Spring 2025 Market Commentary
By Marc Usem and the Affiance Financial Investment Committee
Tariffs Take Center Stage
The S&P 500 fell by -4.3% in the first quarter of 2025 as markets were rattled by the uncertainty surrounding fiscal policy, specifically the introduction of trade wars and dismantling of government institutions. By mid-March, the S&P 500 had declined by -10% marking the first official market correction since 2022. International markets found support from a weaker U.S. dollar and two interest rate cuts by the European Central Bank, driving developed markets 8% higher during the quarter. Emerging markets gained 4.5%, largely due to Chinese technology companies which jumped on artificial intelligence (AI) news as DeepSeek’s R1 model challenged U.S. dominance in the industry. DeepSeek rivaled the performance of ChatGPT and other AI models but with much fewer resources and inferior infrastructure, leaving U.S. firms scrambling to also do more with less and more with more.
Messaging from Washington has unsettled investors, including recent quotes from administration officials regarding the impact of tariffs. Examples include: President Trump, “Trump Says a Recession Might Be Worth the Cost…,” Commerce Secretary Lutnick, “Trump’s policies are ‘worth it’ even if they cause a recession,” and Treasury Secretary Bessent, “the economy may need a ‘detox period.’” The economic establishment has warned that a trade war may lead to a recession and, potentially, stagflation. Recession risk has risen from about 15% at the beginning of the year to 35 to 40% today. The new blanket tariffs of 10% on practically all goods, and higher rates for selected countries with the highest trade deficits, means the U.S. now has the highest tariffs in the world. We would note that as quickly as the tariffs have been put in place, they can also be rolled back, but the impacts may be long-lasting.
In practice, tariffs are simply a tax paid by the businesses and consumers in the country imposing the tariff. If we impose a tariff (tax) on cars of 25%, the car simply costs 25% more, unless importers absorb some of the tax and reduce their profits. Higher prices reduce demand for foreign products and lead to domestic inflation, while the tax revenue goes to government coffers. The intention of tariffs is to drive more domestic production by reducing demand for similar foreign products. However, it takes time to develop domestic manufacturing capabilities and whether domestic manufacturing can build products at prices and quality that are competitive on the world stage remains a question.
The new tariffs are expected to result in reduced consumer demand (spending), reduced consumer confidence, reduced business confidence and capital expenditures, reduced corporate earnings estimates, and higher prices. The markets fear a combination of the above may result in stagflation - slowing GDP and higher inflation. This would be a worst-case scenario for the Fed where they are forced to weigh keeping interest rates higher to combat inflation or dropping rates to stimulate economic activity. The employment market remains the lynchpin to economic resilience and any deterioration in employment numbers may signal a higher risk of economic weakness from the trade wars.
Volatility jumped in the first quarter, but has been modest during the past few years. The average intra-year market decline since 1999 is about 15%. The averages were surpassed by larger drawdowns in 2018, 2020, and 2022. Investors should be willing to withstand the volatility of stocks to receive the benefits of owning stocks for the long term. We recommend that investors carefully weigh near-term cash needs and generally keep 12 to 18 months of cash needs in money market funds or short-term bonds. As markets digest the tariff news, our mantra remains consistent - we know we can’t control the ups and downs of markets, but we can rely on our disciplined investment processes to provide well-designed, tax-efficient, globally diversified portfolios that suit our clients’ investment planning needs.
Thank you for your continued confidence in our work.
Sources: NPR, Newsweek, AMG Funds, New York Times, CNN
The views represented in this commentary are not meant to be construed as advice, testimonial or condemnation of any specific sector or holding. Investors cannot invest directly in an index. Unmanaged indexes do not reflect management fees and transaction costs that are associated with some investments. Past performance is no guarantee of future results. To discuss any matters in more detail, please contact your financial advisor.
