Stocks fell in the first quarter after two consecutive years of gains exceeding +20%. The year started off strong, with the S&P 500 reaching a new all-time high in mid-February. However, sentiment shifted late in February amid rising policy uncertainty in Washington, and the S&P 500 ended the quarter down. There are many moving pieces in markets today, and we want to take a moment to share our team’s perspective. In this letter, we’ll recap the first quarter, discuss the drivers behind the recent market selloff, and provide an update on the economy.

The big development in Q1 was falling stock market valuations, as rising policy uncertainty weighed on investor sentiment. The chart below provides context around the recent pullback, highlighting the divergence between earnings estimates and valuations. The dashed blue line graphs the rolling 12-month earnings forecast for the S&P 500, reflecting Wall Street analysts’ profit expectations for the year ahead. The navy shading graphs the S&P 500’s price-to-earnings (P/E) ratio, or how much investors are willing to pay for those future earnings. The shift in sentiment during Q1, from optimism to caution, caused valuations to decline and stocks to fall.

The right side of the chart shows Wall Street analysts slightly lowered their earnings forecast in Q1, citing the potential for tariffs and slower growth. Investors started to price stocks more conservatively due to concerns about tariffs, slower economic growth, and policy uncertainty.

Last year, the Magnificent 7, a group of leading tech stocks that includes Nvidia, Microsoft, Alphabet, Amazon, Tesla, Apple, and Meta, delivered an impressive +63% return. The group’s strength lifted the broader market, with the S&P 500 gaining +23%. In contrast, the equal-weight S&P 500, which gives all companies the same weight regardless of size, gained only +11%. This year, the dynamic has flipped. Instead of lifting the market, the biggest stocks are now dragging it down. The Magnificent 7 has declined -15% year-to-date, while the equal-weight S&P 500 is down only -1%. The takeaway: smaller companies held up better during the selloff.

It is important to remember that the stock market isn’t the economy. In other words, the performance of the stock market doesn’t always reflect real-time economic conditions. This is because the market is forward-looking and prices in expectations for what’s to come. The next charts graph four economic indicators that offer insight into the state of the U.S. economy: the unemployment rate, retail sales, housing starts, and industrial production.

The top chart graphs the unemployment rate, which remains low by historical standards. Unemployment rose in 2023 and the first half of 2024 as workers reentered the labor market and job growth slowed. This led to concerns about labor market softening and contributed to the Federal Reserve’s decision to start cutting interest rates in September 2024. However, unemployment reversed lower in recent months as monthly job growth picked up. The data points to a resilient labor market, with demand for workers running up against a still relatively tight labor market.

The second chart graphs the year-over-year growth of retail sales, a measure of consumer spending. Growth was strong in 2023, supported by rising wages and the continued drawdown of pandemic-era savings. However, growth slowed in 2024, an indication that while households continue to spend, they’re doing so more cautiously. Potential factors include high interest rates, persistent inflation, and a return to more typical spending patterns.

The third chart graphs the year-over-year growth of housing starts, which are a leading indicator of housing activity. The housing market slowed in recent years as it struggled under the weight of high mortgage rates and decreasing affordability. Homebuilders were hesitant to take on new projects amid weaker demand and elevated borrowing costs, and recent policy announcements are creating more uncertainty. Tariffs and immigration policies create potential challenges for builders, as they may raise material costs and decrease labor availability. However, despite the headwinds, housing starts are still above pre-pandemic levels.

The fourth chart graphs the year-over-year growth of industrial production, which measures the total output of factories, mines, and utilities across the economy. Industrial activity was flat or declined in 2023 and 2024 as high interest rates and economic uncertainty dampened business investment. More recently, industrial output shows signs of recovery, with industrial production growing at the fastest pace since late 2022. The rebound likely reflects expectations for lower interest rates and the resolution of uncertainty after last year’s election. The question is how tariffs will impact manufacturing as 2025 progresses.

Together, the data suggests the U.S. economy is losing some momentum. However, they also show the economy continues to expand, just at a slower pace. The labor market remains solid, and consumer spending is holding steady. The housing sector has cooled from its pandemic highs, but it still exceeds the pace from the 2010s. Meanwhile, manufacturing activity is showing renewed strength. The risk moving forward is that policy uncertainty could weigh on confidence and trigger a slowdown. Economic data will be in focus in the coming months.

There were two notable themes in the bond market in Q1: falling U.S. Treasury bond yields and wider credit spreads. The 10-year Treasury yield fell from a peak of around 4.80% in mid-January to 4.15% in early March. It was a reversal from Q4, when the 10-year yield rose more than +0.75% due to renewed inflation concerns. Several factors contributed to the Q1 reversal, including rising policy uncertainty, the potential for tariffs, and concerns about slower economic growth. The combination prompted investors to move money into longer-maturity government bonds, which are viewed as safe havens. Bond prices rise as yields decline, and Treasury bonds provided diversification benefits in Q1, offsetting a portion of the stock market decline.

Market volatility can be unsettling, but it’s a normal part of investing. Periods of enthusiasm often lead to recalibration. It’s natural to feel uncertain, but history shows that staying invested through volatility and maintaining a longer-term perspective is the prudent approach.

The chart on the next page puts the Q1 market volatility and selloff into perspective. It uses almost a century of S&P 500 price data to show that market pullbacks like this year are not just common—they’re a healthy and recurring part of investing. The chart graphs annual drawdowns, or the largest peak-to-trough decline within each calendar year. The bars show the S&P 500 experiences a pullback nearly every year, with a median intra-year drawdown of -13%. Since 1928, the S&P 500 has experienced a drawdown of -5% or more in 91 out of 98 calendar years, including 2025.

The chart highlights a fundamental reality of investing: market corrections are a normal part of the cycle. These periods can be uncomfortable, but they serve the important functions of resetting valuations and curbing speculative excess. Without occasional declines, markets could become dangerously overextended, increasing the risk of more severe and extended downturns.

Despite these frequent and sometimes severe drawdowns, the S&P 500 has delivered strong returns over nearly a century. This is despite wars, recessions, inflation spikes, financial crises, and a global pandemic. The upward trajectory is driven by economic growth, innovation, and corporate earnings growth. The key takeaway for investors: volatility isn’t a sign that something is broken—it’s the price of admission to investing. Staying invested through ups and downs has consistently been one of the most effective strategies for building wealth over time. Market declines can feel unsettling in the moment, but history shows the powerful effect of compounding returns over time.