Q1 2025 Equity Market Observations
The first quarter of 2025 brought significant volatility to U.S. equity markets due to geopolitical tensions and resurgent protectionism that disrupted global trade dynamics. With ongoing trade tensions, such volatility is expected to persist. These conditions might provide opportunities for some investment managers to outperform equity indexes, particularly those who capture volatility through systematic rebalancing.
Market Volatility and Strategic Context
The S&P 500 has revealed a swift shift from complacency to alarm after the recent 10% sell-off over three weeks, while the CBOE Volatility Index (VIX), also known as the fear index, surged nearly 80% from pre-correction levels. Abrupt changes in market leadership can present challenges for actively-managed strategies; stocks with lower alpha or volatility scores might adversely affect performance if they dominate the portfolio during these shifts.
However, Intech designs its volatility and stock alpha models to attenuate such risks via their complementary nature. Moreover, we aim to capture residual returns, enhancing adaptability and supporting performance even when unexpected market changes pose potential headwinds. This approach ensures that we do not see significant factor tilts when analyzing the portfolio through a risk lens.
The Magnificent Seven
In the first quarter of 2025, the “Magnificent Seven” stocks—Apple, Microsoft, NVIDIA, Alphabet, Amazon, Meta, and Tesla—largely underperformed the S&P 500 Index, which saw a decline of approximately 4.3%. Except for Meta, which posted a year-to-date return of -1.5%, the other six stocks experienced significant declines, ranging from around 11% for Microsoft to over 35% for Tesla (as of late March). This marked a notable shift from their previous market dominance, contributing heavily to the S&P 500’s downturn due to their substantial weighting in the index, while Meta stood out as the sole outperformer among the group.
Figure 1: Magnificent Seven Performance
Market Sentiment
The S&P 500’s correction reflects trade policy fears, with consumer confidence falling to 57.0 in March (University of Michigan) and recession concerns rising. The Bank of America survey in March showed fund managers increasing their cash exposure (4.1% from 3.5%), signaling deep pessimism. The AAII Investor Sentiment Survey was bearish after hitting 55%+ for four weeks, starkly contrasting to 2024’s sub-30% levels, despite the S&P 500’s modest 10% Q1 decline.
Economic Drivers
Protectionism reshaped economics, with tariffs increasing inflation expectations to 2.7% in 2025, though long-term views held steady. The Fed kept rates at 4.25% – 4.50%, cut 2025 GDP growth forecasts to 1.7% from 2.1%, and adjusted Treasury redemptions to boost liquidity. Despite solid retail sales and earnings growth from AI and deregulation, tariff uncertainty and corporate guidance misses (e.g., Micron, Nike) signal more volatility ahead.
Figure 2: Equity Index Performance
U.S. Equity Markets
The S&P 500 entered 2025 buoyed by a 23% gain in 2024, hitting an all-time high in January with a 2.7% monthly rise, driven by post-inauguration optimism and robust tech earnings. This momentum quickly faded. According to Bloomberg, from February 19 to March 11, the index plunged 10%—the fifth-fastest correction in 75 years—wiping out $4 trillion in market value. Year-to-date losses reflect mounting fears of a tariff-driven economic slowdown.
Growth vs. Value Stocks
Growth stocks, spearheaded by tech leaders like NVIDIA and Apple, initially thrived on AI optimism and deregulation prospects. Rising bond yields and trade tensions soon exposed their lofty valuations, triggering underperformance by March of this year. Value stocks, concentrated in financials and industrials, gained ground as protectionist policies favored domestic industries, countering growth’s retreat.
Defensive vs. Cyclical Stocks
Cyclical sectors—industrials, materials, and consumer discretionary—started strong, lifted by anticipated tax cuts and infrastructure spending. As tariff concerns escalated, these sectors stumbled, especially firms tied to global supply chains. Defensive sectors, notably utilities, and consumer staples emerged as havens. This pivot echoes historical flights to safety during turbulent times.
International Indexes
Globally, the MSCI Europe and MSCI EAFE indexes have substantially outperformed the S&P 500 year-to-date. Investors rotated out of U.S. stocks into overseas markets, driven by lower valuations, a rally in European defense stocks, and a tech-driven surge in Hong Kong. Emerging markets faced headwinds from a strengthening U.S. dollar but showed resilience with positive performance.
Figure 3: S&P 500 Index vs MSCI Europe Index Performance
Factor Indexes
In March 2025, the MSCI U.S. equity factors of minimum volatility and value delivered positive returns. The U.S. size (smaller capitalization) and momentum factors, although slightly negative, still outperformed the S&P 500 Index. The U.S. quality factor performed worst among the U.S. equity factors for the month.
Conclusion
The first quarter of 2025 has challenged U.S. equity markets, with the S&P 500 swinging from policy-fueled peaks to tariff-induced troughs. Growth stocks faltered, value stocks steadied, defensive sectors outpaced cyclicals, and non-U.S. equity markets shone amid global trade upheaval and valuations. It becomes increasingly clear that uncertainty and volatility are sticking around, and it will take time for sentiment to improve.
Looking forward, the potential for changes to tariffs, regulation, tax policy, energy prices, and interest rates present both challenges and opportunities. Intech is positioned to potentially leverage these developments, using market volatility to explore opportunities for improving investor outcomes.
