Q1 2025

It is no exaggeration to speak of the end of an era—perhaps of several eras. The end of 80 years of US leadership in NATO and the Western security alliance? Quite possibly. The end of an era of globalisation in trade and finance, promoted for generations by US policymakers? It increasingly seems that way. An end to US asset dominance? Too early to say—but the first quarter of 2025 already saw both US stocks and the dollar under pressure, even before April’s tariff shock. More on Q1 later—but while markets clearly did not expect a hit of this magnitude (US and global stocks hit all-time highs as recently as mid-February), concern was building: European equities enjoyed their strongest quarterly outperformance versus the US in over a decade.

Investors began the year fairly confident a recession could be avoided, but uneasy about stubborn inflation. The new tariff regime shattered this fragile confidence in an instant. Tariffs are clearly inflationary, raising the cost of imported goods; but like a sales tax rise or a spike in oil prices, they also threaten growth, leaving consumers with less to spend and adding cost and complexity for businesses. Trump’s measures will push US tariffs overnight to their highest levels in more than a century—a blunt instrument, hammering on the US economy. For a globalised system built on selling goods to the voracious consumers in the world’s largest and richest economy, this is truly the end of an era.

The tariffs are intended to punish exporters who “unfairly” target the US and to encourage reshoring of supply chains. But they are a crude tool, applied illogically, and likely to hurt Americans at least as much as trading partners—with potentially devastating consequences for poorer countries that export cheap goods to the US but buy little in return.

Brexit imposed trade barriers on the UK, dampening growth and pushing inflation higher than it would otherwise have been, but with relatively little impact on the rest of the world. The pain was largely self-contained. Trump’s tariffs will undoubtedly hurt the US but when a far larger economy turns inward, the consequences travel further. We know that “when America sneezes, the world catches a cold.” Sadly, when the US shoots itself in the foot, the rest of the world ends up limping too.

More forecasters are now predicting a US recession, as consumer spending power is undermined by tariff costs. Lower demand from US consumers will hit exporters worldwide, damaging some sectors more than others and disrupting trade as companies look to remodel supply chains and find new markets for their products. Recession risk is clearly increased in other economies too, all the more so if retaliatory tariffs increase costs for consumers in those economies too.

So much depends on where we go from here, and how long the new tariff regime remains in place: uncertainty abounds. President Trump has stated that “there will be a little disturbance, but we’re ok with that”, but it remains to be seen whether that line holds in the face of challenge from many who see the moves as a terrible own-goal. We should expect internal legal and political challenges, intense lobbying from business, and pressure from Republican politicians concerned about the impact on constituents and on financial markets. The response of the US trading partners is crucial: will Liberation Day be the first salvo in a series of worsening retaliations and countermeasures? Or just the opening move in hardball negotiations that ultimately lead to compromises and scaled-back tariffs Trump can sell as a win?

It may be that in a few quarters, we can look back and realise that early April was the moment of peak panic; but even in that most optimistic view, there will clearly be negative effects on trade, on consumer spending, on corporate profit margins, on growth and on inflation. On the other hand, the harm may continue and deepen, if we spiral into a more intense trade war: early indications of retaliation and counter-response from China suggest this is a real risk.

It is impossible to know at this stage how long tariffs will last and how deeply they will hit: the President has imposed the policy at a stroke, and it could be removed, watered down - or indeed intensified - overnight. This uncertainty is deeply problematic, for the corporate world and for financial markets alike: a deterrent to investment and risk-taking.

While the US economy in particular has continued to show resilience - with recent job creation data surpassing expectations - surveys of firms’ expectations in March were more subdued. But the tariffs threaten damage on a colossal scale, as markets are now trying to reflect. Already, surveys of consumer confidence show concerns over recession and job security at very elevated levels. This will inevitably affect household spending, even before tariff-related inflation filters through. We may expect surveys of business confidence to go the same way, and firms to be wary of decisions on hiring and capital investment.

Markets began Q2 pricing in a re-acceleration of central bank rate cuts in response to the recessionary impact of tariffs. However, with a period of post-Covid “transient inflation” fresh in the mind, which turned out to be much less transient than policymakers predicted, the situation for the key central banks begins to look very delicate. The Fed in particular faces a tricky balancing act: can it justify cutting rates to support growth if inflation actually spikes higher due to tariffs? Or will it be forced to hold fire, risking a deeper downturn? Ongoing uncertainty about central banks' reaction adds to the scope for market volatility.

With policy shifting rapidly, tariffs evolving daily and market volatility intense, any commentary risks being quickly overtaken. Still, early 2025 already offers important lessons: even before the April announcements, change was in the air—and markets were adjusting accordingly.

