The Brave Report: Market Commentary for Q1 2025

Click here for .pdf version of this report: The Brave Report-2025Q1

The party is over, for now…. Markets finally softened in the first quarter, pulling back from all-time highs. A rotation out of some of the large technology names dragged the markets down and created a reprieve from very stretched valuations.  As we were starting to see what seemed like a short-term bottom to end the quarter, Trump sent things into a tailspin with his announcement of aggressive tariffs on almost every country in the world. Even as I write this, I am still trying to digest the announcement and fully understand the economic rationale that allowed the administration to arrive at the plan they presented.  While I think some changes in our trading relationships need to happen, I remain perplexed as to how this was the path that was chosen to get there.

While this commentary is normally about the previous quarter, with what has transpired to start the second quarter I would be doing a disservice if I didn’t discuss what has happened over the last week.  I originally wrote this commentary before Trump’s tariff announcement but this new information and the subsequent market reaction has had an impact on my outlook for the markets and the economy moving forward. I will still provide my normal recap of the first quarter but will also provide commentary on the recent events.

Market Overview

Markets finally showed some weakness, pulling back significantly in the first quarter.  A rotation out of big technology names led the way, with the NASDAQ dropping more than 10%.  The S&P 500 gave back 4.6% and the DOW held up the best, dropping only 1.3%. After hitting new all-time highs in February, we saw a sharp selling to close out the quarter.  A pullback wasn’t completely unexpected, but the severity of the drop, especially among the market leaders, took many by surprise. I expect this type of volatility to continue throughout the 2^nd quarter, especially in light of the new tariff announcements.

On the fixed income side, we saw rates drop throughout the quarter. After peaking at 4.8% in early January, the rate on the 10-year treasury dropped below 4.25% to end the quarter.  Much of this drop was due to a flight to safety as the markets started to sell off. However, the Fed did also indicate a slower pace to rate cuts which is at odds with the drop in rates.  With continued stock volatility to start the 2^nd quarter, I expect to see some volatility from the rate complex as well.  If we see continued downside pressure on the stock market, I expect this safe haven trade to continue.

So, to bring everyone up to speed on what happened last week.  Trump announced wide-ranging tariffs on almost all imports.  These tariffs range from a baseline of 10% up to 46% for Vietnam.  The most notable and impactful are the 20% and 34% tariffs being placed on the EU and China respectively, as these are our biggest trading partners.  We knew that Trump planned to impose some level of reciprocal tariffs but the levels that were announced far exceeded even the high-end expectations.  Additionally, the calculation and rationale to arrive at these numbers do not align with traditional trading calculations. As a result, we saw one of the largest two-day selloffs in market history. The S&P 500 lost more than 10% on Thursday and Friday.

Let me start by saying, I agree that some changes need to be made in regard to our trade agreements around the world.  We have many trading arrangements that need to be renegotiated to safeguard our domestic interests and make sure we are not subsidizing other economies around the world. Many of the current arrangements date back decades and many countries have unilaterally enacted trade protections against the US with little recourse or pushback from us. I also agree that creating incentives for companies to move production back to the United States would be very stimulating for the job market and our economy.

With that said, the tariff plan, as outlined last week, will have a negative impact on the economy.  It will cause inflation to rise, growth to slow and drastically increase the chances of a recession in the coming quarters.

Bringing production back into the US is also not an overnight process and is a very expensive one for most companies.  Many US companies were created and thrived based on the current supply chain and the reduced costs available from producing elsewhere.  This throws all of that into a tailspin and creates a layer of uncertainty for businesses, both large and small. If production costs increase due to the tariffs, many of the small and mid-sized companies will not be able to survive because repatriating production is too expensive and puts too much pressure on margins to make a business feasible.

Additionally, the way the tariff rates were calculated has perplexed many.  Rather than base the reciprocal tariffs on the specific rate these countries are charging us, the administration used the trade deficit with each country to come up with the rate charged.  This calculation assumes that we shouldn’t have a trade deficit or surplus with any country.  This logic is flawed since it doesn’t factor in that the US exports a lot of services and IP resources which don’t show up in trade numbers.  Many other countries also do not have the ability to buy the same amount of US goods as we buy from them. Their economies just aren’t big enough.

So how do I see this playing out over the short and long term and what will the impact be on the markets? There are three paths I think this could take.  I will start with the worst-case scenario.

The worst-case scenario is a continued firm stance.  It is basically that these tariffs get implemented as laid out by the President last week.  He digs his heels in on negotiations and is unwilling to budge from the proposed tariffs.  This causes the EU and China to also dig in and we see a prolonged trade war that spills over beyond just tariffs.  Companies are forced to pause capital spend and hiring due to the uncertainty and we are plunged into a deep recession. This will bring rates down rapidly as investors search for a safe haven and the Fed is forced to cut rates more rapidly, but this is at the expense of economic contraction.  If this is the case, then the markets are nowhere near a bottom, and we are in for a very difficult year.

