It is often said that markets dislike uncertainty, which was certainly in abundance during the first quarter of 2025. In January, the incoming Trump administration wasted no time bringing swift and dramatic changes to trade, regulatory, immigration, and fiscal policies. While many of these policy shifts had been expected, the speed and extent of the overhauls caught the markets off guard at times, which led to elevated volatility throughout the quarter, including a brief 10% drawdown in US stocks.
But the correction was short-lived, and by quarter end, markets had staged a significant recovery. This did not prevent the financial media from blaring headlines like “Worst quarter for stocks since 2022!” Based on the anxiety-provoking coverage, you could be forgiven for thinking we’d suddenly entered a severe recession and that stocks were down maybe 15-20%. However, when the dust settled, US stocks were down less than 5% in 1Q25 (after returning 25% in 2024 and 26% in 2023).
As evidence-based investors, we know to expect volatility. We also know that drawdowns of 5% or 10% are not uncommon. In fact, the S&P500 index has experienced a 5% drawdown about every seven months, on average, and a 10% decline about every 26 months since 1932. While drawdowns are normal and expected, their timing is unpredictable. Sudden corrections can be unsettling, but we should remember that the higher risk and frequency of drawdowns paves the way for higher expected returns over the long run.
Although the US stock market was down less than 5%, last quarter produced a much deeper drawdown for the MAG7 stocks, which are the large tech-related household names we all know. Most MAG7 companies were down double digits in 1Q25, with Tesla faring the worst. Since these seven companies represent a sizable chunk (~32%) of the S&P 500 index, their performance weighed on US stocks broadly.
But despite significant losses in large US growth stocks, highly diversified portfolios held up remarkably well last quarter. This is because nearly every other asset class–including value stocks, foreign stocks, commodities, real estate, and bonds–were positive in 1Q25. Foreign large value stocks were one of the best performers, up more than 12%:
And because so many other asset classes performed well last quarter, many investors may be surprised to see flat or even positive performance when they open their first quarter statements in April. This is a real-time demonstration of diversification at work – achieved by combining different asset classes in the same portfolio to dampen volatility. Last quarter showed us once more that diversification remains the most powerful tool we have to control risk in a portfolio.
Sources:
https://www.fool.com/research/magnificent-seven-sp-500/
