Q1 PIMG Commentary: Re-Emphasizing A Diversified Approach
04.30.25
The first quarter of 2025 offered mixed results for globally allocated investors. The year started with U.S. markets maintaining momentum on the backs of a stable economy and expectations of lower taxes and less regulations. Unfortunately, those expectations were swiftly dashed as the Trump administration’s focus quickly shifted towards perceived trade imbalances. Investors that believed the “America First” platform would benefit U.S. markets, have been surprised, as the opposite has started to play out. The tariff war has indeed begun, and the era of unpredictable U.S. political policy is clearly upon us.
The “Magnificent Seven” (Amazon, Google, Tesla, Meta, Nvidia, Microsoft, Apple) which had contributed to most of recent years’ performance for U.S. indices, was the source of cash as investors booked profits and reallocated those proceeds elsewhere. China’s markets, which are coming off a dismal few years, has produced ~20% returns year to date, while European markets have managed to gain 10% so far in 2025. Canadian equity markets have also performed well on a relative basis, with a small gain over the quarter, driven predominantly by energy, materials and some strength in financials.
Although it’s early days, the benefit of a globally diversified portfolio, is so, far paying off. This could finally be the year when a principled approach to asset allocation will be rewarded. With U.S. equity markets being the clear winner over the last decade, a common question we have heard is, “Why not put all of our investments in U.S. markets?” Similarly, after the negative performance for bonds over recent years, we have repeatedly heard conservative investors ask, “Why do we carry exposure to bonds if returns are limited at best?” Psychologically, recent performance has a habit of persuading investors to believe what has worked recently will work in perpetuity. Investors are often quick to believe that the safest and most rewarding investments are the ones that are doing well. This is known as recency bias. While sometimes this holds true, over time, assets tend to see a reversion to the mean, as investments that have outperformed eventually go through a period of underperformance and vice versa. Many investors forget that from 2000 to 2010, U.S. equity markets provided very little return.
This lost decade wasn’t so painful for Canadian equity investors who enjoyed a prosperous decade of returns thanks to the global commodity boom. A portfolio that is properly diversified, owns assets that offer low-to-negative correlations, often appears foolish when times are good but appears very sensible when the environment is ripe with volatility, as it is today.
While we will stop short of predicting what the next decade has in store for various markets, we will use recent market performance as a reminder of the importance of staying diversified. As portfolio managers we are regularly rebalancing portfolios to ensure client accounts are not materially overweight certain sectors. We strive to ensure clients have exposure to various currencies, and in many cases, a mix of geographical markets. In most instances this means Canadian and U.S. markets, but we will also look to invest in international companies and those that derive meaningful amounts of their revenue from outside of domestic markets. Most clients carry an allocation to fixed income with exposure to corporate, provincial and federal bonds. Historically, fixed income has provided negative correlations to equities, which means when stocks are outperforming, bonds may lag.
All of this adds up to a broader basket of high-quality investments that often move in the same direction yet at times will behave quite differently. Investors that have held a well-diversified portfolio have indeed fared well over the past quarter and we continue to advocate a balanced approach given the near-term volatility.
While the Trump administration’s political plans, its economic impact and the direction of markets remain unpredictable, investor behavior is much more so. Most investors tend to sell into weak markets and buy into strong markets. This behavior can generally be assessed in real time by investor sentiment and can be measured in several ways; 1) cash allocations in portfolios 2) the amount of put options bought relative to call options 3) investor surveys that attempt to gauge professional investors expectations about the near-term 4) insider buying and selling 5) market breadth as per advance/decline data and 6) general commentary amongst the media. When sentiment becomes overwhelmingly negative, it generally represents a time where great buying opportunities emerge. With many of these indicators currently registering readings of extreme fear, it is likely a good time to be putting cash to work. Of course, there could always be further downside and periods of volatility but the time to become overly defensive has passed. The time to be sourcing new opportunities is now.
During the quarter, we were practicing what we preach. In early February, when markets had continued their ascent, many companies we own started to trade at valuations that were elevated. Where warranted, we trimmed names that we still believe in longer term but felt it was prudent to reduce the size of the position, as they had become overweight relative to our targets. Brookfield, J.P. Morgan, Alphabet, Amazon, and Visa all saw some profit-taking close to their recent highs. Some of this rebalancing was added back before the quarter end as prices declined some 10-20% and valuations once again became attractive. Typically, we expect these types of cycles to play out over years, but we were happy to take advantage of a shorter window of opportunity. At the end of the quarter, we retained a somewhat elevated cash position across all mandates.
As mentioned, fixed income markets returned to play its usual roll as volatility reducer. As uncertainty and volatility in equities rose, investors shifted funds to the safety of bonds. This helped fixed income realize a total return of 2-3% and was a welcome change after the last few years of muted returns in the face of rising interest rates. With inflation still lingering, we continue to allocate to short-medium term maturities with a focus on investment grade quality bonds or higher.
It is easy to believe that selling at times of heighted uncertainty can protect investments from heavy losses. The reality is selling in times of heightened uncertainty is generally the best way to ensure losses. Investors are often convinced they can merely sidestep the current environment and get back in when the coast is clear. Time and again this has proven difficult and has cost investors meaningful returns as too often those investors are selling near a bottom and missing out on the recovery. Instead of worrying about the next policy that may impact the markets, we encourage investors to review their investment plan and ensure they are properly diversified. Make sure you are holding enough cash to fulfill your needs over the coming year so you aren’t forced to sell into a weaker market should the environment remain volatile. Being prepared for challenging times is part of the investment cycle but sticking to a disciplined investment strategy is integral and has always served clients well. With many economic issues lingering, and festering political uncertainty, we remain cautious about the near term but optimistic about the long term. Most importantly, we believe client portfolios are well positioned as we head into the second quarter of 2025.
Please reach out with any questions or comments.
Your Plena Wealth Advisory Team
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