While the increase in tariffs would likely have caused heightened uncertainty by themselves, the administration’s inconsistent application of these tariffs has exacerbated this uncertainty and has led to business paralysis in terms of investment decisions. For instance, Trump announced substantial tariffs against Mexico and Canada, only to reverse course and announce subsequent delays around implementation for all or portions of these tariffs within days. As such, US businesses question whether these tariffs are negotiating ploys (and unlikely to materialize or remain in effect for long) or whether these really are part of an economic ideology that will continue to apply over the next year or several years.
Federal Government Layoffs
President Trump has also pledged to reduce the size and scope of the federal government. Since entering office, he created the Department of Governmental Efficiency (DOGE), a non-governmental agency effectively headed by Elon Musk. DOGE’s mandate is to identify areas in which federal government spending can be meaningfully reduced through contract cancellations, employee headcount reductions, and real estate savings. Over the first two months, DOGE’s actions have resulted in reductions of roughly 100K federal employees (out of a federal workforce of roughly 2.3 million). In addition, federal contractors have also enacted layoffs, although the number is hard to ascertain. Thus far, the administration has implemented these layoffs in a chaotic fashion and without much clarity or messaging. There have been several court challenges regarding the legality of these layoffs, and it is unclear where the ultimate government employee workforce reduction shakes out. While government layoffs are yet to show up in the otherwise reasonably healthy monthly employment statistics, it is widely believed that official employment statistics will be much worse over the next several months. Additionally, the rapid pace of layoffs has significantly dented consumer confidence in recent weeks.
Unwinding of the AI Trade
In 2023 and 2024, the S&P 500 was up 25.7% and 24.5%, with strong performance largely driven by the Magnificent Seven and a few other companies (especially semiconductor companies) that were actual or perceived AI beneficiaries. As we noted in January in our Q4 2024 review, the AI trade faced challenges entering 2025 in terms of likely slowing earnings growth relative to the rest of the market coupled with higher valuations and investor expectations.
Q4 2024 earnings and 2025 outlooks proved to be lackluster relative to high expectations and certain hyperscalers such as Microsoft, Amazon, Google and Meta all projected capital expenditure levels far exceeding analyst forecasts. Most of these stocks were already under pressure prior to the broader recent market volatility, and the Magnificent Seven is now down 13.7% YTD through March 10, 2025, as compared to the S&P 500 down 4.6% and the Equal Weighted S&P 500 index down 0.6%. While Magnificent Seven valuations now appear more reasonable, we note that these stocks dropped by 33% from peak to trough during the 2022 drawdown.
Market Backdrop and Current Valuation
As stated earlier, US economic and employment fundamentals were strong entering 2025. Fourth-quarter earnings growth was extremely robust at 16% YOY, and analysts were forecasting an additional 13% earnings growth for CY 2025 driven by healthy consumer and business spending. However, policies regarding tariffs and federal government workforce reductions have significantly dented business and consumer confidence (as evidenced by manufacturing and consumer surveys and through reduced earnings forecasts for certain consumer stocks such as airlines and retailers). It remains to be seen whether this effect is short-term in nature or whether it spirals and triggers a recession. Within the US, while consumer spending has been very healthy over the past couple of years, the data is nuanced. Lower to lower-middle income consumers have been struggling over the past two years while middle-to-upper income consumers have held up extremely well, buoyed by stable employment and increases in home and stock market values. If job losses were to accelerate or this heretofore healthy segment of consumers ratchet back spending, the US economy could quickly lose strength and enter a recession. As equity markets are forward looking, investors are already speculating that earnings growth for 2025 and possibly 2026 are likely to be lower than currently projected. At 5,572, the S&P 500 is currently trading at 20.0x forward earnings, down from 22.3x peak levels on February 19th. While closer to historical fair valuation from a multiple standpoint, the market is not cheap. Furthermore, there is downside risk to forecasted earnings for 2025 and for 2026. During the October 2022 lows, the S&P bottomed at 15.7x forward earnings during a period of rising rates and inflation. With inflation and rates having likely peaked, it is unlikely that valuations will compress that far unless there is a severe recession. However, if one applied a 17x-18x forward multiple to reduced 2026 earnings of $260-$270 (relative to current consensus estimates of $308), the S&P 500 could easily decline another 15%-20% from present levels by YE 2025. Given the incredibly high levels of policy uncertainty, risks are relatively balanced towards both upside and downside cases. However, the potential for downside has increased materially in recent weeks.
Upside Case
Trump backs away from escalating tariffs and the pace of federal job reductions slows. His policy agenda shifts towards pro-growth measures, including extending tax cuts and possibly reducing corporate tax rates further. AI demand remains robust while capex plans remain within forecasted levels. S&P earnings for 2025 might reach $270 (near forecast levels) and investors will pivot towards an outlook of continued strong growth in 2026, with earnings growing to $300 to $310. The Fed likely delivers at least three rate cuts and possibly more during 2025. Under this scenario, the S&P may close 2025 between 6,100 – 6,500 (10% to 17% upside from current levels).
