Executive Summary:
- Stocks Correct in First Quarter, Pulled Lower by Tech/AI, While Bonds Gain
- Tarriff Uncertainty Undermines Economic Outlook
- Non-U.S. Markets and Economies Receive White House’s Wake Up Call
- 2017 Tax Cut Renewal by Year-End Needed to Avert Latter-Day Fiscal Cliff
- Portfolios Stay on Defense, Lengthen Bond Mix
What happened in the financial markets in the first quarter? Financial markets were choppy in the first quarter, with stocks showing significant weakness in the second half. The S&P 500 ETF declined by 4.3%, on a par with the weak start to 2022. The S&P began 2025 with gains, on optimism about the new administration, reaching an all-time high on February 19th. But second thoughts about President Trump’s tariff rollout triggered a 10% correction over the next 16 trading days. The quarter’s pain was sharpest in the technology/AI space, which had led gains in the last two calendar years, with the NASDAQ sliding 8.4%. Rotation out of U.S. tech benefitted U.S. value (the Russell 1000 value index returning +1.6%) and non-U.S. developed markets (the EAFE ETF gaining 6.8%, driven by Europe and Hong Kong).
Thayer client portfolios held up relatively well on this shifty landscape. This reflected a combination of 1) a modest tactical equity under-weight to stocks overall, 2) meaningful exposure to rising international markets, and 3) a bias away from tech/AI, on earlier-expressed valuation concerns. The bond allocation also proved helpful, with the broad AGG index gaining 2.7%, as investors sought safety and seemingly prepared for new economic headwinds.
What is driving Federal Reserve Bank’s and other GDP projections lower? Tariff upheaval, and uncertainty about specifics and logistics due to uneven communication from the White House (with early April announcements on tap), have put pressure on economic views. Most trading partners, including Mexico, Canada, China, and the Eurozone, are in the tariff crosshairs, as are many industries, among them steel, aluminum, and car producers. The uncertainty has undermined corporate planning, and by extension hiring and investment. After two and a half years of solid 2-3% growth, U.S. GDP prospects have dimmed, and recession odds have risen.
The gloominess is not necessarily new. It marked the earlier days of the Federal Reserve’s aggressive policy interest rate hike campaign in 2022, but surprisingly robust consumer spending, accounting for about two thirds of our GDP, kept output afloat. More recently, however, there are louder signs of consumer fatigue. Among several, the Conference Board’s March “expectations index” dropped to a 12 year low and well below a level that typically indicates recession. More tangibly, retail sales have come under recent pressure, notably in department stores and restaurants.
The Fed itself lowered its 2025 U.S. GDP forecast in the March meeting, to 1.7% from 2.1% three months earlier. While this might point to easier rate policy ahead, the complicating factor is inflation, which the Fed now predicts will end the year at 2.8%, up from a previous 2.5% expectation. Here again, tariffs are seen as a factor, given that U.S. importing companies pay the surcharge to the U.S. Treasury, and then must decide whether to pass these costs on to their customers. Not surprisingly, Chair Jay Powell used the term “tariff inflation” multiple times in his press conference. With the growth and inflation changes arguably offsetting, he stuck with a forecast for two quarter point cuts this year, which would bring the federal funds rate down to 3.75-4.00%.
How do investors calibrate tariff and America-first policy implications? The new White House’s move toward a more America-first trading and geopolitical posture may already have had market implications, including the improved relative performance of international stocks. Ex-U.S. trade alliances appear to be firming (several in Asia and also between Europe and South America) and political and spending priorities are changing. A wake-up call seemingly has been answered in the Eurozone and specifically Germany, given that perceptions of a receding U.S. defense security blanket have given rise to a greater need for self-sufficiency. Freed up by borrowing relaxation, Germany’s new spending plans on defense and infrastructure have ramped up to about $1.1 trillion, which according to J.P. Morgan would be “the largest fiscal stimulus the country has seen since post-Cold War reunification”.
