Q1 2025 - Market Review
ECONOMIC COMMENTARY
In these commentaries, we typically limit ourselves to cover events that occurred during the quarter but, in light of the capital markets’ gyrations following Liberation Day’s tariffs announcement, we’re making an exception and we’re extending the review to include the first few days of April.
Donald Trump was sworn into office on January 6th and didn’t waste any time to wreak havoc. Even if the tariff regime is expected to have a greater negative impact outside the US, the suspense surrounding Washington’s delivery approach appeared to hurt the US more than the rest of the world. To this point, the S&P 500 Net Total Return Index[1] declined 5.,67% in March, its worst month since December 2022. For the quarter, the S&P 500 Net Total Return Index was down 4.37%, its worst quarter since the second quarter of 2022. In contrast, the MSCI All Countries World Equity Index declined 2.15% while the S&P TSX Composite Index managed to post a positive return of 1.51% during the quarter. Notably, during the quarter, US equities underperformed European equities by the widest margin in three decades. Indirectly, Trump may have succeeded in Making Europe Great Again! Also, Trump’s veiled territorial ambitions may have succeeded to inject some life in the Canadian Federal election campaign. Similarly, growth stocks globally underperformed value stocks by the widest margin since 2012, as the combination of downward earnings growth revision and upward inflation revision disproportionately affected growth stocks.
To the extent that it was better to be diversified by region, country, sector, and style during the first quarter, that was not the case starting on April 3rd as markets were shocked by the fact that the announced tariffs were much higher than anticipated but perhaps even more shocked to realize that the mathematical formula the Trump team came up[2] with to determine its own tariff response had nothing to do with… tariffs. This further undermined the market participants’ confidence in the soundness of US policy making. As a matter of fact, the US dollar Index, which is a gauge of the strength of the US dollar relative to a basket of other developed markets currencies, had its worst day in years on April 3rd and is off more than 6% from the highs earlier this year. It is unclear if the President really thought that tariffs would solve everything (including depreciating the US dollar) the same way he thought that injecting bleach would kill Covid. Nevertheless, the equity markets’ rout continued on April 4th and in overseas markets on April 7th, as China unveiled its own set of tariff responses, which included some targeted restrictions against a handful of American firms. As a result, at the time of writing this on April 7th, most national equity markets are down between 10% and 20% month-to-date and between 15% and 30% since peaking around February 19th.
Losses were unfortunately not confined to equity markets. In fact, commodities, as proxied by the S&P GSCI Commodities Index is also down over 10% as oil and copper corrected spectacularly. Risk aversion also percolated into corporate bonds as US high yield spreads jumped over 100 basis points since mid-March to their highest level in 18 months. Had it not been for the perception that balance sheets are healthy, spreads would have moved sharply higher. Even Gold, which had its best quarter since the 1980s on the back of central banks’ accumulation, was off in early April. As for Bitcoin and other digital currencies, well, news of the establishment of a strategic US reserve did not prevent it from behaving like a leveraged version of the Nasdaq. As it stands, the only segment where positive returns were observed were government bonds as traders moved to discount 2 to 3 additional FED rate cuts before the end of the year. That said, it was not enough to make a real difference.
WHAT HAVE WE DONE SO FAR?
As you may recall, in discretionary accounts, we reduced the exposure to Canadian equities if families were not already underweight. We executed on that strategy the day after the White House suspended the application of trade tariffs against Canada, 24 hours after announcing them in early February. As Canadian equities bounced back on that headline, we viewed this as a 2nd opportunity to do something we should have done the first time around as we felt that the Canadian economy was more vulnerable to Trump’s unpredictability than the consensus was.
Then, in early March, we noticed that the Canadian bond yield curve had steepened noticeably, which seemed to us at odds with the increasing risks of a US induced growth shock on a global scale. As such, we took the opportunity to reduce short-term corporate credit exposure in favor of longer dated maturity bonds in the fixed income strategy of discretionary accounts.
