Entering 2025, U.S. equity valuations were high, with various valuation measures suggesting this market is one of the costliest since 2000. The S&P 500 returned twenty-plus percent in 2024 for the third time in four years and investors continued to pump money into US Large Cap equities. With no signs of a significant slowdown in growth or corporate earnings, and the prospect of eventual rate cuts, market valuations implied there was little consideration for any events that may disrupt continued strong growth.
The stock market peaked with the S&P 500 index hitting a new all-time high on February 19, 2025. Since that point, market volatility has picked up through the first quarter of 2025 and as of March 13th the S&P 500 is nearing correction territory, about 9% off its mid-February peak. Much of the recent concern is policy-induced growth fears related to global trade disruptions (i.e., implementation of tariffs) and the faster-than-expected reshaping of the government workforce (i.e., DOGE-related layoffs). 
Many major models of stock market valuation indicate that the US equity market is expensive. The Buffett Indicator, which measures the market cap of the S&P 500 as a percent of GDP, says the market is overvalued. The Fed Model, which compares the earnings yield of the S&P 500 (the inverse of the PE ratio) to the 10-year Treasury yield or to a corporate bond yield, shows that stock returns relative to bond returns are the lowest since 2000 – the dotcom bubble.1
Current policy around tariffs and DOGE represents the first true potential threat to continued strong earnings growth and higher US stock prices. This fundamental shift along with an expensive US stock market has certainly been the catalyst for this recent round of volatility. However, the long-term positive or negative impact of these policies on economic and corporate earnings growth is still uncertain.
While US equities have struggled, other asset classes have performed well to start the year. Europe and China equities are up double digits to start the year, boosting developed and emerging market equities into positive territory (+8.3% YTD for the MSCI EAFE and +3.45% YTD for MSCI Emerging Markets). The shift in equity performance partly reflects improving growth prospects in many global regions, while US growth is moderating from a high level. Policy announcements are also weighing on confidence in the US more than in other regions. Within the US, value stocks have performed much better than their growth counterparts, a reversal from previous year trends. Fixed Income has returned to being as ballast in portfolios, the Bloomberg US Aggregate Index is up 2.27% year-to-date (the Global Aggregate index is also up 2.6%) as the 10-year treasury rate dropped just over 0.25% year-to-date driving bond prices higher.
This new bout of market volatility has reemphasized the importance of portfolio diversification. The long-term trend of US equity market outperformance has provided investors with a false sense of security that these markets always outperform. Our portfolios have continued to maintain diversification and remain allocated to other areas of the stock universe. Keep in mind that these allocations are far less than would be allocated if we felt strong conviction to their underlying fundamentals. However, market changes can happen suddenly without warning and negatively impact portfolio performance.
Our intentional portfolio exposure to US large cap value stocks, international equity markets, and hedged equities are providing positive returns when other equity asset classes are under pressure. In fixed income, we have added to longer duration high grade fixed income and premium equity income strategies to provide strong cashflow and ballast during equity market drawdowns. Lastly, we hold uncorrelated alternatives to dampen the negative impact of the equity markets. We are not implementing these changes today. These changes have taken place as we have managed portfolios through continually changing market conditions.
In our 2025 Annual Investment Outlook article, we stressed “this year will be complex and difficult. With expensive stock and bond markets, the potential for and speed of change is quite high.” We are now in the middle of changing market conditions and portfolios are behaving as planned. The concerns regarding global trade disruptions and the implementation of tariffs, the reshaping of the government workforce, particularly DOGE-related layoffs and the potential threat to continued earnings growth and higher stock prices due to new policies will more than likely continue for the first half of 2025. We continue to assess market conditions and our outlook daily. And as we closed out our Investment Outlook, “Like central banks, we remain data dependent and alert to various potential paths for the economy and financial markets from here.”
S&P 500 Index - Widely regarded as the best single gauge of large-cap U.S. equities. The index includes 500 leading companies and covers approximately 80% of available market capitalization.
MSCI EAFE Index - The MSCI EAFE Index is designed to represent the performance of large and mid-cap securities across 21 developed markets, including countries in Europe, Australasia and the Far East, excluding the U.S. and Canada.
MSCI Emerging Markets Index - The MSCI Emerging Markets Index captures large and mid-cap representation across 24 Emerging Markets (EM) countries*. With 1,250 constituents, the index covers approximately 85% of the free float-adjusted market capitalization in each country
Bloomberg US Aggregate Index - is a broad-based flagship benchmark that measures the investment grade, US dollar denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, fixed rate agency MBS, ABS and CMBS (agency and non-agency).
Global Aggregate index - The Bloomberg Global Aggregate Corporate Index is a flagship measure of global investment grade, fixed-rate corporate debt. This multi-currency benchmark includes bonds from developed and emerging markets issuers within the industrial, utility and financial sectors.
Footnotes:
1 – “It’s not all about Tariffs”, Brian S. Westbury. Chief Economist, First Trust Advisors, L.P., March 10, 2025