Downside Case
Tariffs intensify with retaliatory actions by other countries and federal job cuts continue at high rates throughout the year. 2025 earnings are lower than forecast at $255 to $260 and analysts reduce 2026 projected earnings to $260-$270 (from $308 currently). The market falls to 17x-18x forward earnings to roughly 4,400 to 4,800 or 15%-21% lower than current levels and 22% to 28% below recent equity mark peaks.
International Equities
Unlike the S&P 500, major international equity markets have appreciated YTD with International developed equities (MSCI EAFE) and emerging markets (MSCI Emerging Markets) indexes up 8.7% and 4.5%, respectively. Strong international developed equity performance has primarily been driven by a 12.7% increase in Europe equities. Emerging market performance has been driven by a 19.1% increase in Chinese equities.
European equity performance has largely been driven by a) recent pledges to aggressively ramp up fiscal spending for defense and infrastructure expenditures, led by Germany and b) relief that European countries have been relatively spared by US tariff policy thus far. The newly elected German chancellor’s pledge to spend whatever it takes to shore up defense (assuming the measure is passed by German legislature) is a radical departure from previous German governmental adherence to fiscal austerity. If the measure passes the German parliament (there are some implementation challenges) and other European nations follow suit, Europe could benefit from a multi-year increase in fiscal spending which should benefit European defense and cyclical industrial sectors materially.
Chinese equity performance has largely been driven by investor expectations around forthcoming significant governmental stimulus aimed at driving increased domestic consumption. The government recently set a 5% annual Real GDP growth target for 2025 which was above expectations. Additionally, following several years of anti-business regulatory crackdowns, the government is pivoting towards a more business friendly approach, especially in the higher growth technology and internet sectors.
Investors are wondering whether the era of US exceptionalism is over and whether international markets are set for a multi-year run of relative outperformance. While we believe that significant European fiscal spending increases could be game changing, we note that there are still several challenges in actual implementation. Additionally, given structural demographic challenges and high property sector and local bank indebtedness, China’s stimulus may not be large enough to meet heightened investor expectations. Furthermore, international markets are not immune from a slowdown in US economic conditions. Finally, following recent equity market rallies, valuations for Europe and China are no longer extremely cheap but, instead, close to historical averages. Over the past decade, there have been numerous instances where international equity markets have outpaced US markets over short time periods only to significantly reverse course and ultimately materially underperform. While we do believe that international markets may continue to outperform US markets over the next 6-18 months (especially if a Russia / Ukraine settlement occurs), we believe the US will outperform over longer time periods due to higher and more predictable earnings growth coupled with better corporate governance and more shareholder friendly practices.
Summary
US policy is presently highly uncertain. This uncertainty is exacerbated by President Trump’s communication style, engendering sharply increasing equity market volatility and the large magnitude of intraday market swings. We expect that global markets (but especially US equities) will continue to experience higher volatility and may remain range bound until clearer policy direction and implementation emerges. The market seems to have realized that neither a “Trump Put” or a “Fed Put” is imminent.
We encourage investors not to try and time the market or trade around volatility. Rather, we recommend adhering to mid-term investment plans by:
Maintaining overall public equities exposure and gradually adding to US equities during further US equity market weakness.
Add duration to fixed income when the US Treasury 10-year yield nears 4.5% as the risk / reward becomes favorable, with a sufficiently high current income if securities are held to maturity.
We recommend that investors stay the course and continue allocations to private investment strategies where appropriate. It is important to build vintage year diversification, and several private investment strategies such as PE secondaries and niche private credit are highly compelling given the current environment.
Perspective Amid Market Uncertainty
Perspective Amid Market Uncertainty
Since peaking at 6,147 on February 19th, the S&P 500 has declined by 9.4% to 5,572 as of March 11, 2025. YTD, the S&P 500 is down 5.2%. Interestingly, this decline in the S&P is not part of a worldwide selloff in equities. In fact, international equities (MSCI ACWI ex USA Index) are up 6.0% YTD. Rather, it represents a reversal of the long-lasting US exceptionalism trade where US equities dramatically outperformed international equities since YE 2022 and over the past 15 years more broadly. In the note below, we discuss the reasons for US equity market weakness and implications for performance going forward.
US Equity Market Weakness
As we flagged in our Q4 2024 publication dated January 14, 2025, US markets were highly valued at almost 22x forward EPS expectations vs. long-term averages of roughly 17x. Entering 2024, economic fundamentals and the outlook for corporate earnings growth remained strong, and investor sentiment was extremely positive as investors were embracing potential positive pro-growth Trump administration policies while discounting those with negative implications. When investor expectations are unusually high, any hint of potentially negative news or even uncertainty can derail sentiment and lead to swift market selloffs. Over the past few weeks, the S&P 500 has declined as US economic uncertainty has grown significantly due to tariff policy and layoffs in the federal government and related contractor ecosystem. In addition, the market has also been hit by an unwinding of the AI trade.