In parallel, since last summer, we have been converting a portion of our clients’ global equity fund allocation to Canadian dollar hedged versions of the same strategies wherever possible, in an effort to shield portfolios from a scenario in which the US dollar would experience a crisis of confidence. We plan to continue to do that as Washington keep turning friends into foes and where the rule of law is increasingly being challenged.
Lastly, a month ago, we developed a plan to reduce global equities, should they rebound from the level they were following Volodymyr Zelenskyy’s White House visit. At that point, we realized that for 35 years, we had been playing a relatively easy game of checkers and that we were now required to learn to play 3-dimensional chess. Of all the actions and declarations witnessed since Trump’s 2nd inauguration, we feel that this is likely the one that has the most chance of affecting the distribution of outcomes beyond the 4-to-5-year horizon that we normally consider in our portfolio construction framework. Basically, we felt that the range of possible outcomes had increased substantially but that the expected median outcome was probably not better. With that in mind, we wanted to take portfolio risk down further than the prior actions described above had contributed to do. Unfortunately, markets swiftly moved further down, and we did not have another window to execute.
WHAT ARE WE GOING TO DO NEXT?
Some of you will note that, for a while, we have been talking about growing risks everywhere and you may be wondering why we have not sold risky assets more aggressively. There are a couple of reasons for that. The first reason is that, as mentioned above, until late March, the markets’ correction was largely a US equity-centric phenomenon. Discretionarily managed accounts were still posting positive returns for the quarter and were outperforming their respective benchmark by a significant margin, especially in global equities where the downside is limited from 40% to 50% of the index downside in most cases. This reinforces our confidence in our group of core third-party managers and validates our core belief in active management. It is only in the last three trading days that broad equities have been engulfed into Trump’s engineered turmoil. To make a long story short, we don’t think a lot needs to be done. We construct portfolios in a way that they should provide robust performance across most environments that are susceptible to develop over a 4-to-5-year horizon, such that we don’t have to alter them every time the environment changes. The idea is not to try to deliver the best results over a 1-to-2-year horizon at the cost of failing miserably the rest of the time. The second reason is that we cannot let the tactical asset allocation process derail the long-term strategic objective. Even if we succeeded in calling a temporary market top and sold everything immediately, it would have been useless had we not successfully re-entered with perfect timing as well. As we wrote about before[3], this is not a valid investment approach.
While we’re not betting on an immediate reversal of Trump’s international trade policies, we’re not prepared to bet on a further degradation of the situation beyond current levels either. Ultimately, we think that the President will be forced to reverse course, voluntarily or not. With that in mind, we believe that markets have moved lower enough for us to be thinking about adding selectively to equities at the margin, in a disciplined manner. The CBOE Volatility Index (see below) is approaching levels not seen since the onset of the pandemic and the Conference Board’s latest survey of US Consumer sentiment sank to a 12-year low in March. Moody’s March survey of business confidence fared no better. We’re approaching the point of maximum pessimism, which could mean that we are approaching a constructive entry point.
LIFE AFTER LIBERATION DAY
We believe that the market reaction to Liberation Day’s announcement is consistent with the idea that tariffs were higher than anticipated but at the same time unlikely to be permanent. We feel that if participants thought that tariffs would become permanent, equities could broadly be down another 15% to 20% from here. On the other hand, if tariffs suddenly disappeared, the markets would likely bounce back but perhaps not to the level that prevailed on April 2nd as Washington hasn’t exactly behaved in the most trustworthy fashion in the past few months. It will take time to restore confidence, if it is possible at all. In the short term, if Trump’s team of advisers plays its cards smartly, it will try to minimize the reaction of other countries and invite them to negotiate. At the same time, the advisers should entice the President to reassure his constituents by reminding them that more aggressive tax cuts are coming soon. Lastly, the President should restrain himself from provoking Jerome Powell. If these conditions are respected, we believe that the level of uncertainty, as proxied by the CBOE Volatility Index, will decline from its absurdly high current level.
Patrimonica’s Investment Team
[1] Returns presented in local currency unless specified otherwise.
[2] Net bilateral exports to the United States divided by exports to the United States