Markets in Focus: Navigating Markets in a Climate of Uncertainty

Reflecting on the market performance so far this year, it’s becoming increasingly evident that volatility is here.

The explanation for the spike in stock market volatility can be summarized in one word - uncertainty. We experienced uncertainty over the future of economic growth, uncertainty over the new presidential administration policies, and uncertainty over the future path of Federal Open Market Committee (FOMC) policies.

The performance of the U.S. economy in Q1 2025 reflected that uncertainty. Large-cap stocks, as represented by the S&P 500 index, posted negative returns of -4.2%, reflecting a decline in investor confidence amidst concerns over the potential for global trade wars and a potentially slowing domestic economy. The technology-heavy Nasdaq-100 index also saw a substantial decrease of -8.3%. This decline marked a notable shift from the previous two years of strong double-digit annual returns in the U.S. equity market.

International stocks, measured by the MSCI ACWI Ex USA, were much stronger in comparison, returning a positive 6.3% year-to-date through March 31st.

The U.S. bond market in Q1 2025 benefited from the economic uncertainties as investors shifted to the relative safety of fixed income. Treasury yields generally fell, driven by concerns about economic growth and the uncertain policy environment. The Bloomberg U.S. Aggregate Bond Index, a broad measure of the U.S. investment-grade bond market, gained 2.7% during the quarter. This indicates increased investor demand for safe-haven assets like U.S. government bonds as equity markets experienced volatility and the economic outlook became less certain.

Entering the Year from a Position of Strength

As we highlighted in our Q1 Markets in Focus, the U.S. economy entered the year in a position of strength. The final reading of 2024 GDP showed that the U.S. economy grew by 2.8% during the year, with the fourth quarter growth reported at 2.3% (BEA.gov). Growth continued to be driven by a strong U.S. consumer but was also helped by increased government spending, residential spending, and net exports.

The labor market also remains strong, with the unemployment rate remaining at 4.2% - the average monthly unemployment rate over the past 75 years is 5.7%. Monthly payrolls averaged 200,000 per month over the past three months (December 2024-February 2025). And there are still more jobs available for people actively seeking employment than there are prospective workers to fill them.

Tariffs and their Impact

One of the most dominant themes shaping the U.S. economic outlook for the remainder of 2025 is the implementation of broad and reciprocal tariffs. As mentioned in our Q1 commentary, this was one of the largest risks to continued growth - unknown policies of the new presidential administration. The shift in U.S. trade policy has generated significant uncertainty across global markets and has the potential to meaningfully reshape international trade relationships. The unexpected size and scope of these tariffs, along with the possible retaliatory measures from trading partners, could lead to wide-ranging disruptions in global supply chains and increased costs for businesses and consumers within the U.S.

An overview of tariffs, including why countries use them and their potential impact on the economy and businesses, can be found here, Understanding Tariffs: Their Mechanisms, Motivations, and Impacts.

Expectations for the Fed

The Federal Open Market Committee (FOMC) oversees monetary policy, meaning the committee alters short-term interest rates depending on whether they think the economy is overheating (inflation is too high) or slowing down too much (unemployment is too high). Over the past few years, its primary focus has been on inflation, meaning they have increased interest rates to maintain stable prices.

Inflation has declined meaningfully since 2022 but hasn’t yet reached its target, a Core PCE reading of 2% (as of February 2025, Core PCE was 2.8%). Meanwhile, as mentioned earlier, the employment picture in the United States is strong, with the unemployment rate at 4.2%.

Expectations coming into the year were that monetary policy in the U.S. would generally see a cautious and gradual easing throughout 2025. The Federal Reserve is navigating the delicate balance between controlling inflation, which remains above target, and supporting economic growth, which shows signs of slowing. The pace and extent of any interest rate cuts will likely depend on the evolving trends in inflation and overall economic activity.

Key Economic Risks Heading into Q2

• Risk 1: Impact of U.S. Tariffs and Trade Tensions:

  The implementation of broad and reciprocal tariffs by the United States poses a significant downside risk to the U.S. economic outlook for the remainder of the year. The tariffs outlined in early April could lead to substantial disruptions in how trade occurs on a global scale, resulting in increased costs for businesses through higher import duties, which could pass through to consumers in the form of higher-priced goods. Estimates suggest that these tariffs could have a material negative impact on U.S. GDP growth and could also contribute to increased inflationary pressures. Furthermore, the likelihood of other countries increasing their tariffs on U.S. goods imports could further escalate trade tensions and worsen the negative consequences for international trade. The prospect of a full-blown trade war scenario represents a significant threat to the stability and growth of the U.S. economy.

• Risk 2: Persistent Inflation or Stagflation Concerns:

  Despite the slow moderation in inflation during the first quarter of 2025, inflation rates in the U.S. remain stubbornly above the Federal Reserve's target. This persistence of higher-than-target inflation raises concerns about the potential for stagflation, a challenging economic condition characterized by a combination of high inflation and slow economic growth. The risk of stagflation is particularly concerning because it presents a dilemma for policymakers, potentially requiring trade-offs between controlling price increases and supporting economic activity. The cautious approach adopted by the U.S. Federal Reserve regarding interest rate cuts reflects these concerns. The potential for tighter monetary policy in response to persistent inflation could dampen economic growth by increasing borrowing costs and reducing investment and consumer spending.

• Risk 3: Potential for Economic Slowdown:

  Beyond the risks associated with tariffs and inflation, there are concerns about a broader economic slowdown in the U.S. The Atlanta Fed's GDPNow model's projection of a contraction in Q1 2025 highlights the possibility of weakening economic momentum. Factors such as slowing consumer spending, cautious corporate investment, and the lingering effects of higher interest rates could contribute to a more pronounced economic slowdown than currently anticipated by some forecasts. Such a slowdown could negatively impact corporate earnings, employment, and overall market sentiment.

Managing the Urge to Make Rash Decisions

Market volatility can be unsettling, and it’s common to want to make a quick change to your investment portfolio to try to minimize the pain of loss. However, it’s important to remember that trying to time the market is very difficult. We describe some of the reasons in further detail in this post, Staying the Course: The Benefits of Sticking to Your Asset Allocation During Market Volatility.

Historically, days of large equity market drawdowns are usually clustered around days of large equity market returns – volatility usually works in both directions.
We will continue to assess the tariff situation and provide updates as necessary. While we remain optimistic about the long-term growth of the U.S. economy, we acknowledge that volatility will likely remain for the foreseeable future. The most important thing for investors is to make sure they remain in-line with their overall financial plan and, if something within that plan changes, to work with a trusted advisor to make any tweaks necessary.

Want to read more about the markets and economy? Check out our blog post, "Impact of Trump's Tariffs on Equity Markets"

___________

Investment advice offered through OneDigital Investment Advisors LLC. The materials and the information provided are not designed or intended to be applicable to any person's individual circumstances. These statements do not constitute an offer or solicitation in any jurisdiction. Any reference to a specific company is not a recommendation to buy, sell, or hold any security. Any economic forecasts in this commentary are merely opinion, and any referenced performance data is historical. Past performance is no guarantee of future results. All investment involved risk of loss. Some information has been obtained by sources we believe to be reliable. OneDigital Investment Advisors LLC makes no representations as to the accuracy or validity of this information. Additionally, OneDigital Investment Advisors does not have any obligation to provide revised investment commentary in the event of changed circumstances. Views and Opinions expressed herein are provided as of April 11, 2025.