1st Quarter, 2025
Isolationism is not a path to sustainable economic growth.
THE MARKETS
In the first quarter of 2025, markets faced a reality check as unease grew over tensions between the U.S., Europe, and Canada. The new administration’s demands on tariffs, wavering support for NATO and Ukraine, and shifting spending priorities fueled uncertainty.
At the same time, major investment banks have lowered earnings expectations for 2025, aligning with the Federal Reserve’s downward revisions to GDP and sharp declines in business and consumer confidence, as reflected in the latest Conference Board polling. Rising uncertainties have weakened market sentiment, leading to a decline in the dollar as foreign investors lose confidence.
The bond market reflects these concerns, with yields falling across the curve and a slight reinversion at the short end. Widening credit spreads between Treasury and corporate bonds further signal expectations of an economic slowdown.
THE ECONOMY
Before Inauguration Day, U.S. GDP growth for 2025 was projected at 2.4%, down from 2.7% in 2024. However, chaotic policy announcements have now lowered expectations, with renewed inflationary pressures and a modest rise in unemployment.
Last week, Fed Chair Jerome Powell forecasted 1.7% GDP growth for 2025 and 2.7% inflation. Meanwhile, Conference Board data shows sharp declines in business and consumer confidence, with six-month outlook expectations at their lowest since 2013. Plans for major purchases like homes and vehicles continue to drop.
A striking aspect of the Conference Board survey is the prevalence of references to the "Trump Agenda," both positive and negative, regarding economic uncertainty and inflation. Notably, 66% of respondents anticipate a recession, a stark shift from last year’s expectation of a soft landing.
Treasury funding remains a key focus, as slowing tax receipts, reduced foreign holdings of U.S. debt, and continued reliance on short-term Treasury bills create pressure. The Fed’s decision to scale back its balance sheet reduction to $5 billion from $25 billion per month provides modest relief.
Growing estrangement from Europe and Canada, driven by U.S. policy shifts, is heightening uncertainty, increasing volatility, and diminishing hopes for a soft landing. The perception of the dollar as a crisis safe haven is being challenged by isolationist rhetoric. Foreign investors are shifting assets into euros, pounds, Asian currencies, and gold, all of which are gaining against the dollar. This trend appears to be accelerating.
A broader geopolitical and economic divide between the U.S. and Europe is forming, affecting governments, businesses, and the public. China stands to benefit, as Xi Jinping capitalizes on these tensions by courting global business leaders with promises of market access. For Europe, strengthening ties with China presents an economic opportunity and a potential buffer against Russian aggression. With the Eurozone more critical to China than Russia’s territorial ambitions, a new détente could emerge.
INVESTMENT STRATEGY
Notwithstanding the recent surge in market volatility spawned by political and economic uncertainty, our primary objective of maintaining and increasing the purchasing power of your portfolios remains intact. We are actively assessing the multiple challenges that companies and their managements face. We are mindful that the likelihood of unintended consequences is heightened.
Two important game changers are the estrangement of Europe and Canada from the U.S. regarding the future of NATO and the isolationist policy of imposing tariffs on numerous countries, many of whom are traditional allies. This policy has the potential to foment trade wars, supply chain disruption and renewed inflation. Implementation of both policies carries a risk of unleashing significant unintended consequences.
As long-term equity investors, we are committed to ownership in companies whose businesses and competitive positioning are durable, thus creating growing and resilient cash flows. We will continue to exercise prudence and maintain balance as appropriate to individual risk profiles, including selective pruning of equities to harvest capital appreciation when these opportunities present themselves.
Fixed income holdings of short duration U.S. Treasuries afford investors flexibility, liquidity, and positive real returns. Although corporate spreads have widened modestly, they do not provide compelling opportunity. At this time, the growing prospect of tariff-driven inflation and reduced GDP growth increases the likelihood of credit downgrades. Isolationism is not a path to sustainable economic growth.
POINTS OF INTEREST
The arrival of China as a global economic power and the use of economic sanctions against Russia and Iran have unleashed geopolitical forces that want to create alternatives to the U.S. dollar’s supremacy. Its’ status as the world’s reserve currency, attained following WWII, has been sustained by its’ reliability in settling international transactions. Confidence and economic resilience of the American economy have under pinned the safety of holding dollars. This view of dollar omnipotence has been of great help in the financing of U.S. fiscal needs.
We are now faced with a new challenge to the dollar’s role should the use of tariffs devolve into perceived attack on our trading partners. Further estrangement of NATO allies would be yet another hindrance. Although we are mindful of potential U.S. vulnerabilities arising from policy mistakes, we believe extrapolating current U.S. dollar weakness to mean diminished long-term stature would be incorrect. The U.S. economy is not immune to economic cycles, but its resilience and adaptive nature should not be underestimated, in spite of being tested in the near term.