Quarterly Perspectives: Q1 2025

Published April 22, 2025.

Transcript

Introduction to Quarterly Perspectives

Hello, and welcome to quarterly perspectives first quarter twenty twenty five.

 

My name is Josh Ernst, and I'm a member of the investment strategy team at Focus Partners.

 

I'll be your host for this presentation.

 

This presentation details quarterly equity and fixed income performance along the framework of absolute returns, relative returns, and future expectations for market performance.

 

We will then go on to discuss recent interest rate movements and inflation expectations.

 

Last, we examine how different asset classes contributed to an overall portfolio return.

 

We hope you enjoy today's presentation.

 

Now let's get started.

 

We begin our discussion with a high level look at a collection of major asset classes.

 

As we can see from the illustration, U. S. Stocks were down during the first quarter, reversing the positive trend from the fourth quarter.

 

Developed international and emerging markets stocks were up during the first quarter, reversing the negative trend from the fourth quarter.

 

Returns for US bonds were up, and global ex US bonds were slightly down for the quarter.

 

Next, I'll draw your attention to the upper right hand portion of the graphic.

 

The United States dollar was down three point nine percent for the quarter and down zero point three percent over the last twelve months.

 

Now let's look a little deeper at what was driving the returns of stocks and bonds.

 

We'll start by taking a look at how global equities performed for the quarter, and we'll isolate the performance between US and developed international stocks.

 

The two charts show the performance of different investment styles between the US and international stocks.

 

The bright blue bars represent the performance of different investment styles, and the dark blue bars represent the total market performance for the region.

 

US returns are measured with the Russell indexes, and international market returns are measured with the MSCI World X US Index Series, which represents global developed market performance, excluding the United States.

 

As we can see from the dark blue line on the chart on the left, the US market was down four point seven percent in the first quarter, compared to up five point eight percent for developed international markets from the chart on the right.

 

Large value stocks and large neutral stocks, on average, outperformed the market in the United States.

 

Large value stocks led the pack domestically, which is a new trend compared to last quarter on a relative basis.

 

Internationally, large value, large neutral, and small value stocks tended to outperform the market with international large value stocks posting the best performance for the quarter among the international developed regions.

 

But no matter the recent trends, it's important to remember that we shouldn't make longer term projections based on short term performance.

 

Now we take a longer view to see how different investment styles have performed for standard periods ending March thirty first twenty twenty five.

 

Looking at annualized returns in the US, we can see that markets have shown resilience, especially over a one year period, when faced with significant headwinds, such as the continued conflicts of war across the globe, uncertainty surrounding the future path of interest rates and inflation paired with what the Fed is projecting, and growing dysfunction on Capitol Hill.

 

Despite these potential issues, US markets returned seven point two percent over the last year and have been nearing or exceeding twelve percent per year during longer time horizons.

 

Large growth in large neutral stocks had the best performance for the trillion one year period, gaining seven point eight percent which beats the US market by zero point six percent.

 

We can also see that small and value stocks have generally been out of favor during these time periods.

 

Consequently, we expect that portfolios that have a small value tilt, such as those that we typically design for clients, will have underperformed portfolios that are market cap weighted or tilted to large growth stocks at these longer investment horizons.

 

Keep in mind that the very long term evidence demonstrates that on average, small stocks outperform large stocks and value stocks outperform growth stocks, but size and value factors can still go through extended periods of underperformance like those shown above.

 

Turning to international markets, we see that large cap value stocks have led the pack over the one year period.

 

At the longer time horizons, we see varying performance among different styles with large cap stocks posting leading performance over the trailing three, five, and ten year periods respectively.

 

Relating to the prior slides, we see that international markets have underperformed the US market by two point one percent during the last twelve months, as well as at longer horizons with the three, five, and ten year performance trailing by three point two percent, six point three percent, and six point three percent, respectively.

 

It's also worth noting that the US total stock market has had an exceptional ten year run, with the bulk of it being driven by richening valuations and strong corporate real earnings growth.

