What Worked, and What Didn't

In recent weeks, financial market volatility has been so extreme that some investors may have already forgotten about non-tariff related market news, such as DeepSeek’s artificial intelligence (AI) model or fourth-quarter earnings season delivering one of the strongest quarterly growth rates since the pandemic. As for the S&P 500^®, first quarter 2025 marked the worst quarterly return since 2022 (Figure 1).

Figure 1: Index Performance, %

U.S. trade policy sparks a global financial market sell-off 

	1Q25	Jan	Feb	Mar
U.S. Equity
Russell 3000®	-4.7	3.2	-1.9	-5.8
S&P 500	-4.3	2.8	-1.3	-5.6
WisdomTree US Quality Div Growth	-0.9	3.1	0.1	-4.0
Avantis U.S. Large Cap Value	-2.0	4.2	-1.1	-4.8
S&P 500 Equal Weight®	-0.6	3.5	-0.6	-3.4
S&P 500 Value®	0.3	2.9	0.4	-3.0
S&P 500 Growth®	-8.5	2.7	-2.9	-8.2
S&P MidCap 400®	-6.1	3.8	-4.3	-5.5
S&P MidCap 400 Value®	-3.7	4.0	-3.0	-4.5
S&P MidCap 400 Growth®	-8.4	3.8	-5.6	-6.4
Russell 2000®	-9.5	2.6	-5.3	-6.8
Russell 2000 Value®	-7.7	2.1	-3.8	-6.0
Russell 2000 Growth®	-11.1	3.2	-6.8	-7.6
MSCI USA IMI/Real Estate (25-50)	2.4	1.6	3.6	-2.7
International Equity
MSCI ACWI Ex USA IMI	4.6	3.7	1.1	-0.1
MSCI World Ex USA	6.2	5.0	1.8	-0.6
MSCI World ex USA Quality	3.4	5.2	0.8	-2.5
MSCI World Ex USA Value	10.3	4.7	3.3	1.9
MSCI World Ex USA Growth	2.1	5.2	0.2	-3.1
MSCI World Ex USA Small Cap	3.4	3.2	-0.4	0.6
MSCI EM IMI	1.7	1.1	0.0	0.5
Fixed Income
Bloomberg U.S. Aggregate	2.8	0.5	2.2	0.0
Bloomberg Municipal	-0.2	0.5	1.0	-1.7
Bloomberg U.S. Corporate High Yield	1.0	1.4	0.7	-1.0
Bloomberg EM USD Aggregate	2.3	1.1	1.6	-0.4

Source: Morningstar Inc.; Data as of 3/31/2025

When equities fall into a correction, like the one the S&P 500 experienced on March 13, we believe it is imperative to frame the occurrence within the context of the business cycle. Historically, corrections have been short-lived if the business cycle avoids recession; however, this is not the case if an economic contraction occurs. We currently maintain a positive, yet increasingly cautious, view of the cycle due to significant foreign trade policy uncertainty. From a fundamental perspective, the business cycle remains robust given the strength of the U.S. consumer, labor market and decelerating path of inflation.

As trade policy will have a significant influence on economic activity in 2025, we are monitoring a few, key guideposts to determine the market’s path forward:

• U.S. tax policy: to help offset the potential impact of tariffs on both consumers and businesses.
• Negotiations with Japan: as a guide for how other countries might look to adjust trade policies with the U.S.
• Response from the Federal Reserve (Fed): for now, policymakers have been consistent about their need to see economic data weaken before adjusting monetary policy. As of this writing, there continues to be a significant divergence between the negative consumer and business sentiment and the contrastingly solid economic data, which continues to point to a slowing expansion phase of the business cycle.

Which Asset Classes Led in Q1?

Developed International Equity

Our thesis: Despite strong performance in the first quarter, we maintain an unfavorable view on developed international equity over the long term but believe it can offer important diversification benefits in portfolios. In 2025, consensus expects economic growth in developed international markets to accelerate from 2024, albeit at levels well below that of the U.S., due to expected headwinds from foreign trade.

What worked in the quarter: After the worst fourth-quarter decline since 2018, developed international equities rebounded with their best first-quarter return since 2023. The move was mostly led by equities in Europe as tariff concerns did not materialize until late in the quarter. However, through April 11, equities in Germany had completely reversed their rally since federal elections in late February.

