Choppy Waters, Steady Course: How Diversified Portfolios Weathered a Turbulent Q1

The first quarter of 2025 delivered its share of headline-grabbing events—from ongoing trade disputes to inflation fluctuations—causing volatility across global markets. Despite the uncertainty, diversified portfolios helped smooth the ride for long-term investors. Like a deep-sea fishing trip, it may get choppy, but staying on board remains the best way to catch your dinner.

Tariffs and Trade Tensions

The biggest market-moving story this quarter was the reemergence of tariffs. The administration introduced sweeping trade measures in early April, imposing a 10% tariff on goods from countries not retaliating against US exports, while threatening tariffs over 100% on imports from China. These moves, aimed at revitalizing US manufacturing, raised investor concerns around inflation and global economic contraction.

Tariffs often result in higher prices as the extra costs get passed on to US consumers. While intended to drive domestic consumption, consumers may feel the pinch in categories ranging from electronics to food. This inflationary pressure, paired with slower growth, raises the specter of stagflation—a rare but possible outcome. Historically, however, even during past stagflationary periods, markets have performed better than expected. In 9 out of 12 such years since 1930, the inflation-adjusted return on US equities remained positive.

Inflation and Interest Rates

The Federal Reserve kept the federal funds rate steady at 4.25%-4.5% after their March and May meetings, citing persistent inflation and uncertainty in the economic outlook. The Core Consumer Price Index for March fell to 2.4%, down from 2.8%, but still above the Fed’s 2% target. Inflation in the coming months will depend on the labor market, consumer spending, and continued global trade dynamics.

While markets dislike uncertainty, the Fed’s cautious stance provides some clarity for investors. It signals a measured approach to rate adjustments, allowing markets to process economic data more thoughtfully.

Diversification in Action

The S&P 500 ended Q1 down 4.3%, despite early-year highs. A major drag was the sharp decline in tech stocks—particularly NVIDIA, which lost nearly $600 billion in market cap in one day following disruptive AI developments in China. The swift reversal highlights the risk of concentrated positions in any single sector or company.

In contrast, developed international equities gained 6.2%, while emerging markets added 2.9%. Even countries impacted by US tariffs—such as China and Mexico—posted positive returns, underscoring the value of global diversification. Though US stocks have dominated the past two decades, Q1 offered a reminder that leadership rotates, and a globally balanced portfolio is key to long-term success.

Market performance over the last two decades (shown in the table below) could have easily influenced investors to skew their portfolios toward US stocks, but the recent and sudden shift in US stock market performance is a reminder of the importance of diversification. The table below illustrates this point in a historical context, where a “lost decade” for US stocks from 2000-2009 didn’t have to be a lost decade for a diversified portfolio.

Volatility: A Normal Part of Investing

Market volatility surged this quarter, driven largely by policy uncertainty and shifting investor sentiment. April 3rd and 4th marked the worst two-day stretch for the S&P 500 since the COVID-19 crisis. However, just days later on April 9th, the market rebounded, up 9.5%—the third-largest single-day gain in the past 30 years.

This dramatic swing reinforces a critical lesson: missing just one big “up day” can drastically reduce long-term returns. For instance, over the past 20 years, seven of the ten best days in the S&P 500 occurred within two weeks of the ten worst days. Timing the market is not only difficult—it’s detrimental to the long-term performance of your portfolio.

Long-term investors benefit most from staying the course. One strong day may not move the needle much over 5 or 20 years, and trying to predict that day is nearly impossible.

Staying Disciplined During Market Stress

While market turbulence may tempt investors to take action, history shows discipline is the better strategy. The US has weathered the Great Depression, the 2008 recession, and the COVID-19 downturn. Markets have rewarded those who remained invested through each crisis.

We believe in the power of diversification and long-term planning. Your portfolio is built not just to endure short-term volatility but to help you pursue financial success over time. Unless your personal circumstances or goals change, your plan likely doesn’t need to. As always, if you have any questions please reach out to us.

Can Inflation be a Good Thing?

When it comes to inflation, a small amount of it is healthy for the economy. That’s because when consumers and businesses expect prices to continue rising, they are more likely to buy something today. Strong current demand spurs growth on the supply side of the economy since businesses expand their workforces and production to meet this demand. As you can see, low and consistent inflation creates a virtuous cycle that is good for economic growth. In fact, the opposite scenario – deflation – would likely be more problematic than moderate inflation. The US Federal Reserve has set a target of 2% for core inflation with the duel aim of avoiding deflation or high inflation.

As we transition ‘back to normal’ there has been high consumer demand, massive governmental stimulus, supply chain issues, and global shortages of raw and manufactured goods. The Federal Reserve anticipates that most of these inflationary forces will abate. Caught between managing inflation and spurring growth, they’ve emphasized their goal of bringing employment back to pre-pandemic levels. If inflation proves to be less transitory than most economists expect, the Federal Reserve will likely take steps such as raising interest rates to avoid overheating the economy.

Inflation becomes dangerous when it causes too much growth and prices rise faster than wages, with everyone worse off in terms of purchasing power. To help counteract this effect for many retirees, the Social Security Administration bumped benefits for 2022 by 5.9% (compared to an annual average adjustment of 1.65% over the last decade)! For wage earners, incomes have and should continue to rise. So, for most clients there is a good amount of insulation against inflation via higher cash inflows. We also recommend appropriate cash reserves since cash is very susceptible to inflation. The inflation-adjusted ‘return’ of cash is virtually guaranteed to be negative. The risk of losing purchasing power can be mitigated through long-term, thoughtful investments and cash flow planning.

When it comes to the portfolio, we’ve designed the investment allocations with risks – like inflation – in mind.

  • Stocks typically hold up well against inflation in the long-term because companies can pass higher costs along to consumers. The bulk of most client portfolios are invested in US, developed international, and emerging market equities.
  • Bond returns may be muted or negative on a “real” (inflation-adjusted) basis in an inflationary scenario. This is especially true if interest rates rise – which is likely if the Federal Reserve deems it necessary to rein in inflation.
    • We have positioned portfolios with a healthy allocation to short-term bonds to diminish this risk. Shorter maturity bonds are less impacted by rising interest rates because they mature more frequently and can reinvest into higher interest rates.
    • We also avoid any allocation to long-term bonds right now because those would be most significantly hurt by rising interest rates. Yields at those maturities are not compelling enough for this large risk.
  • Commodities and real estate are “hard assets” that should do well in an inflationary scenario.
    • Real estate investments provide a hedge due to land scarcity and because rents tend to adjust with inflation, providing income protection.
    • Commodities have been the best performing asset class this year in part due to inflationary factors. While a laggard in the low yield and low inflation environment of the late 2010s, commodity funds have done well as an investment because prices for goods as far ranging as copper, lumber, and crude oil have all risen considerably this year.

No one knows which portfolio risk will present itself next, so we want to stress the importance of remaining diversified and disciplined in achieving long-term investing success.  If you have any questions or concerns about the positioning of your portfolio, let’s discuss it at your earliest convenience.