“Uncertainty, that’s what one fears most.”
— from the 1965 movie “War and Peace”
The overriding theme for the first quarter of 2025 undoubtedly was “Uncertainty.” From threats of imposed tariffs, suspension of some tariffs and re-implementation of other tariffs, investors were inundated with news stories of international trade that may or may not be relevant that same day. Investors also experienced uncertainty in the equity markets. The CBOE Volatility Index (VIX Index), which measures volatility in the stock market, rose to heights which have only been seen a small number of times in the last several years.
Additionally, investors experienced uncertainty regarding the recent artificial intelligence (AI) phenomenon. Investors are monitoring the current landscape in order to determine the impact AI will have on the economy and the markets. It is uncertain as to what scale various companies will invest in AI infrastructure, as well as its impact on employment. Investors are also monitoring the potential returns this new technology will deliver to companies investing in AI. Will it be worth it? Also, throw in an industry disruptor, such as Deep Seek (the China based AI engine), and the level of uncertainty continues to increase.
Market Rotation
The markets experienced a rotation of sorts during the first quarter. Foreign
developed equity markets outpaced U.S. equity markets, a reversal from the last several years. Notably, some European markets saw first quarter returns near or above +10%, as the economies in those regions have begun to improve following several years of languishing. Within Emerging Markets, the Hang Seng Index in China rose dramatically during the first quarter as that country benefited from the AI boom, as well as various government stimulus programs.
Domestically, investors rotated out of Growth stocks as Value stocks significantly outperformed Growth stocks, a marked reversal from 2023 and 2024.
Tough Tariff Talk
There have been many headlines written in the first quarter regarding potential new tariffs announced by the current White House administration. Tariffs are generally viewed to be inflationary as they increase the prices of goods and are typically headwinds for consumers, manufacturing and housing, and may hinder economic growth. Indeed, GDP forecasts have been lowered since the beginning of the year. Additionally, first quarter earnings growth forecasts have recently been lowered compared to the beginning of the year as analysts weigh the impact of a global tariff war on economic growth. However, tariffs can also be viewed as beneficial to redevelop U.S. manufacturing. The current global trade environment remains fluid and continually changing, and we continue to monitor developments regarding this situation.
Corporate Earnings – Continuing Strong Growth but Slightly Tempered Expectations
Fourth quarter earnings results for 2024 came in generally very strong, with year-over-year growth of 17.1% achieved, led by the Financials, Communications and Technology sectors. This led to calendar year 2024 year-over-year earnings growth of 12.1%, slightly above the long-term average.
Calendar year 2025 earnings growth is forecasted at 10.6%, with the Health Care and Technology sectors expected to provide leadership. Calendar year 2026 earnings growth is forecasted at 14.1%.
With the stock market experiencing falling prices in the first quarter of 2025, price-to-earnings (P/E) have also fallen. The forward P/E ratio for the S&P 500 has fallen from 22.0X reached in mid-February and currently sits at 20.5X, closer to its long-term average. When factoring in earnings growth via the price/earnings-to-growth ratio (PEG ratio), the S&P 500 is currently trading at 1.9X, slightly higher than the long-term average of 1.7X.
Foreign developed markets finished calendar year 2024 with a modest year-over-year earnings growth rate of 1.0%. Year-over-year earnings growth rates for calendar year 2025 and 2026 are forecasted at 8.7% and 9.9% respectively, less than the forecasted growth rates for U.S. large caps. The forward P/E for EAFE is currently at 14.3X, fairly close to its long-term average while the PEG ratio is currently 1.5X, also fairly close to its long-term average.
We believe the projected EPS growth rates for U.S. large cap stocks appear both attractive and achievable, especially when comparing against foreign developed markets. Despite recent downwards revisions of earnings forecasts, we believe U.S. large caps are deserving of the premium P/E relative to U.S. small caps and foreign developed when factoring in the sustainability of U.S. large cap earnings growth.
Analysts are less optimistic regarding earnings growth in the U.S. than they were late last year as downward earnings revisions have outpaced upward earnings revisions for 2025, 2026 and 2027. Meanwhile, the opposite is true for foreign developed markets as upward earnings revisions have outpaced downward earnings revisions for the next three years. However, despite these trends, forecasted earnings growth rates are still higher for U.S. markets. In particular, the mega cap stocks have, and are expected to continue to, provide sustainable earnings growth.
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