Looking ahead: Despite relatively low valuations, the earnings outlook for the Eurozone remains clouded by a weak economic backdrop. The manufacturing sector has remained in contraction territory for more than two years, which casts doubt on an economic recovery, especially for an economy still reeling from an energy crisis that began in 2022.

Core Fixed Income

Our thesis: Core fixed income tends to be the primary ballast in multi-asset portfolios given its broad diversification across U.S. Treasury, corporate and securitized markets.

What worked in the quarter: Falling long-term interest rates were the primary driver of returns for the quarter.

Looking ahead: Over the long term, we believe core fixed income provides stability in portfolios. In the near term, increased clarity on the path of interest rates should support returns, in our view.

Emerging Market Debt

Our thesis: We remain constructive on emerging market (EM) debt as we believe the asset class offers better fundamentals and higher yields than developed market debt. We also prefer U.S. dollar-denominated EM debt, which should provide an additional tailwind in periods of dollar strength.

What worked in the quarter: Despite widening spreads relative to U.S. Treasuries, interest rates for most EM sovereign bonds declined in the first quarter due to slowing global growth concerns and foreign trade uncertainty. While most of the index is comprised of sovereign bonds, corporate bonds represent approximately 25%, and several issuers from China and Mexico had bonds that rallied. The rally of bonds in China followed reports of better-than-expected economic growth.

Looking ahead: Like U.S. high yield, EM debt offers an attractive yield pickup with relatively low correlation to core fixed income, and with stronger underlying fundamentals, in our view. Due to the significant volatility towards the end of the quarter, valuations appear rich relative to other fixed income asset classes; however, we continue to believe EM debt offers long-term value.

Which Asset Classes Led in Q1?

U.S. Large-cap Equity

Our thesis: We believe U.S. large-capitalization (cap) equities are the long-term growth and innovation engine of public equities given their sustainable, high-quality fundamental characteristics, overall.

What happened in the quarter: The index fell into a 10% correction on March 13, primarily due to trade policy uncertainty. Mega-cap technology stocks were impacted most; however, their downturn began earlier in the quarter following investor concerns regarding the outlook for U.S. leadership in AI.

Looking ahead: Consensus expects 2025 earnings growth to broaden across large cap and beyond the Magnificent 7 companies (Alphabet, Inc.; Amazon.com, Inc.; Apple, Inc.; Meta Platforms, Inc.; Microsoft Corp.; Nvidia Corp. and Tesla, Inc.). Earnings growth and profit margins may be impacted by foreign trade policy, but we believe the higher quality nature of large-cap companies can help them better navigate this environment relative to smaller-cap companies. 

U.S. Mid-cap Equity

Our thesis: The current backdrop of elevated inflation and interest rates is challenging for U.S. mid-cap equities, but we believe they should benefit from their U.S.-centric revenue exposure over the long term.

What happened in the quarter: The index reacted negatively to foreign trade uncertainty, and also entered correction territory in March. Defensive sectors, such as Health Care, held up best, while higher beta sectors, such as Information Technology, performed the worst.

Looking ahead: In our view, the outlook for mid cap remains dependent on the path of interest rates and inflation. While mid-cap valuations are relatively low, we believe higher long-term interest rates, inflation and uncertain trade policy are headwinds for mid-cap earnings growth and margin expansion. 

U.S. Small-cap Equity

Our thesis: The current backdrop of elevated inflation and interest rates is challenging for U.S. small-cap equities, but we believe they should benefit from their U.S.-centric revenue exposure over the long term.

What happened in the quarter: The index fell into a correction as investor concern mounted about the ability of smaller companies to navigate the trade policy uncertainty, in addition to the backdrop of higher interest rates and inflation. Small-cap equities ended the quarter approaching bear market territory, down more than 15% from their November high.

Looking ahead: While valuations for small-cap equity are historically low relative to those of large cap, small-cap valuations are approximately in line with their long-term average. We believe an earnings growth catalyst will be required to reduce multiples from current levels, which could be challenging in this environment. Clarity on interest rates, inflation and trade policy will be necessary to improve our outlook for small cap.