Summary of Q1 2025 Markets
In the first quarter of 2025, global financial markets experienced significant volatility, primarily driven by geopolitical tensions, trade policy shifts, and evolving monetary policies. The U.S. stock market faced substantial challenges due to the Trump administration’s implementation of broad tariffs on foreign imports. These measures sparked fears of inflation, reduced consumer confidence, and media chatter about the potential for recession, leading to a sharp sell-off in U.S. major market indices.
Market declines started to materialize in the last week of February and continued on through the end of March as volatility continued to escalate. From a U.S. equity sector perspective, the darling sectors of 2024, information technology and consumer discretionary stocks were hardest hit, down 12.7% and 13.8%, respectively. Foreign markets fared better. The U.S. bond market was also well-behaved, which helped hedge some of the equity market volatility in balanced portfolios.
How did we get here?
It’s important to go back in time to gain some perspective on the current state of affairs in the U.S. economy. Yes, tariffs and trade wars have been the fixation of the media and Wall Street, but there is much more to the situation beneath the surface. The U.S. has bigger problems. Since 2008 when I joined Harvest, one item that has consistently been true is that America has been adding to her national debt. I remember my predecessors, both the founder of the company, Stephen Duklewski, and our former director of operations, Doug Jones writing many of these market letters and using the phrase, “kicking the can down the road” in reference to a lack of will by our elected officials to address the mounting debt problem.
Out of curiosity, I went back to my first year in the financial services business, 1998, to see where things stood from a debt perspective. At that time, the national debt was approximately $10.6 trillion. Still a large number, but as a function of U.S. Gross Domestic Product (GDP) the economy was at a reasonably healthy 62% debt-to-GDP ratio. At present, the national debt stands at $36.7 trillion, and our debt-to-GDP ratio is 123%. Higher debt-to-GDP ratios can indicate a country’s difficulty in repaying its debt, potentially leading to economic instability. In 2008, this came to the forefront of news as the European sovereign debt crisis began to unfold, leading to the derisive acronym PIIGS, referencing Portugal, Ireland, Italy, Greece, and Spain – the five nations with the worst debt issues. This led to spending freezes, austerity, restructuring of debt, and a lot of pain for the citizens of these nations.
Today, Italy and Greece still have debt-to-GDP ratios of 138% and 149% respectively. France, not part of the 2008 European debt crisis, but currently struggling with economic malaise from high levels of debt has a debt-to-GDP ratio of 116%. At 123% debt-to-GDP, the U.S. is not among good fiscal company and has a problem that needs to be addressed in a timely fashion. In March, Ray Dalio, Founder of Bridgwater Associates, a large hedge fund that serves institutional clients including pension funds, endowments, and foundations, warned that “an emerging crisis in U.S. debt is looming, and high, unsustainable levels of debt could bring supply and demand issues in terms of the U.S. being able to issue and sell treasuries”. In simple terms, his concern is that foreign nations would lose their appetite to buy U.S. treasury bonds due to perceived lack of creditworthiness, causing significant domestic and international market turmoil should America not be able to borrow what it needs to keep the government running in its current state.
The Trump administration, through the Department of Government Efficiency (DOGE), has set out to reduce, “waste, fraud, and abuse” of taxpayer revenue by cutting spending and excess labor costs. More succinctly, they are targeting $1 trillion in spending cuts. The tariffs are intended to reduce/eliminate the massive trade deficit, add revenue to the Treasury’s coffers, and put the U.S. on a more level playing field among nations with which we do most trade. The combination of DOGE cuts to spending, and the anticipated tariff turmoil essentially front-load the pain into 2025, with a hope of recovery in late 2025 and 2026. The tariff revenue would be used to offset the “cost” of extending the tax cuts provided by the Tax Cuts and Jobs Act from President Trump’s first term. The plan may or may not work, and this is a huge gamble. The biproduct has been an ever-changing and unpredictable landscape for investors to navigate, absent any historical context. Perhaps things could have been addressed in a more orderly and less chaotic fashion.
There is more going on beneath the surface, and this brings us full circle back to the debt and deficit issue. Two things were occurring in late 2023 and 2024 that have had a significant impact on the perception of the economy continuing to be stronger on the surface levels measures, such as GDP, the labor markets, and stock market valuations, than what was actually true. The first was how treasury issuance was handled. Starting in Q4 of 2023, then Treasury Secretary Janet Yellen, started leaning more on shorter term treasuries (via normal issuance and auctions) to fund the U.S. Federal Government’s obligations. This was a stealthy (but destabilizing over the long-term) way to inject liquidity into the economy, keeping equity markets artificially inflated. It continued throughout 2024. At the same time, Federal Reserve Chairman, Jerome Powell was raising rates and executing the Fed’s Quantitative Tightening (QT) plan to reduce the money supply and cool inflation. Essentially liquidity was added to the financial system by Yellen, to offset the monetary tightening policies of the Fed. The second was abnormally high levels of government spending and hiring in 2023 and 2024. The Federal government went on a blitzkrieg-style hiring and spending spree in 2023 and 2024. Government hiring contributed 28% and 23% respectively to the change in non-farm payrolls for those two years. By comparison, government hiring contributed between 5.5% and 6.5% in the prior two years, which was still above average according to the Bureau of Labor Statistics. Government spending contributed on an above average basis to GDP over that same period of time as well (nearly 25% of GDP). In summary, the prior administration, through the help of unprecedented hiring, spending, and managing treasury bond issuance did a masterful job of juicing the economy in the final two years of President Biden’s term.
As the situation stands, there is approximately $9.2 trillion of debt that will mature or need refinanced in this calendar year, representing about 25% of the total U.S. debt burden. The current annual cost to service the debt (interest payments) is over $1 trillion dollars. Under normal circumstances, when inflation eases and the economy slows, 10-year treasury bond yields will fall. While the Trump administration and current Treasury Secretary, Scott Bessent, are not outwardly cheering for a mild recession, it could set the stage for lower 10-year yields. This means that new bonds could be issued in 2025 at a lower interest expense to the government, thereby reducing the cost to service the debt, and undoing the destabilizing policies from former Treasury Secretary Yellen. Again, pain in 2025; recovery in 2026.
The Road Ahead
The list of things we feel with some confidence that have a decent probability of occurring is short. It includes the following: 1. GDP will come in soft for Q1 of 2025. 2. The Fed will cut rates in June or July. Beyond that, it is too soon to tell. Should inflation continue to be sticky and start to rise again we may not see the anticipated three to four rate cuts between now and early 2026. 3. The mega-cap tech names, a.k.a. “The Magnificent 7” stocks (Alphabet, Amazon, Apple, Microsoft, Meta, Nvidia, and Tesla) that led the charge higher in the markets for the past few years, were already facing very difficult revenue and earnings comparisons, and are now facing the complexity of tariffs. Tempering expectations for a swift rise to new all-time highs in these stocks seems prudent. 4. Second quarter earnings reporting is going to be “interesting” and could produce elevated volatility as companies report earnings for Q1 results and may struggle to provide accurate forward-looking guidance (or suspend guidance) due to trade/tariff uncertainty. 5. This too shall pass, but it is important to understand that we don’t see a quick path for the market to return to all-time highs. Patience, discipline, and process are far more important now than they have been in the two or three prior years.
Michael Meily, ChFC, CLU, CASL, RICP
Managing Member
Sources Cited:
Hedgeye Risk Management
CNBC
Bureau of Labor Statistics
Atlanta Federal Reserve
www.usdebtclock.org
CME Group
Gallop
