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First Quarter 2025 Review
Tariffs Grab the Headlines
Over the past few months, investors have witnessed a significant repricing of risk assets, particularly equities, as the new Administration offered a glimpse into its policy initiatives. Front and center were new tariff policies aimed at equalizing the economic terms of the trade relationships the United States maintains with its global partners.
On April 2, a universal 10% tariff was announced on all U.S. imports, effective April 5. Further, higher tariffs ranging from 11% to 50% were applied to imports from 57 countries with significant trade deficits with the United States. Tariffs on imports from China were elevated to 145%, while the level set for most goods coming into the United States from Canada and Mexico was 25%. As for the European Union, a 25% tariff was applied to all car imports as well as 20% on all other EU imports. In many cases, consumers “bought ahead,” including items ranging from smart phones to automobiles, recognizing that price increases were likely just around the corner.
The immediate impact of these announcements was significant. Stocks sold off sharply, the dollar fell, and economists around the globe lowered their growth forecasts. The International Monetary Fund (IMF) lowered its 2025 global growth forecast from 3.3% to 2.8% citing the disruptive effects of the U.S. tariffs. The World Trade Organization (WTO) reported an 80% decline in U.S. – China merchandise trade, acknowledging what looks to be a significant strain on the relationship between the two economies. Indeed, many economists have sounded the alarm for the heightened prospect of stagflation, defined as persistent high inflation combined with high unemployment and stagnant demand – as well as a recession (two consecutive quarters of negative growth in GDP).
Stocks Suffer
At quarter-end, we saw evidence of analysts’ earnings estimates beginning to be trimmed, but the market sell-off, in our view, can largely be attributed to valuation compression, as measured by Price to Earnings (P/E) ratios. Simply put, with declines in consumer confidence, uncertainty regarding new tariff policy, and geopolitical stalemates around the globe, investors decided they were not going to “pay up” for future growth prospects that are unpredictable. This was especially evident in small-cap growth stocks, which fared the worst of any equity investment style in the first quarter. Our early read on management commentaries based on the transcripts of earnings calls is that executives are hedging their revenue and profit forecasts and taking a “wait and see” approach to the eventual impact of newly enacted policies.
Change Leads to Uncertainty and the Market Doesn’t Like Uncertainty
Surprise and change are an anathema to most investors since both lead to uncertainty and subsequent volatility. In the 1970s, investors flocked to “ruler stocks,” known for their consistent earnings and cash flow streams that could confidently be plotted into the future with a straight edge (hence the use of the term ruler). Any meaningful pause or disruption in earnings growth led to a loss of confidence in the company’s management and a selloff in the shares, with the stock serving time in the “penalty box” until confidence could be restored. As a result of earnings “hiccups,” ruler stocks became “show me” stocks, only to return to their prior moniker after the resumption of consistently favorable earnings reports, hence restoring investor confidence. Investors with the ability to keep calm and not react emotionally fared well by capitalizing on the disconnect between perception and reality, purchasing shares on stock price weakness. After all, one three-month period of sub-par earnings does not make for a “broken company.”
Similarly, when a new Administration takes office – Federal or local - invariably, new policies are introduced that are eventually signed into law. Naturally, these changes are more subtle and likely easier to accept by a constituency when an incumbent maintains power, as citizens tend to expect “more of the same.” Last November’s U.S. presidential election result marked a rare return to power by a former incumbent, setting the stage for a substantial – if not complete - unwinding of his successor’s policies and regulations. While it is yet to be determined if the new tariff policies have the desired effect of increasing government revenue and decreasing the trade budget, the impact on consumer confidence is undeniable. The University of Michigan consumer sentiment report for the U.S. dropped sharply to 50.8 in April, from 57 in March, the lowest level since June 2022. Reasons for the sharp decline – a drop of 30% since December 2024, include mounting fears of inflation, recession, trade wars, unemployment, and personal income. Concerns about U.S. policymaking have spread across borders, as the U.S. Dollar, the global currency of choice, has weakened approximately 9% this year, and foreign purchases of U.S. Treasury securities have also slipped.