Tariffs
During the US presidential election campaign, Trump pledged significant increases in tariffs as a signature element of his second term agenda. After entering office less than two months ago, he has followed through and proposed several tariff measures. If fully enacted, the effective US tariff rate would reach the highest level since the 1940s.
While the increase in tariffs would likely have caused heightened uncertainty by themselves, the administration’s inconsistent application of these tariffs has exacerbated this uncertainty and has led to business paralysis in terms of investment decisions. For instance, Trump announced substantial tariffs against Mexico and Canada, only to reverse course and announce subsequent delays around implementation for all or portions of these tariffs within days. As such, US businesses question whether these tariffs are negotiating ploys (and unlikely to materialize or remain in effect for long) or whether these really are part of an economic ideology that will continue to apply over the next year or several years.
Federal Government Layoffs
President Trump has also pledged to reduce the size and scope of the federal government. Since entering office, he created the Department of Governmental Efficiency (DOGE), a non-governmental agency effectively headed by Elon Musk. DOGE’s mandate is to identify areas in which federal government spending can be meaningfully reduced through contract cancellations, employee headcount reductions, and real estate savings. Over the first two months, DOGE’s actions have resulted in reductions of roughly 100K federal employees (out of a federal workforce of roughly 2.3 million). In addition, federal contractors have also enacted layoffs, although the number is hard to ascertain. Thus far, the administration has implemented these layoffs in a chaotic fashion and without much clarity or messaging. There have been several court challenges regarding the legality of these layoffs, and it is unclear where the ultimate government employee workforce reduction shakes out. While government layoffs are yet to show up in the otherwise reasonably healthy monthly employment statistics, it is widely believed that official employment statistics will be much worse over the next several months. Additionally, the rapid pace of layoffs has significantly dented consumer confidence in recent weeks.
Unwinding of the AI Trade
In 2023 and 2024, the S&P 500 was up 25.7% and 24.5%, with strong performance largely driven by the Magnificent Seven and a few other companies (especially semiconductor companies) that were actual or perceived AI beneficiaries. As we noted in January in our Q4 2024 review, the AI trade faced challenges entering 2025 in terms of likely slowing earnings growth relative to the rest of the market coupled with higher valuations and investor expectations.
Q4 2024 earnings and 2025 outlooks proved to be lackluster relative to high expectations and certain hyperscalers such as Microsoft, Amazon, Google and Meta all projected capital expenditure levels far exceeding analyst forecasts. Most of these stocks were already under pressure prior to the broader recent market volatility, and the Magnificent Seven is now down 13.7% YTD through March 10, 2025, as compared to the S&P 500 down 4.6% and the Equal Weighted S&P 500 index down 0.6%. While Magnificent Seven valuations now appear more reasonable, we note that these stocks dropped by 33% from peak to trough during the 2022 drawdown.
Market Backdrop and Current Valuation
As stated earlier, US economic and employment fundamentals were strong entering 2025. Fourth-quarter earnings growth was extremely robust at 16% YOY, and analysts were forecasting an additional 13% earnings growth for CY 2025 driven by healthy consumer and business spending. However, policies regarding tariffs and federal government workforce reductions have significantly dented business and consumer confidence (as evidenced by manufacturing and consumer surveys and through reduced earnings forecasts for certain consumer stocks such as airlines and retailers). It remains to be seen whether this effect is short-term in nature or whether it spirals and triggers a recession. Within the US, while consumer spending has been very healthy over the past couple of years, the data is nuanced. Lower to lower-middle income consumers have been struggling over the past two years while middle-to-upper income consumers have held up extremely well, buoyed by stable employment and increases in home and stock market values. If job losses were to accelerate or this heretofore healthy segment of consumers ratchet back spending, the US economy could quickly lose strength and enter a recession. As equity markets are forward looking, investors are already speculating that earnings growth for 2025 and possibly 2026 are likely to be lower than currently projected. At 5,572, the S&P 500 is currently trading at 20.0x forward earnings, down from 22.3x peak levels on February 19th. While closer to historical fair valuation from a multiple standpoint, the market is not cheap. Furthermore, there is downside risk to forecasted earnings for 2025 and for 2026. During the October 2022 lows, the S&P bottomed at 15.7x forward earnings during a period of rising rates and inflation. With inflation and rates having likely peaked, it is unlikely that valuations will compress that far unless there is a severe recession. However, if one applied a 17x-18x forward multiple to reduced 2026 earnings of $260-$270 (relative to current consensus estimates of $308), the S&P 500 could easily decline another 15%-20% from present levels by YE 2025. Given the incredibly high levels of policy uncertainty, risks are relatively balanced towards both upside and downside cases. However, the potential for downside has increased materially in recent weeks.
