Quarterly Market Commentary – Mosaic Model Portfolios
In their quarterly update, the Multi-Asset portfolio team at Madison Investments discusses the events of the quarter, and provides an outlook for the markets moving forward.
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Market Recap – First Quarter 2025
The script was completely flipped during the first three months of 2025. The so-called “Magnificent 7” U.S. mega cap growth stocks behind the S&P 500 Index’s meteoric rise off the 2022 low, were promptly sent from the penthouse to the outhouse, taking the S&P 500 Index down -4.3% for the quarter. Fortunately, the index decline was as narrow as its prior advance and outside of the Mag-7 world, seven of the eleven S&P sectors provided positive returns. Value stocks also generated gains, with the Russell 1000 Value Index up +2.1% versus a steep -10.0% decline from the tech heavy Russell 1000 Growth Index.
The quarter was marked by two distinct events that brought serious questions to investors’ minds. First, was the release of the DeepSeek-R1 AI model in China in late January. The model was purportedly created at a mere fraction of the existing AI models in the United States, brining into question the hundreds of billions being spent on AI capital expenditures by the large U.S. firms, who coincidentally, are still looking for a road to realize any material revenue from said AI spending. Then, with ongoing tariff talk causing rising uncertainty among businesses and consumers alike, in an early March interview, President Trump declined to rule out a recession and spoke of a “period of transition” as his policies play out. Investors were instantly unnerved at the prospect of the Administration playing a game of chicken with the economy and our global trading partners.
As bad as things felt domestically, the perennially underperforming international equity markets caught a bid. The broad market MSCI ACWI ex-US Index returned +5.2%, outperforming the S&P by nearly 10%. Eurozone stocks were already performing well when Germany, the bastion of fiscal rectitude, put forth a fiscal stimulus package aimed at infrastructure and defense. The proposed package was seen as a green light for the entire Eurozone to open the fiscal spigot to support the economy. Chinese stocks also performed well, up 15.0%, as investors continue to expect more fiscal policy ease to counter Trump 2.0’s trade war.
Turning to fixed income, bonds did well and provided refuge from stocks as interest rates fell during the quarter due to concerns of an economic growth scare associated with the trade war and waning confidence. The Bloomberg U.S. Aggregate Bond Index returned a respectable +2.8%, led by U.S. Treasuries and mortgage-backed securities.
Performance
Despite being offsides this quarter with our preference for U.S. over international equities, a significant headwind given the 10% performance differential between the MSCI ACWI ex-US and Russell 3000 Indexes, portfolios performed very well, especially in portfolios that utilize a higher proportion of ETFs.
Within U.S. equities, our below- market Mag-7 exposure was a huge help, as was our preference for high quality stocks and an overweight to the outperforming energy sector, which was up 10.2%. Small cap stocks struggled over the quarter and our overweight allocation detracted from returns.
Internationally, the headwind generated by our underweight stance was mitigated by outsized returns in our more Europe heavy holdings. Despite the big returns from China, our EM Asia position detracted from performance, as did our overweight to Japan.
Fixed income allocations benefited from our sizable overweight to mortgage-backed securities and U.S. Treasuries versus corporate bonds, which effectively neutralized our more modest relative duration positioning.
Outlook & Positioning
We entered the year cautiously optimistic based on vastly improved small business sentiment and the outlook for deregulation. However, with inflation remaining sticky and the Administration’s penchant for tariffs, uncertainty and confidence have reverted all the way back near pre-election levels. We were of the mind that much of the Administration’s initial tariff talk was posturing to extract concessions and policy goals, but as the quarter wore on the approach took on a more reckless tone. Confidence is fickle and uncertainty is anathema to businesses and consumers. Stoking uncertainty and eroding confidence greatly increases the risk of recession. High frequency economic data have clearly been clouded by the front running of tariffs, and it’s highly likely that 1Q 2025 real GDP growth will be negative. That said, we remain encouraged by the relative calm of the credit markets, where spreads have widened, but are not alarming. The labor market and consumer spending have cooled but remain stable. The first months of the second quarter will be critical in determining where we are heading. If agreements can be reached on trade, the markets will likely look to the positive aspects of deregulation and tax policy, creating a more favorable business climate over the back half of the year. However, if the trade war escalates and businesses and consumers retreat into preservation mode, recession is a distinct possibility. We are comfortable with our current level of portfolio defense via our minor equity underweight and tilt toward high quality within both stocks and bonds, but stand ready to increase measures should the situation deteriorate.
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