Executive Summary
- The S&P 500 registered its worst quarterly performance since Q3 2022
- Economic, geopolitical, and market uncertainties remain elevated
- S&P 500 corporate EPS is forecasted to grow 11.5% in CY 2025
- 8 of 11 large cap sectors are positive YTD
- HY Credit and UST rates are not reflecting economic contraction
- The Federal Reserve is on the sidelines and projects lower real rates
The first quarter of 2025 has been a period of significant economic, geopolitical and market turbulence in the United States. Slowing economic data, rising global tensions and increasing policy uncertainty contributed to an unwinding of the so-called “Trump trade,” giving way to increased market volatility, lower UST yields and U.S. equity market corrections. The uncertainty has only increased with the Federal Reserve on the sidelines and the administration placing greater emphasis on funding (i.e., lower rates) over the wealth effect (i.e., stock market).
Following a 57.8% total return over the prior two years, marking its best two-year performance since 1998 (26 years), the flagship S&P 500 corrected more than 10% in the latter half of Q1 leading to its worst quarterly performance (-4.3%) since the peak of the hiking cycle in Q3 2022.
Aside from the Nasdaq-100 and Nasdaq Composite indices, which benefitted in December with greater weightings towards large-cap growth, the major equity indices (S&P 500, Dow Jones Industrial, S&P MidCap 400 & Russell 2000) registered monthly declines in three of the prior four months starting in December. Large-cap growth held up near its cycle highs into mid-February before succumbing to the rotation of selling pressure. Today, each of the majors have corrected at least 10% from their recent highs, while all reside below their respective 200-day simple moving average (sma).
For most stocks outside of large-cap growth, the corrective price action started in December, when eight of 11 large-cap sectors finished that month in the red for an average decline of 7.7%, while all 11 small-cap sectors finished in the red for an average decline of 8.3%. By the end of Q1, the 11 large-cap sectors declined an average of 9.7% from their respective 52-week highs, while the 11 small-cap sectors declined 17.1% from their respective 52-week highs.
From a glass half full perspective, most large-cap sectors experienced their greatest declines in December and downside momentum has since been waning. At the end of Q1, eight of 11 sectors are positive YTD.
While U.S. equity markets are correcting their historic gains from the prior two years, many overseas economies are rebounding from prior economic slowdowns driven in part by fiscal and monetary stimulus and a weakening U.S. dollar. China’s stimulus measures included wage increases for millions of government workers, higher state and local government bond issuance to support real estate and the banking system, expansion of the consumer goods trade-in program, and an overall increase to the budget deficit to the highest on record since 2010. Europe’s increasing fiscal spending is in part driven by its focus on rebuilding national defense as U.S. leadership has cast doubt on NATO mutual defense clauses. Notably, Germany is aiming to overhaul long standing debt rules and releasing its “fiscal break.”
U.S. economic data has been cooling throughout 2025. Housing inventories have risen to pre-covid levels raising concerns there could be a slowdown in residential construction later this year. The 30-year fixed-rate mortgage fell to 6.65% in late March, but it likely needs to move lower to improve existing home sales which for two years have been hovering at levels last seen during covid and the GFC eras. While employment appears solid, there are signs amidst quit rates, real wages, new hires, and average weekly hours which may suggest future upward pressure in the unemployment rate. Consensus currently projects 2025 Real GDP of 2%, however the widely referenced Atlanta Fed GDPNow economic model now projects a sizeable contraction (-2.8%) for Q1 2025. The alternative model forecast adjusting for imports and exports of gold projects a contraction of 0.5%.
The Federal Reserve paused its rate cutting cycle with Chair Powell affirming the Fed is in “no hurry” to cut rates at the most recent March FOMC. The Fed’s quarterly SEP (March) projected lower growth (GDP from 2.1% to 1.7%) and higher inflation (core-PCE from 2.5% to 2.8%) for CY 2025 but held constant its FFR guidance at 3.9%, implying just two 25bp rate cuts. The Fed noted the economy is in good shape but also placed strong emphasis on the increasing uncertainty surrounding the economy and its future projections. Some argue the Fed’s monetary policy is too tight, creating a passive tightening effect by waiting for bad news to act which puts excess strain on cyclical areas of the market. The old market mantra “don’t fight the Fed” has been replaced by “don’t fight the Treasury”
Looking Ahead
Corporate earnings and revenue expectations have come in throughout Q1. According to FactSet, projected S&P 500 earnings growth for CY 2025 has declined from 14.8% at the start of the year to now 11.5%, while projected revenues have fallen from 5.8% to 5.4%. For Q1 2025, analysts are project S&P 500 EPS growth of 7.3% and revenue growth of 4.2%. The S&P 500’s forward 12-month PE ratio is currently 20.5 which is down from 21.5 at YE 2024, but above the 5-year and 10-year averages of 19.9 and 18.3, respectively.
The administration’s April 2nd “Liberation Day” implements a range of tariffs on imports. These tariffs are designed to be broad-based and reciprocal, matching the duties that other countries charge on U.S. products. This contributed to elevated uncertainties for the capital markets as the specifics evolved and resulting impacts remain unclear.
While markets hate uncertainty, there are reasons to believe much of the risk is already priced into the stock market which could be closer to bottoming than continuing meaningfully lower. The strength in foreign equity markets reflecting greater monetary and fiscal stimulus supports an improving global growth outlook. Long UST yields are rangebound with the UST 10-year yield at 4.25% at the end of Q1 which is well above the 2024 lows of 3.6% suggesting the rates market is currently not fearing recession. HY Credit spreads (chart below) have widened marginally in 2025 and remain far below prior recession levels.
The information contained herein is provided for informational and educational purposes only, and nothing contained herein should be construed as investment advice, either on behalf of a particular security or an overall investment strategy. All information contained herein is obtained by Nasdaq from sources believed by Nasdaq to be accurate and reliable. However, all information is provided “as is” without warranty of any kind. ADVICE FROM A SECURITIES PROFESSIONAL IS STRONGLY ADVISED.
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