Capital Markets Perspective | 1Q 2025

Writing this commentary on Monday, April 8^th, I have to wonder if anyone cares about what happened during the first quarter at this point. As I’m sure you are aware, things have changed just a bit since quarter end. We went from the uncertainty of what tariffs could look like to the more troubling certainty of what they do look like, and markets are not cheering. Yes, the word “certainty” may be a bit strong, hopefully so, but I guess I’ll address that next month. For now…

Let’s start with the positives. Corporate profits as a percentage of Gross Domestic Product (GDP) keep rising and hitting new highs. Based on the fourth quarter, that number stood at 13.5%. And other than non-earning smaller firms within the Russell 2000 (and there are a lot of them), corporate America isn’t overleveraged, so overall, firms are in a good place to weather a storm. That’s probably a good thing, as even before the official tariff announcements, the Atlanta Fed’s GDPNow estimate dropped to -4% for 1Q. However, that’s not as bad as it sounds, as evidently a lot of gold has been imported ahead of tariffs and that throws off the GDP numbers. Adjusting for that, the Fed is projecting a 1Q GDP contraction of 1.4%. Still not good, but it won’t be nearly as bad as the headline may appear, so keep that in mind.

Jobs have also been a bright spot, with the U.S. adding 228,000 in March, far above the consensus estimate of 140,000, according to the Bureau of Labor Statistics. Unemployment did tick up slightly but has remained in the 4 to 4.2% range for about the past year. And consumer spending, which fell in January for the first time in two years, rebounded into positive territory in February.

But the soft economic data – data based on surveys of expectations and sentiment – is not providing much comfort at present. Consumer expectations for inflation one year from now have increased to 4.9%, and related, when asked how they feel about their overall financial situation in a year’s time, responses indicate that consumers are as glum as they’ve ever been. More importantly, according to Apollo’s Chief Economist Torsten Slok and data from Chief Executive Magazine, CEO confidence in the economy one year from now has also plummeted, surpassing the drop in 2022, and reaching levels not seen since 2012.

Remember, uncertainty and volatility are the reasons that we get paid nicely to hold equities over time. So, buckle up, and help your clients to stay invested and stay diversified.

What happened in the markets during the quarter?

EQUITIES: EUROPE AWAKENS

The sleepy European stock market woke up during the quarter, advancing by 10.5% in dollar terms, outpacing the S&P 500® by almost 1500 basis points (bps). However, international developed equities as a group were weighed down by Japan, which was up by only 0.3%. A falling U.S. dollar contributed nicely to the return on foreign assets held by Americans, adding almost 4% to gains. Compelling valuations and a rapidly shifting global economy refocused investor attention on non-Mag 7 assets. Emerging markets also performed well, increasing by about 3%, although that was entirely due to China, without which emerging market equities declined by 1.7%.

At the sector level economic concerns drove consumer discretionary stocks lower by 13.7%, followed closely by the former high flying tech sector, which lost 12.8%. Energy (+8.6%), health care (+5.5%), and utilities (+5.3%) were the best performing sectors, in part due to less reliance on foreign revenues.

Earnings season is always important, but as CEO’s begin to host calls with investors this week, and if the White House doesn’t back down on the proposed tariffs, be prepared for a flood of negative revisions to forecasts. The volatility may just be beginning.

BONDS: YIELDS FALL ACROSS THE CURVE 

With U.S. equity markets falling, investors took refuge in all things fixed income. Long-term Treasuries gained almost 5%, TIPS were up 4.3%, and the broader bond market advanced by 2.8%. The yield on the 10-year fell by 35 bps and the 10-year minus 3-month inverted once again. This as the Fed stood pat, holding the Fed Funds rate at the 425 to 450 level at both of their meetings, while expressing concerns about slower growth and higher inflation. Futures markets continue to price in a 25 bps cut at the June meeting.

Spreads on high yield debt widened materially from 292 to 355 by the end of the quarter, hurting the returns to junk bonds, which still managed to hold onto a 1% gain for the three-month period. Leveraged loans followed high yield lower in March, but also posted a positive return for the quarter of 0.5%. Municipal bonds were the only sector that was lower for the quarter, returning -0.2% after a 1.7% sell-off in March. That weakness was due to a confluence of factors: higher supply, lower dealer liquidity support, and some tax season selling, according to Nuveen.

COMMODITIES: TANGIBLE ASSETS SURGE

With global trading alliances being challenged, tariff uncertainty during the quarter, and increasing concerns about inflation, commodities advanced by almost 9%. Both gold and silver increased by over 18% as investors sought out safe haven assets. Copper also hit an all-time high as traders rushed to buy in advance of tariffs, pushing the metal up by 25%, and helping the industrial metals complex to an 8.6% gain. The energy sector advanced by about 11% thanks to a 31% surge in natural gas prices, while oil price gains were much more subdued on production increases and expectations for lower demand; Brent crude futures gained 3.7% and WTI crude was up 2.1%. Rounding out the major commodity categories, agricultural contracts returned 2% for the quarter.

How are Frontier Strategies positioned?

ALLOCATION CHANGES

Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Active ETF, Conservative Income and Faith-Based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we instead direct clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.

Focusing on our Core Strategies, relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. and international small caps, emerging market equities, managed futures, floating rate loans, TIPS, and cash/short term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. At the beginning of April, our asset allocation models continued to add exposure to TIPS within most strategies by reducing exposure to investment grade debt, although overall changes were modest.

Expected returns for most asset classes increased in March, with the largest changes occurring for high yield bonds and U.S. small cap stocks. International small caps continue to offer the highest long-term expected returns, followed closely by emerging market equities. While high yield bonds look the most attractive on a relative basis compared to other fixed income sectors based solely on expected return, given how tight spreads remain and how low defaults have been, and considering how expectations stack up against our forecasts for the asset class over the last twenty years, high yield is not particularly compelling at this point.

PERFORMANCE ATTRIBUTION

The first quarter of the year was generally a strong one on a relative basis for Frontier Strategies. While being overweight U.S. small caps was detrimental to both absolute and relative returns, our underweights to U.S. large caps (and by extension the Mag 7, which all struggled), and our overweights to international small caps and emerging markets more than offset the weakness in U.S. small caps. Being underweight REITs was also a positive in the equity space. Within fixed income our TIPS exposures were rewarded, as that segment of the market greatly outperformed the bond market as a whole, and lower credit quality sectors like high yield (which we were underweight) and leveraged loans, specifically. Interestingly, both commodities and long-term Treasuries performed quite well, and while certain Frontier Strategies held Treasury positions, commodities were largely absent from our portfolios.