The first quarter of 2025 was a tale of two halves. Financial markets started the year on a positive note, supported by optimism around the new administration's pro-growth policies, but sentiment shifted in mid-February. Three key factors stood out: concerns over large-cap technology spending following the emergence of Deep Seek, uncertainty stemming from new trade and tariff announcements, and a widening valuation gap between U.S. and international equities, which prompted a rotation toward international markets. The S&P 500 Index declined by more than 4%, while U.S. large-cap growth and small-cap stocks fell nearly 10% for the quarter. However, U.S. large-cap value and international equities delivered positive returns (2% and nearly 7%, respectively) and fixed income saw a flight to safety, with the broad U.S. bond market gaining close to 3%. Thus, investors with diversified portfolios across asset classes and sub classes were less impacted by the pullback, highlighting the importance of maintaining balanced exposure.
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Although market pullbacks can cause anxiety, it's important to put volatility in context. Over the past 45 years, the average intra-year pullback for the S&P 500 Index was over 14%. Yet, despite these pullbacks, 75% of those years ended with a positive return, and the average annual return was over 10%.
Similarly, monthly S&P 500 returns over the past decade include many instances of sharp declines; yet investors that stayed invested through the gyrations experienced strong outcomes.
Uncertainty around tariffs, government efficiency, and immigration policy has contributed to the Federal Reserve (Fed) taking a more cautious stance in 2025. While two rate cuts are still expected this year, they are likely to come later in 2025, as the Fed waits to better understand how tariffs will impact inflation, employment, and growth.
Much will depend on the level, scope, and duration of the tariffs. Higher levels, more countries impacted, and prolonged tariffs, raise the risk of elevated inflation, slower economic growth, and rising unemployment. The recently announced universal 10% tariff, along with reciprocal measures, signals a more aggressive stance than initially expected. However, negotiations remain ongoing, and exemptions or a narrowing in scope are still possible. We expect to see some moderation in the level and scope of tariffs as negotiations with countries commence.
Another point to consider is that unlike President Trump's first term, when the administration led with positive policy developments, followed by tariff-related uncertainty; this term has opened with tariff uncertainty upfront. Importantly, we need to remember that the Trump administration is also focused on pro-growth policies such as deregulation and cutting taxes. Investors should keep in mind that while uncertainty is in today's headlines, also think about the potential positives ahead.
I recently returned from Europe and the flight back was bumpy, an experience that serves as a helpful analogy. When a plane hits turbulence, the captain advises passengers to stay seated and buckled in. It's natural to feel uneasy, but the turbulence eventually passes. It's similar when you face market volatility. Volatility can be unsettling, but remaining anchored to your financial plan, like remaining seated and calm during turbulence, is essential. Just as a seatbelt offers protection, diversification helps cushion market shocks, and patience is often rewarded.
One of the key lessons from the 2008 financial crisis is that investors that sold during the downturn missed the strong recovery that followed. Time in the market matters. For example, an investor who put $100,000 into the S&P 500 Index thirty years ago and stayed invested, saw their account grow to over $2 million by the end of 2024. However, missing just the ten best days would have cut that in half.
Lastly, I would encourage investors to think about how far out their financial destination is. If your objectives are five, ten, or more years away, periods of market volatility can present opportunity. An effective way to take advantage of this is through a systematic investing plan. Making regular contributions can help reduce the impact of timing and turn volatility into a long-term advantage. For those less comfortable with regular contributions, an indexed annuity may be worth considering. It gives you an opportunity to participate in up markets, while limiting the downside in tougher market conditions. As always, I recommend speaking with your advisor to determine which strategies best align with your financial destination. At TD Wealth, our role is not only to guide you through the turbulence, but to also ensure you stay on course toward your financial destination.
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