On the other side of the spectrum, and I think the scenario we are all hoping for, these initial tariffs are a strong negotiating tactic.  They are an attempt to peg the starting point to negotiations and we see swift concessions and a walkback in the rates if other countries are willing to come to the table.  The administration shows good faith that if countries are willing to negotiate then the tariffs will be delayed or the rates will be reduced on a case-by-case basis.  This removes some of the uncertainty for companies and they can more confidently chart a path forward. That path could include repatriating some production, but it can be done at their speed and in a much more thoughtful manner. Optically, Trump can claim victory and we get a more fair-trade environment.  In this case, we would see some continued volatility on the short term, but we would avoid recession, and the economy and markets would grow.

The last scenario, and the one I think is the most likely, is that these aggressive tariffs are a negotiating tactic and it brings many small countries that are completely reliant on US exports to the table to negotiate. However, we see continued pushback from our largest trading partners, the EU and China. This creates a prolonged trade war with these countries that slows economic growth and makes inflation much stickier.  A recession is still on the table but could be avoided if rates drop enough.  In this scenario, the markets find a bottom, but uncertainty keeps volatility high until we see some kind of real resolution. I equate this with what happened back in 2018 when Trump levied tariffs on China, and we saw a continued back and forth between the two countries for months.  Volatility spiked but eventually cooler heads prevailed, and an agreement was reached.

In all of these scenarios, volatility will remain high for the foreseeable future, and we will see sharp market swings based on every bit of good or bad news that comes out of the White House. We will continue to see the word recession tossed around as investors try to handicap the chances of a recession happening and the depth of any recession should it happen. Again, my hope is that this is short-lived and has given some stocks a chance to drop back to more traditional multiples. However, I fear that Trump’s stubbornness will force this potential trade war to disrupt markets and create uncertainty for the remainder of the year.

So, with all of this uncertainty, how do we invest moving forward?  The first thing I will say is not to panic.  These tariffs were just announced last week, and we are still trying to determine how they will impact the economy. If you have short-term capital needs, you should probably not have been fully invested in the first place and should look to raise capital on any strength.

For long-term investors, which is most of you reading this, it is important to stay the course.  We know that we see pullbacks like this every few years.  We saw a similar drawdown as recently as 2022. Whenever we see spikes in volatility like we have seen, I like to put things into perspective.  Even with the large drawdown we have seen, the S&P 500 is still positive since the beginning of 2024, so the world is not ending. We also know that, historically, being invested far outperforms trying to time the market. Looking back, 42% of the best market days happen during bear markets and missing out on these days can have a very detrimental impact on long-term performance.

Additionally, when people hear the word recession, they tend to panic and think the world is ending. And yes, we have seen some very painful recessions in our lifetime. However, if we look at historic market performance during and after a recession, the results might surprise you. Going back to 1953, we have seen 11 recessions.  The average rate of return during those recessions was up 1.4%.  If you look two years beyond the start of these recessions, the average return is 32%.

Now, I am not saying we are at the bottom of the current drawdown.  Depending on the path of the tariff negotiations, we could still see considerable downside from here. But, for long-term investors now is the time to maintain a balanced asset allocation.  We will look for opportunities to bargain shop with any existing or new cash but will do so very cautiously. We may also look to increase some of our treasury exposure on the margins. We don’t want to be the ones trying to catch a falling knife, but we also want to be able to enter the market at depressed levels if we can.

Strategy Commentary

I trimmed some equity exposure in the first quarter as some stop losses kicked in on some names that had run up. I would have liked to trim a bit more but the speed of the decline has now put us in an environment where we need to wait things out.  I am still holding out on putting new money to work in equities but will be looking to dollar cost average into some beaten-up areas, especially if we see markets take another leg lower.  If we start to see some resolution around the tariff plans, we could see a sharp rip higher, but I am not trying to day trade this type of news-driven market.

Although I have trimmed some positions slightly, I continue to maintain my overweight to technology and communication services.  They have been beaten up over the last quarter, but they are now trading at multiples that are much more palatable. I also think some of the names in the space are a bit more insulated from tariffs.  This could change if any countries try to regulate technology as a negotiating tactic in the trade war, but we have not seen that as of yet.

International markets have also been roiled by the recent tariff announcements.  European and Chinese markets had outperformed in the first quarter and were showing signs of returning to growth.  However, that has now all changed.  I am currently maintaining a neutral stance on these markets and am maintaining a normal allocation to these regions.

On the fixed-income side, I started to add back to some longer-dated treasury positions, mostly using ETFs.  We have already seen a bit of a rush to safety, and I expect this to continue as volatility remains high. I currently favor a more bar belled approach by maintaining my equity exposure but also keeping elevated levels of safer assets such as cash and treasuries.  This serves two purposes; it maintains some dry powder that can be put to work if we do see a bottom in the stock market but also provides some protection if there is a continued rush to safety.