More recently, the markets have rallied as the new Administration has retreated from its tough stance on tariffs, particularly regarding China, as well as some of the negative rhetoric directed at Federal Reserve Chair, Jerome Powell, viewed by many financial commentators as apolitical and independent. As stated earlier, “surprise and change are an anathema to most investors,” and this is especially true at the macroeconomic level.
Is There a Cause for Optimism? Yes, But on the Other Hand…
The short answer is, “yes, there always is,” but simply repeating the mantra that “things always get better,” might be a flawed strategy over the near-term. Tariff policy often takes years to agree upon and implement, and it has only been weeks since the initiatives were formally articulated. There’s a great deal of information that still must be digested. While there is a strong initiative to bring manufacturing back to the U.S., new plants and facilities can take years to build, as well as major retrofitting projects. Investors need to be reminded of the 100-year chart depicting major political and financial crises such as the Great Depression, the post-World War II recession, the Arab oil embargo, Black Monday, the dot-com bubble, 9/11, and more recently, the Covid-19 pandemic. While there is always a tendency to say, “this time it’s different,” indeed the stock market’s long-term price chart covers the sweet spot of “lower left to upper right.” This is not to imply in any way that a green “all clear” signal is flashing buy signals across all U.S. equities. However, historically, extreme periods of bearish sentiment have represented buying opportunities. Further, negative earnings revisions, which we are beginning to see in greater frequency - albeit counterintuitively - have been a harbinger for future stock market returns. On April 24, Strategas Research Partners noted, “The first sign of the President’s new tariffs hitting the economy and public finances was evident this week, with Treasury receiving $11.7 billion of tariff revenue collections, compared to just $4.0 billion for the same period a year ago.”
Selectivity Rules
Over the years, we have often stated our approach to stock selection by identifying what we believe are key characteristics of attractive investments. They include strong and rising free cash flow, rising incremental profit margins, attractive valuation, changing positive internal catalysts, increased market share, and strong management capable of adapting to changing economic environments. Additionally, we believe it will be informative to our readers to outline (below) some of the types of companies we seek to invest in – not just today, but in all market environments.
Focus on Organic Growth Opportunities
With economists reducing their GDP growth forecasts over the next year, we suspect investors will place a premium on companies possessing the ability to increase their sales and earnings at rates well-in-excess of the broader market through organic (non-acquisitive) growth. Companies in the early stages of a new product cycle or brand line extensions of popular products often offer superior opportunities for organic growth and economic resilience, in our opinion. In a declining growth environment, we also recommend looking for companies with the ability to capture an increasing share of their end-markets.
Focus on Companies that Make Other Companies More Productive
With productivity gains and resulting cost savings becoming more difficult to achieve given the age of the current expansion and macroeconomic headwinds, we believe that companies will focus on those products and services offering a “value proposition” or enhanced return on investment (ROI). We have seen examples of this in a host of different areas, ranging from companies that utilize software to help streamline supply chains to those new media companies that can help advertisers allocate spending more efficiently.
Pay Attention to the Quality of Earnings
Over time, the market’s performance has generally been driven by the path of corporate earnings, so having conviction in the quality of a company’s earnings is critical. To us, a good measure of a corporation’s quality of earnings is how closely its free cash flow (net income + depreciation & amortization +/- changes in working capital – capital expenditures) matches its net income.
Finally…What’s Ahead?
We’ll certainly know more once the first quarter earnings season concludes, and managements have weighed in on their near and intermediate prospects. But for now, we have chosen to be opportunistic and highly selective in our approach. Across our strategies, we have managed risk by trimming what we believe were large (and successful) holdings while initiating several eclectic positions ranging from a movie theatre chain in our SMID Core strategy to a company that generates, converts, and stores electricity around the globe, poised to benefit from the proliferation of data centers, in our All-Cap Equity ex-MLP strategy. While the investment community’s focus has clearly been on the macroeconomic and geopolitical environment, we’ll continue to devote our attention to identifying anomalies in the market. They can result from excessive changes in sentiment (positive and negative) that arise from emotional/less-informed buying and selling, leading to opportunities that we seek to capitalize on for our clients.
We look forward to communicating our thoughts to you in our next quarterly correspondence. As always, we appreciate your trust. For questions, please contact:
Marshall Kaplan
Rochelle Wagenheim
Michael Nelson
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