Upside Case
Trump backs away from escalating tariffs and the pace of federal job reductions slows. His policy agenda shifts towards pro-growth measures, including extending tax cuts and possibly reducing corporate tax rates further. AI demand remains robust while capex plans remain within forecasted levels. S&P earnings for 2025 might reach $270 (near forecast levels) and investors will pivot towards an outlook of continued strong growth in 2026, with earnings growing to $300 to $310. The Fed likely delivers at least three rate cuts and possibly more during 2025. Under this scenario, the S&P may close 2025 between 6,100 – 6,500 (10% to 17% upside from current levels).
Downside Case
Tariffs intensify with retaliatory actions by other countries and federal job cuts continue at high rates throughout the year. 2025 earnings are lower than forecast at $255 to $260 and analysts reduce 2026 projected earnings to $260-$270 (from $308 currently). The market falls to 17x-18x forward earnings to roughly 4,400 to 4,800 or 15%-21% lower than current levels and 22% to 28% below recent equity mark peaks.
International Equities
Unlike the S&P 500, major international equity markets have appreciated YTD with International developed equities (MSCI EAFE) and emerging markets (MSCI Emerging Markets) indexes up 8.7% and 4.5%, respectively. Strong international developed equity performance has primarily been driven by a 12.7% increase in Europe equities. Emerging market performance has been driven by a 19.1% increase in Chinese equities.
European equity performance has largely been driven by a) recent pledges to aggressively ramp up fiscal spending for defense and infrastructure expenditures, led by Germany and b) relief that European countries have been relatively spared by US tariff policy thus far. The newly elected German chancellor’s pledge to spend whatever it takes to shore up defense (assuming the measure is passed by German legislature) is a radical departure from previous German governmental adherence to fiscal austerity. If the measure passes the German parliament (there are some implementation challenges) and other European nations follow suit, Europe could benefit from a multi-year increase in fiscal spending which should benefit European defense and cyclical industrial sectors materially.
Chinese equity performance has largely been driven by investor expectations around forthcoming significant governmental stimulus aimed at driving increased domestic consumption. The government recently set a 5% annual Real GDP growth target for 2025 which was above expectations. Additionally, following several years of anti-business regulatory crackdowns, the government is pivoting towards a more business friendly approach, especially in the higher growth technology and internet sectors.
Investors are wondering whether the era of US exceptionalism is over and whether international markets are set for a multi-year run of relative outperformance. While we believe that significant European fiscal spending increases could be game changing, we note that there are still several challenges in actual implementation. Additionally, given structural demographic challenges and high property sector and local bank indebtedness, China’s stimulus may not be large enough to meet heightened investor expectations. Furthermore, international markets are not immune from a slowdown in US economic conditions. Finally, following recent equity market rallies, valuations for Europe and China are no longer extremely cheap but, instead, close to historical averages. Over the past decade, there have been numerous instances where international equity markets have outpaced US markets over short time periods only to significantly reverse course and ultimately materially underperform. While we do believe that international markets may continue to outperform US markets over the next 6-18 months (especially if a Russia / Ukraine settlement occurs), we believe the US will outperform over longer time periods due to higher and more predictable earnings growth coupled with better corporate governance and more shareholder friendly practices.
Summary
US policy is presently highly uncertain. This uncertainty is exacerbated by President Trump’s communication style, engendering sharply increasing equity market volatility and the large magnitude of intraday market swings. We expect that global markets (but especially US equities) will continue to experience higher volatility and may remain range bound until clearer policy direction and implementation emerges. The market seems to have realized that neither a “Trump Put” or a “Fed Put” is imminent.
We encourage investors not to try and time the market or trade around volatility. Rather, we recommend adhering to mid-term investment plans by:
Maintaining overall public equities exposure and gradually adding to US equities during further US equity market weakness.
Add duration to fixed income when the US Treasury 10-year yield nears 4.5% as the risk / reward becomes favorable, with a sufficiently high current income if securities are held to maturity.
We recommend that investors stay the course and continue allocations to private investment strategies where appropriate. It is important to build vintage year diversification, and several private investment strategies such as PE secondaries and niche private credit are highly compelling given the current environment.
Sid Nadkarni
Chief Investment Officer
Sid joined Bitterroot Capital Advisors in 2019 with more than 16 years’ experience in the investment management business. Before joining Bitterroot, Sid was Senior Portfolio Manager with the Abu Dhabi Investment Authority (UAE’s sovereign wealth fund) and previously held a similar position and title for Shell Asset Management in the Netherlands. Sid began his career as an investment banker with Arthur Andersen in Virginia and then later at Lehman Brothers in New York City.