. and foreign markets in some time. We will be keeping an eye on this trend.
Fixed Income and Credit: It’s been a good time to be an active manager in the credit markets. The roller-coaster ride continued in the quarter with the 10-Year U.S. Treasury Bond (“10Y UST”) spiking early in the year to nearly 4.8% before falling all the way back down to 4.25% at quarter end. The general decrease in rates was favorable for fixed income investments. As an example, Vanguard’s Intermediate Corporate Bond ETF (VCIT) was +2.6% during the quarter. Longer duration bonds such as the iShares 20+ Year Treasury Bond ETF (TLT) reacted more favorably ending the quarter +4.9%. While it’s tough to predict direction from here the volatility presents nice opportunities for rebalancing.
Pro-Inflation Investments: We have been vocal for some time about adding inflation protection to portfolios. Payday arrived for certain inflation hedges in Q1. Most notably, precious metals saw substantial inflows. The gold and silver ETFs (GLD and SLV), for example, both finished the quarter up nearly 20%. Industrial metals also rose led by copper (CPER), which rose 25.6%. The “inflation narrative” continues to be a popular topic in the financial media suggesting continued tailwinds.
A Look Ahead
The tariff discussion is expected to be driving markets for the foreseeable future. Increases in tariffs will be viewed as a headwind for stocks (i.e., adverse to profit margins, hiring and corporate investment). On the flip side, slowing growth would likely push bond yields lower (i.e., leading to gains in bond prices). The challenge is that any sudden changes in policy could cause quick reversals in markets. In any case, our bet is on continued volatility, and we expect to be active in rebalancing portfolios during 2025. We do see increasing opportunities in medium to long-dated bonds given the federal government layoffs, persistently high Federal Funds Rate and increases in tariffs.
We will also point out that, despite the rhetoric, the U.S. government seems no closer to balancing a budget – with a budget deficit of $336 billion in January-February of 2025 (i.e., a pace of over $2 trillion per year). We continue to like inflation hedges until fiscal austerity returns and we believe government spending will be highly beneficial to certain equity sectors as well.
We hope your year is off to a great start and we thank you for continued trust in Patina Wealth.