Coming into the start of the year, many investors were optimistic that the 2024 trend of US exceptionalism, where US stocks outperformed their global counterparts, would continue. The newly elected Republican administration and their “America First” policies provided a reason to expect this and headwinds for international economic growth.
However, the year has played out quite different so far. Volatile US trade policies have dampened regional growth and increased inflation expectations, while Europe has responded with stronger fiscal measures than anticipated. The backdrop has led to emerging market equities outperforming, with notable strength seen from China and Korea. Value stocks have outperformed growth stocks, smaller companies have lagged. The MSCI World Small Cap index has returned -3.6% year to date. Commodities have been the top performing asset class, with gold prices rising by 19% year to date.
In bond markets, rising recession risks have lifted US Treasuries to a 2.9% year to date return. In contrast, European sovereign bonds have been weighed down by expectations of increased government spending, with German Bunds ending the quarter down 1.6%. Japanese government bonds have notably underperformed, down 2.4%, from inflationary pressures.
Throughout the first quarter, US equity markets were heavily influenced by tariff-related news. March saw tariffs being placed on steel, aluminum, and vehicles, which added to the ones placed on Mexico, Canada, and China in February. Market sentiment fluctuated as investors anticipated the severity of upcoming announcements set for April 2. Concerns grew that trade dynamic uncertainty was slowing US economic activity, evidenced by incoming data, such as the decline in capital expenditure intentions from small business surveys. Small caps and cyclical sectors, including Communication Services, Consumer Discretionary and Information Technology dragged down the S&P 500 over the month of March, continuing the trend from the beginning of the year. Recession probabilities from economist rose from their normal 10% – 15% to ranging between 30% – +50%, due to the forecasted impacts from tariffs.
In March, the Federal Reserve opted to keep interest rates unchanged. Fed Chair Jerome Powell also indicated potential future rate cuts, emphasizing the focus on downside growth risks rather than inflation. By the end of the March, US 10-year Treasury yields had decreased to 4.2%, down .36% from the start of the year. The deterioration in investor sentiment led riskier fixed-income securities (corporates and high yield bonds) to underperform Treasuries. The U.S. dollar depreciated sharply over the month, particularly against the Euro.
In Canada, higher than expected inflation data in March caused the Canadian Fixed Income Universe to end the month slightly down. The Bank of Canada seemed reluctant to continue further easing in the short term. Canadian equities ended the month down 1.5% but are still holding a modest 1.5% gain year to date.
In Europe, the new US administration’s confrontational approach spurred European policymakers to implement fiscal stimulus measures. European Commission President Ursula von der Leyen proposed a substantial €800bn spending plan to bolster the bloc’s defense capabilities. This plan includes €150bn in new European borrowing and an additional €650bn in fiscal space, allowing countries to increase defense spending without breaching EU fiscal rules.
Germany’s likely incoming chancellor, Friedrich Merz, also took steps to stimulate the German economy. His proposals included easing the debt brake specifically for defense spending and introducing a new €500bn infrastructure spending plan. These announcements surprised the markets over the month, causing 10-year German Bund yields to rise over .30%. Borrowing costs across other Eurozone member states also increased. Equity investors responded favorably to the improved growth outlook that the fiscal spending created, with Germany’s DAX Index achieving its strongest first quarter performance since 2023.
The European Central Bank (ECB) additionally supported monetary easing, confirmed to continue by the comments of ECB President Christine Lagarde at the bank’s March meeting. Since the start of the year, Eurozone interest rates have been reduced twice. Markets are anticipating a further reduction of .60% by the end of the year.
In the UK, Chancellor Rachel Reeves announced £8.4 billion in new spending cuts. Despite this, UK assets remained largely unaffected. The 10-year Gilt yields ended March just .10% higher than where they were at the beginning of the year. UK equities has been one of the top performing regions year to date.
In Asia, equity markets have shown a lot of volatility. Chinese stocks performed the best, gaining 15% from the start of year. This was driven by several factors: US tariffs were less damaging than anticipated before Liberation Day, the positive sentiment continued towards Chinese technology companies since DeepSeek’s AI breakthrough in January, and that Beijing hinted at a more supportive policy stance. Conversely, Indian stocks struggled, falling by 2.9% year to date. In Japan, the equity market faced headwinds due to a stronger yen, which was influenced by narrowing interest rate differentials.
Despite the potential threat of tariffs to the growth outlook, strong corporate fundamentals have helped to prevent significant spread widening in US credit. In Europe, local government bond market movements negatively impacted credit returns, but European investment grade credit spreads have narrowed since the start of the year. The weaker US dollar provided support for emerging market debt, while a sharp decline in US real yields led to an outperformance in inflation-linked bonds.
March has seen heavy market volatility. With uncertainty remaining for global growth and trade dynamics, it will likely remain in the foreseeable future, as markets adjust to frequent changes in government policy and global trade dynamics. Like every downturn, the price discovery process will play out and asset prices will find a footing. In the meantime, active portfolio management will provide value for reducing losses and taking advantage of buying opportunities.