In 2024, US assets had led the way higher - as they had for most of the post-pandemic period: US stocks outperformed dramatically, fuelled by a series of rate cuts and the apparent success of global policymakers in navigating a rare economic soft-landing. Technology and growth stocks had led the way, a narrow group of leaders accounting for a huge proportion of the market’s rise. The US Dollar had strengthened too, boosting returns for global investors who held US stocks (and further penalising US investors who had diversified overseas). We questioned how far expensive momentum stocks could go and highlighted the important role out-of-favour assets in a properly diversified portfolio, such as European and Asian equities, and government bonds, to protect against a shift in sentiment.

Leadership shifted dramatically in the first quarter of 2025. After hitting record highs in February, stocks faltered as investors started to price in more damaging and disruptive tariffs than previously thought. US stocks fell, dragged down by demanding valuations and uncertainty over the scale of the economic hit that April’s tariff announcement would bring, while their European and Asian counterparts rallied - the biggest divergence of relative performance in a decade.

US equities recorded their worst quarterly return since Q3 2022, down over 4%, with the "Magnificent Seven" tech stocks accounting for the entire decline. European equities, which had lagged in recent years and languished on lower valuations, gained 5%, supported by hopes of further monetary and fiscal stimulus and expectations that a reshaped security environment would drive a sustained rise in government defence spending; UK stocks slightly outperformed, with the large cap index gaining 6%. Emerging market equities gained over 5%, led by a rise of 15% in Chinese stocks, which benefited from advances in local AI technologies and expectations of recovery in consumer spending. Of course, the market crash of early April makes these first quarter data seem academic.

The growing uncertainty about impending tariffs as the first quarter progressed saw strong performance from “safe haven” assets like gold and bonds, yet again underlining the case for portfolio diversification. Gold reached record prices above $3,000/oz - a rise of 19% in the quarter. Bonds experienced cross-currents, with yields on Gilts and European government bonds rising slightly as markets priced in a sustained shift higher in defence spending, and the strain that this could put on already-stretched public finances. US Treasuries outperformed: yields fell as investors sought the security of fixed income (and, perhaps, hoped that a focus on cutting excessive public spending would improve the long-term debt outlook for the US). This led to a gain of almost 3% for US Treasuries, and over 4% for longer-dated bonds, which are more sensitive to changes in yields. US TIPS, with built-in inflation protection, slightly outperformed conventional bonds, against a background of concerns that tariffs will drive higher consumer prices.

Oil prices were little changed in Q1, but have fallen sharply in early April, as speculators price in the likely impact of reduced demand in a slowing economy. This may provide some relief, as a fall in oil prices reduces price pressures throughout the economy and eases the strain on consumers’ finances.

In currency markets, the previous trend of Dollar strength experienced a setback. The Trump administration has been targeting a weaker Dollar, as a measure to support US manufacturing, and this has been playing out, with the Dollar declining over 4% against a broad index of its trading partners in Q1 (and declining further in the early days of April). The Pound continued to recover, rising to $1.30 vs the Dollar - a far cry from the depths below $1.10 seen in the brief Truss premiership. It remains to be seen whether a weaker US Dollar will help US manufacturers; it does, however, add to inflation risks, as imported goods become more expensive in US Dollar terms.

Markets hate uncertainty, and sadly we face plenty of it. How long the new tariffs remain in place and how deeply they will impact remains unclear—Congressional challenges, court rulings, business and political lobbying and potential international retaliation could all reshape the landscape. Equally, Trump is signalling a willingness to “take the medicine” of economic and market pain to reshape the US’s trading relationships: this could change overnight, but it seems rash to bet on an early deal. The ability of central banks to act to cushion the blow of tariffs is far from certain.

For investors, the message remains one of diversification. In our year-end review, we noted the importance of maintaining exposure to a range of asset classes and regions—not just chasing past winners. That view was reinforced in Q1, as formerly dominant U.S. technology stocks faltered while commodities, value stocks, and non-U.S. markets outperformed.

There may well be more pain ahead, but this too shall pass. History shows us that index losses are temporary, as long as we resist the urge to panic and sell out. Market volatility is painful but it is the inevitable accompaniment of strong long-term investment returns: the risk that underpins the reward. It is also the foundation of opportunity - amid the chaos and disruption, investors who can stick to their process and philosophy, can set up for better returns in the future. As markets digest these new challenges, disciplined investors who remain diversified and focused on fundamentals will be best positioned to navigate the road ahead.

N.b. All content is based on data at the time of writing on 09/04/25.