Q1 2025

As we said in the last quarterly letter just three months ago, we notice that despite the Fed cutting short-term rates, long-term interest rates have gone up. The bond market is not going along with the Fed. Interest rates must ultimately reflect the cost of money; inflation matters. We are still seeing moderate warning signs. The confidence that inflation is behind us is still the unanswered question, especially with inflationary implications in the near-term due to volatile tariff posturing.

 And then there’s the tariffs…the story of the first quarter of 2025 and front and center for the remainder of the year. The US stock market posted a down quarter, with the S&P 500 falling 4.6% and the tech-heavy NASDAQ dropping 10.4% over the first three months of the year. The pullback was fueled by concerns over the Trump administration’s tariff policies and their potential economic impact. The Russell 2000, an index of small cap stocks, shed nearly 10% on the prospect of the Fed holding rates higher for longer.

 We should bear in mind that investor sentiment can be very fickle. Ultimately stock performance will be driven by company earnings and their future projections. In other words, right now sentiment and money flow seem to be dominating market movements, which is typical in short periods. But eventually it will be about how these policies impact company profits.

 Right now, we need to be prepared for additional economic uncertainty related to tariffs and the uncertainty it is bringing. However, we also need to prepare for other possibilities.

 For example, a big part of the tariff uncertainty is the fact that the administration keeps changing the parameters. Companies could adjust better to the tariffs if they knew exactly what they were. While it seems unlikely that the administration will back off tariffs completely, it isn’t hard to imagine the tariff rules becoming clearer to market participants. That could revive business spending and put the economy back on solid footing.

 We will continue to assess the circular, ever-changing math regarding the impact that the new tariff regime will have on the economy and inflation, while we concede that it’ll be tough to know how the final landscape looks for the US and its relationship with global trading partners. If trade relations end up moderating, there could be stimulative benefits of rate cuts from the Fed. There also could be stimulative effects on the tax policy front later this year. As we make investment decisions, we’ll keep all these considerations in mind.

 Nonetheless, after coming off two years in a row of 20% + returns in the stock market, we continue to have an eye toward risk management within our clients’ portfolio strategies. Long-time clients of the firm likely understand our method of utilizing strong market periods to advocate for reallocating from stocks into bonds. In addition, we trimmed back our clients’ portfolio weightings in a few specific longtime holdings; realizing some gains in the process, and “taking a few chips off the table”.

 As we move through 2025, additional trimming within the portfolios may occur to continue managing against the concentration risk that exists in a big way today within broad stock market indices. At the same time, we’ll continue to keep an eye on our watch list of companies that are potential candidates to be added to the portfolio(s).

 Within fixed income, the bond market has shown moderate volatility over the second half of the first quarter, with Treasury yields lower by approximately 0.30% – 0.40% in the 2 – 7-year range. There is value still to be had in the bond markets today, with attractive opportunities within corporates bonds in the 7-12-year range. Tax-exempt municipal bond markets have been offering great buys in the 10+ year area. Look for some disruption in bond yields going forward until there is solid direction on tariffs.

 We wish you all a wonderful spring and start to summer 2025. Make sure you all get in as much time as possible with friends & family, as time truly is the most valuable commodity in the world. And if you think of it, pour a glass of your favorite cocktail and raise it up for Mark Hoonsbeen.

 As always, our very best,

Salut –

The Team at Nicollet Investment Management