April 2025 edition

Key takeaway

• Our key message since downgrading stocks in late February remains that investors should be more neutral and less on offense relative to recent years given a more mixed risk/reward backdrop.
• This view remains intact, though after the sharp market selloff, our work suggests this is not the time to become more negative, at least not in the short term.
• We expect the path forward will remain bumpy. Markets are now at least better discounting some of the uncertainty, and the bar for positive surprises has been reset lower. Thus, there is a risk of further market downside, but also a little bit of good news could go a long way.

Risks happen quickly

Experience helps. As a strategist going through the pandemic, where the prevailing wisdom by most on Wall Street was that COVID concerns were overblown akin to the fleeting market decline around the 2003 SARS outbreak, I felt a sense of déjà vu into late February—coincidentally roughly five years since the pandemic hit.

That is, there appeared to be complacency in the markets with the belief that the administration’s tariff policies were potentially more bark than bite. That view shifted in real time as the administration rolled out a tariff policy that was much tougher than widely assumed. Thus, the market adjusted quickly.

That said, even before the tariff announcement, there were signs building that the market’s risk/reward had shifted in a less favorable way. Indeed, modest deterioration in earnings, technical, and economic trends were already apparent and reinforced the importance of staying grounded in the data and a weight-of-the-evidence approach.

From an investment standpoint, the question is not whether there is uncertainty but whether one is being adequately compensated for taking on risks relative to the perceived uncertainty. 

Uncertainty reigns, but what’s priced in?

From an investment standpoint, the question is not whether there is uncertainty but whether one is being adequately compensated for taking on risks relative to the perceived uncertainty.

The recent pullback better reflects some of the concerns relative to the complacency back in February. Through in early April, the S&P 500 is down nearly 16% from its February peak, small caps have entered bear market territory, and former market darlings in the tech sector have gone from leaders to laggards.

Moreover, we are seeing a spike in demand for insurance against further stock market declines and moves up in the Volatility index (VIX), which tend to work as contrarian indicators.

Buying stocks after a 10% pullback, even if there was further short-term pain, has typically rewarded longer-term investors, with the caveat that avoiding recession matters. 

• Since 1950, there have been 56 pullbacks of 10%. Out of those instances, stocks were higher one year later 49 times.
• Notably, in the seven instances where stocks declined, six coincided with a recession. Thus, the path of the economy remains critical.

Our head of U.S. economics sees recession risk around 50%. That is near what the market is pricing in with a roughly 16% setback, as the typical peak-to-trough decline for the S&P 500 has been about 24%.

Either way, the economy is expected to weaken given many companies are in a wait-and-see mode, while corporate earnings are likely to be reset lower at a time where valuations are improved but not compelling.

Moreover, the potential for a tit-for-tat response and an escalation into a trade war lingers. That is effectively what the market is attempting to price in. Thus, we expect the choppy market environment to persist over the next several weeks and possibly months.

We are not likely to see a quick return to new highs, yet on a shorter-term basis, markets once again appear to be getting stretched to the downside and nearing a point of stabilization.

Positioning amid the complexity

We’ll get through this challenging market period. We always have—whether it’s the COVID-induced market selloff or the Global Financial Crisis, or the 11 recessions we have had since 1950s.

• It’s also important to recognize through every one of those challenging periods, stocks eventually rebounded to make record highs. We don’t expect this period to be any different, even while we expect a continued bumpy path forward.
• From an investor standpoint, timeframes matter. Over a 5-year period, a 60/40 portfolio, as an example, has been up historically 99% of the time.

Tactically, we continue to advocate for a more modest portfolio risk posture relative to the past few years—one that is more neutral, aligned with long-term target allocations. For those investors with excess cash relative to equity targets, we would use a dollar-cost average approach to help smooth the ride.

We continue to favor large caps over small caps. Importantly, the relative price and earnings trends of small caps relative to large caps remain weak. In the small/mid cap space, we prefer mid caps given stronger earnings trends, less debt, and a more stable return profile over a market cycle.

International markets had been acting better on a relative basis but are not immune to the negative impact from tariffs and the global selloff.

We are largely sticking with high quality fixed income. As growth fears have recently dominated inflation concerns, high quality bonds are outperforming and providing that important portfolio stabilizer.

We are upgrading our outlooks incrementally for investment grade (IG) corporates from less attractive to neutral and high yield (HY) corporates from least attractive to less attractive. 

• The relative value offered by IG and HY has improved after a prolonged period of historically tight valuations. Credit spreads within each sector are currently flirting with 18-month highs and their longer-run averages in response to tariff-related economic disruptions and rising global growth fears.

Alternatives should help qualified investors navigate markets and embrace continued wider outcomes.

Gold—We still see value in holding a position as a portfolio diversifier given heightened geopolitical risks and central bank buying, though it’s likely set for a near-term breather.

The current market backdrop remains fluid. As always, we will continue to follow the weight of the evidence and keep an open mind.