 

In a recent AQR research paper suggests that to expect a repeat of this performance over the next decade, even with the aggressive increase in earnings growth, investors would have to continue to bid up valuations far above where they were at the height of the tech bubble.

 

Nonetheless, given the higher US return over the longer term horizons, we expect portfolios concentrated in US stocks to have outperformed a globally diversified portfolio.

 

However, as we'll see in the next slide, these relative performance numbers aren't reason enough to abandon international stocks.

 

Thus far, we've discussed quarterly performance on a relative and absolute basis.

 

Now let's take a look at current stock market valuations and how they relate to future expectations of market performance.

 

The charts on this slide show how expensive stocks are by measure of the price to earnings ratio, a very common metric used to value equities.

 

The higher the ratio is, the more expensive the asset class is overall.

 

Thought of another way, these values depict how expensive one dollar of earnings is.

 

For example, as we can see in the chart on the top left, the average dollar of earnings for the total US stock market costs roughly twenty four dollars and ten cents.

 

Internationally, as we can see in the chart on the top right, earnings are cheaper at just over sixteen dollars and thirty cents per dollar of earnings on average.

 

The values represented here use historical fund and ETF data to establish the price ratios, and the average PE is reflected by the dotted line on the chart.

 

These averages start in the first quarter of two thousand four for US measures and in the fourth quarter of two thousand six for international stocks.

 

Noting the strong market performance during the last twelve months, we see both broad US and international markets are now trading close to or above their recent historical averages.

 

We can also see that small value stocks in global developed markets appear cheap relative to their recent historical averages.

 

All else equal, we would like to pay less for a dollar of earnings.

 

These valuation ratios aid in setting expectations about the future.

 

Low valuations today imply higher future returns and vice versa.

 

The recent strength of broader US market performance means that it is reasonable to expect lower returns than in the past when valuations were below their long term historical averages.

 

The opposite is true for international markets and small value stocks globally.

 

It is reasonable to expect higher returns than in the past when valuations were above their long term historical averages.

 

I'll emphasize that this is a long term relationship and that short term outcomes will likely be dominated by unexpected market forces.

 

Here we have the same analysis, but isolating US equities so we could see how valuations compare across different styles.

 

Recalling the annualized performance slides, we know that large growth has had an exceptional ten year period.

 

We can see that the growth in prices has exceeded the growth in earnings as the PE ratio is thirty one point five to close the quarter, which is above its average since two thousand four.

 

Small value, on the other hand, has a PE ratio of thirteen point nine and remains under its average since two thousand four.

 

Although many investors may be interested in chasing the returns of large growth companies, we would point to these valuation charts as one reason to stay the course in a diversified portfolio tilted small, relatively inexpensive companies.

 

Next, we'll take a look at fixed income performance, the shape of the current yield curve, and how the market is currently pricing inflation.

 

The charts on the screen show the average performance of different bond maturities in the segments of the fixed income market that we commonly track.

 

We typically prefer investing in bonds that are shorter maturity and higher quality compared to the broader market.

 

In the chart on the left side, we see that bonds of all maturity ranges had positive performance, but markets favored longer maturities relative to intermediate to shorter maturities, with the ten to twenty year segment posting the largest gain because of their sensitivity to rates decreasing.

 

The chart on the right shows the performance of different intermediate maturity credit quality bonds.

 

We see that there was positive performance across the different credit qualities listed with the exception of municipals being slightly negative for the quarter with investors favoring inflation protected debt relative to other credit segments.

 

Next, we'll look at the treasury yield curve and what it means for returns going forward.

 

Here we plot the yield curve to show the current yields for treasury bond investments at different maturities.

 

The light blue line represents current rates, the dark blue line represents rates from the end of the prior quarter, and the gold line represents rates from one year ago.

 

With the exception of the ultra short term portion of the curve, rates decreased for all maturities during the quarter.

 

As stated previously, this complimented longer dated maturity debt.

