2025 Q1 Market Commentary: So, This Is Why We Diversify?
Just two days after the first quarter of 2025 ended, President Trump announced sweeping tariffs on countries around the world. These tariffs were significantly higher and more widespread than anyone expected. This led to a sharp sell-off in global equity markets in the ensuing days. We have written a separate post about current market conditions, and you can read that here. While the current market volatility might feel more urgent, we still believe it’s important to review what happened in the first quarter, even though it already seems like a distant memory.
The year was off to a rough start for US stocks well before the tariff announcement on April 2nd. The S&P 500 index was down 4.6% for the first quarter, while smaller US stocks, as measured by the Russell 2000, were down almost 10%. Not all US stocks struggled, though, as Large Value stocks were up almost 6% compared to a decline of 7.5% for Large Growth stocks. International stocks also performed very well, with developed market stocks up 7% and emerging market stocks up 3%. Real Estate, as measured by the REIT index, was also up almost 3% on the year.
It looked like we might finally be seeing a reversal of some of the extremes we discussed in January, like growth vs value, US vs international and the Mag 7 vs everything else. After two years of the biggest US stocks driving nearly all the market performance, those stocks declined while others outperformed. This was a significant rotation within the equity markets as you can see in the above Morningstar chart comparing Q1 2025 to Q4 2024.
There was another positive sign in the first quarter, as bonds served their role as the safety valve for your portfolio. US Core bonds were up around 3% in the quarter, with longer-term treasuries performing even better. There was much discussion after 2022 about the failure of bonds to properly diversify portfolios as both bonds and stocks fell that year. However, we were in a unique interest rate environment at the time, with rates being held at extremely low levels since the COVID pandemic. Going into 2025, interest rates were at a much higher level, making bonds a lot more attractive as a diversifier in your portfolio. With stocks posting double-digit returns in both 2023 and 2024, you might have overlooked the bonds in your portfolio, but they are there for a reason. When rebalancing portfolios over the past two years, we have been trimming from stocks and adding to bonds because of this outperformance. We know that more often than not, when stocks struggle, bonds can be the ballast in the portfolio. The chart below shows how that worked in the first quarter of 2025.
While the media headlines in the first quarter were screaming about the losses in the S&P 500 and small cap stocks, there was very little focus on the positive returns in bonds and international stocks. For years, we have seen US stocks outperform all other asset classes, and at times, you have probably wondered why you even own anything else. Hopefully, the first quarter helped remind you exactly why.
Diversification means never having the best performing portfolio, but it also means never having the worst. It means you will always have something in your portfolio you hate, and you will always have something else that you love. Diversification means admitting that we don’t know what the future will bring, and we can’t predict which asset will perform the best. It means accepting the incredible uncertainty in the world and not trying to outsmart yourself.
We preach diversification because we believe it’s the best way for investors to build a portfolio that you can live with through all the ups and downs in the market. The best way to protect and grow your portfolio is to stay invested for the long-term, and the easiest way to make sure you can stay invested is to diversify. As always, if you’d like to discuss your portfolio, please reach out to us.
-Chris Benson, CPA, PFS
The views expressed represent the opinions of L.K. Benson & Company and are subject to change. These views are not intended as a forecast, a guarantee of future results, investment recommendation, or an offer to buy or sell any securities. The information provided is of a general nature and should not be construed as investment advice or to provide any investment, tax, financial or legal advice or service to any person.