More broadly, defense spending among NATO’s 32 members is likely to rise. Trump is not wrong that the U.S. carries by far the most weight, by a huge margin in whole dollar terms (its $968 billion defense budget well over Germany’s $98 billion, the U.K.’s $82 billion, and France’s $64 billion), as well as significantly in percentage-of-GDP terms, with the U.S. at 3.4% while the aforementioned three are just over 2%. At a February conference, NATO Secretary Mark Rutte expressed that the 2% level agreed to ten years ago must now by upped to at least 3%, driven by such exigencies as the encroaching Russian threat, and need to re-arm in order to send weapons to Ukraine. On this backdrop, positive long term growth effects are seen for a Eurozone economy that has been relatively dull for many years.
What is the outlook for and importance of 2017 TCJA renewal? President Trump’s 2017 tax legislation, the Trump Tax Cut and Jobs Act (TCJA), which included cutting the corporate tax rate from 35% to 21% and the top individual marginal rate from 39.6% to 37%, is set to expire on 12.31.25. Whether or not it is renewed has major implications; if not, an effective tax increase of some $4 trillion over ten years would result, an unprecedented hike. Indeed, it has echoes of the year-end 2012 “fiscal cliff”, referencing the scheduled expiration of the 2001 and 2003 Bush tax cuts, which was headed off by new legislation.
With its namesake’s return to office, unlike in the earlier case, prospects for TCJA renewal would appear to be good. But this is complicated by delicate politics, including the narrow three seat House Republican majority. The bill also is wrapped up in broader fiscal jockeying, including initiatives to dramatically cut spending, spearheaded by Elon Musk’s DOGE team. While Trump would prefer one large bill, it might be carved into pieces, and linked to other initiatives such as immigration reform. Overall, we can almost always feel assured that Congress will find a way to kick the can down the road given how politically damaging a return to higher taxes would be, but visibility is low, and almost certainly there will be drama.
Any changes in portfolio positioning, and why? We feel portfolios overall are appropriately allocated with a moderately defensive mix. We did make a small adjustment in the bond book, with duration adjusted higher to roughly match the benchmark’s 6 years. This reflects lower confidence about U.S. economic performance over the course of 2025. We will learn more from corporate guidance this month as we move through earnings season, but our sense is that retrenchment and sobriety will be themes.
As always, as we underscored in our March 10 comments, staying diversified and disciplined, and keeping the longer-term objective in mind, remain key underpinnings of the investment effort. We have been gearing up for and writing about anticipated higher volatility, as uncertainty tends to have that impact. We will continue to navigate this landscape, in partnership with our clients.
David Beckwith, Chief Investment Officer
Thayer Partners Quarterly Commentary, First Quarter 2025
Executive Summary:
What happened in the financial markets in the first quarter? Financial markets were choppy in the first quarter, with stocks showing significant weakness in the second half. The S&P 500 ETF declined by 4.3%, on a par with the weak start to 2022. The S&P began 2025 with gains, on optimism about the new administration, reaching an all-time high on February 19th. But second thoughts about President Trump’s tariff rollout triggered a 10% correction over the next 16 trading days. The quarter’s pain was sharpest in the technology/AI space, which had led gains in the last two calendar years, with the NASDAQ sliding 8.4%. Rotation out of U.S. tech benefitted U.S. value (the Russell 1000 value index returning +1.6%) and non-U.S. developed markets (the EAFE ETF gaining 6.8%, driven by Europe and Hong Kong).
Thayer client portfolios held up relatively well on this shifty landscape. This reflected a combination of 1) a modest tactical equity under-weight to stocks overall, 2) meaningful exposure to rising international markets, and 3) a bias away from tech/AI, on earlier-expressed valuation concerns. The bond allocation also proved helpful, with the broad AGG index gaining 2.7%, as investors sought safety and seemingly prepared for new economic headwinds.
What is driving Federal Reserve Bank’s and other GDP projections lower? Tariff upheaval, and uncertainty about specifics and logistics due to uneven communication from the White House (with early April announcements on tap), have put pressure on economic views. Most trading partners, including Mexico, Canada, China, and the Eurozone, are in the tariff crosshairs, as are many industries, among them steel, aluminum, and car producers. The uncertainty has undermined corporate planning, and by extension hiring and investment. After two and a half years of solid 2-3% growth, U.S. GDP prospects have dimmed, and recession odds have risen.