 

Looking forward, Federal Reserve policy is a bit murky as the outlook for the path of rates remains uncertain.

 

Expect interest rate volatility in the shorter term periods.

 

Beginning in the third quarter of last year, two quarters ago, the yield curve no longer is inverted, as it had been since the start of the third quarter in twenty twenty two.

 

As stated in the past, when this happens, particularly between the two year and ten year points on the curve, it is widely regarded as one of the precursors, but not as a guarantee, to an impending recession.

 

It remains to be seen whether the prolonged yield curve inversion will prove to be an indicator of a recession.

 

Finally, we plot the market's forecast of inflation by taking the difference in yields between US Treasury bonds and TIPS at different maturity levels.

 

Like the last chart, the bright blue line represents current inflation expectations, the dark blue line represents inflation expectations from the end of the last quarter, and the gold line represents inflation expectations from one year ago.

 

Current market estimates for future inflation have been little changed compared to the prior quarter and this time last year.

 

Over the past year, inflation readings have continued to moderate, and recent favorable trends appear to convince the Federal Reserve that inflation may be under control.

 

However, recent months have shed light on the fact that the Fed will need more time to meet its two percent inflation objective and see an evidence that inflation is able to stay at that target in a sustainable manner.

 

The Fed has shifted its focus to the economic implications of newly imposed tariffs and maintains projections of two more quarter point rate cuts in twenty twenty five.

 

As these expectations continue to evolve, it is important to remember that these levels of inflation are baked into prices today. The markets are priced in an average inflation rate of approximately two point six percent per year for the next five years.

 

And the market collectively expects inflation to similarly outpace the Fed's two percent target over the next thirty years.

 

Not only are these expectations baked into bond prices, but they're also baked into equity prices.

 

Making a bet on lower inflation would mean that we expect inflation to fall short the current forecast.

 

Next, let's take a look at how some major asset classes contributed to a sixty forty index mix this quarter and how that index mix behaved during recent history.

 

On this slide, we look at the absolute impact of different asset class returns on the quarterly return of a sample sixty percent stock, forty percent bond index mix.

 

With the US stock market moving downward and international stock markets and bond markets moving up this quarter, we can see that equity and fixed income asset classes contributed to the overall increase of the index mix.

 

International large cap stocks were the largest contributor for the quarter while US large cap stocks had the smallest contribution to overall return.

 

Diversifying stocks across geographies and investment styles as well as allocating the bonds helped avoid undue portfolio concentration risk this quarter.

 

This resulted in the sixty forty index mix achieving a return of zero point two percent versus the US total market return of negative four point seven percent.

 

The portfolio was able to achieve a smoother outcome with less overall risk given its diversification across the different asset classes.

 

Here we see a collection of major asset class calendar year returns displayed on a cool chart.

 

Looking at year to date returns in the rightmost column, we see that all asset classes with the exception of US small value stocks and US large growth stocks measured by the S and P five hundred, a popular headline index, posted positive performance with international large value stocks gaining the most value at ten point three percent.

 

We can also see that the performance of each individual asset class tile shows no predictable return or relative ranking from one year to the next.

 

A diversified index mix, such as the sixty percent stock, forty percent bond index mix shown in the white tile, tends to stay away from the extreme returns, both positive and negative, on a yearly basis and over time, while also dampening the volatility of returns.

 

This is an example of the potential benefits of a well diversified portfolio.

 

It also helps us as investors to stay in our seats through any given quarter of market turbulence and not take away our ability to prosper from the many quarters to come.

 

And with that, we've reached the conclusion of today's presentation.

 

Thank you for joining us, and we'll see you next quarter.

Beacon Hill Private Wealth is an independent, fee-only, fiduciary investment advisor providing evidence-based wealth planning solutions that simplify our clients' financial lives. Founder Tom Geoghegan, CFP®, CIMA®, CPWA®, RMA® is also a member of the National Association of Personal Financial Advisors (NAPFA).      

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