The gloominess is not necessarily new. It marked the earlier days of the Federal Reserve’s aggressive policy interest rate hike campaign in 2022, but surprisingly robust consumer spending, accounting for about two thirds of our GDP, kept output afloat. More recently, however, there are louder signs of consumer fatigue. Among several, the Conference Board’s March “expectations index” dropped to a 12 year low and well below a level that typically indicates recession. More tangibly, retail sales have come under recent pressure, notably in department stores and restaurants.
The Fed itself lowered its 2025 U.S. GDP forecast in the March meeting, to 1.7% from 2.1% three months earlier. While this might point to easier rate policy ahead, the complicating factor is inflation, which the Fed now predicts will end the year at 2.8%, up from a previous 2.5% expectation. Here again, tariffs are seen as a factor, given that U.S. importing companies pay the surcharge to the U.S. Treasury, and then must decide whether to pass these costs on to their customers. Not surprisingly, Chair Jay Powell used the term “tariff inflation” multiple times in his press conference. With the growth and inflation changes arguably offsetting, he stuck with a forecast for two quarter point cuts this year, which would bring the federal funds rate down to 3.75-4.00%.
How do investors calibrate tariff and America-first policy implications? The new White House’s move toward a more America-first trading and geopolitical posture may already have had market implications, including the improved relative performance of international stocks. Ex-U.S. trade alliances appear to be firming (several in Asia and also between Europe and South America) and political and spending priorities are changing. A wake-up call seemingly has been answered in the Eurozone and specifically Germany, given that perceptions of a receding U.S. defense security blanket have given rise to a greater need for self-sufficiency. Freed up by borrowing relaxation, Germany’s new spending plans on defense and infrastructure have ramped up to about $1.1 trillion, which according to J.P. Morgan would be “the largest fiscal stimulus the country has seen since post-Cold War reunification”.
More broadly, defense spending among NATO’s 32 members is likely to rise. Trump is not wrong that the U.S. carries by far the most weight, by a huge margin in whole dollar terms (its $968 billion defense budget well over Germany’s $98 billion, the U.K.’s $82 billion, and France’s $64 billion), as well as significantly in percentage-of-GDP terms, with the U.S. at 3.4% while the aforementioned three are just over 2%. At a February conference, NATO Secretary Mark Rutte expressed that the 2% level agreed to ten years ago must now by upped to at least 3%, driven by such exigencies as the encroaching Russian threat, and need to re-arm in order to send weapons to Ukraine. On this backdrop, positive long term growth effects are seen for a Eurozone economy that has been relatively dull for many years.
What is the outlook for and importance of 2017 TCJA renewal? President Trump’s 2017 tax legislation, the Trump Tax Cut and Jobs Act (TCJA), which included cutting the corporate tax rate from 35% to 21% and the top individual marginal rate from 39.6% to 37%, is set to expire on 12.31.25. Whether or not it is renewed has major implications; if not, an effective tax increase of some $4 trillion over ten years would result, an unprecedented hike. Indeed, it has echoes of the year-end 2012 “fiscal cliff”, referencing the scheduled expiration of the 2001 and 2003 Bush tax cuts, which was headed off by new legislation.
With its namesake’s return to office, unlike in the earlier case, prospects for TCJA renewal would appear to be good. But this is complicated by delicate politics, including the narrow three seat House Republican majority. The bill also is wrapped up in broader fiscal jockeying, including initiatives to dramatically cut spending, spearheaded by Elon Musk’s DOGE team. While Trump would prefer one large bill, it might be carved into pieces, and linked to other initiatives such as immigration reform. Overall, we can almost always feel assured that Congress will find a way to kick the can down the road given how politically damaging a return to higher taxes would be, but visibility is low, and almost certainly there will be drama.
Any changes in portfolio positioning, and why? We feel portfolios overall are appropriately allocated with a moderately defensive mix. We did make a small adjustment in the bond book, with duration adjusted higher to roughly match the benchmark’s 6 years. This reflects lower confidence about U.S. economic performance over the course of 2025. We will learn more from corporate guidance this month as we move through earnings season, but our sense is that retrenchment and sobriety will be themes.
As always, as we underscored in our March 10 comments, staying diversified and disciplined, and keeping the longer-term objective in mind, remain key underpinnings of the investment effort. We have been gearing up for and writing about anticipated higher volatility, as uncertainty tends to have that impact. We will continue to navigate this landscape, in partnership with our clients.
David Beckwith, Chief Investment Officer