First Quarter 2025 Memo: Perspective, Patience, & Possibilities

While we always perform rigorous analysis on the economic and market environment, we operate with the humility that the future is uncertain and investing is driven by expected returns and probabilities. Risk and tactical opportunities can be executed on the margin in benign environments and in periods of tumult, fat pitches do emerge (higher probability, higher expected return investments). Disciplined risk taking is critical during both periods as noted by race car driver Rick Mears who won the Indy 500 four times:

“To finish first, you must first finish.”

At Essential Partners, our interpretation of this quote centers on drastically outperforming broad stock markets during downturns so we can deploy dry powder bestowed upon us by the gifts of economic portfolio diversification. Our Core Four investment framework does not attempt to achieve perfect balance to each of the Four economic environments as dictated by the change of expectations in economic growth and inflation. Rather, the intent is to ensure each client partner has “some” exposure to each of the Four given their personal situation and our tactical views. The cadence is Personal > Core Four > Tactical – – all with extreme tax efficiency. For additional detail on the Core Four, read this: Essential Partners Core Four Framework.

What Has Transpired & Where Are We Now?

1. The past 15 years have been the best performing in U.S. stock market history and coming into 2025, valuations of companies were near all-time highs on multiple valuation metrics driven by the Mag7.
2. The general view was that President Trump would implement pro-growth policies (lower taxes, less regulation, etc.) that would further stoke an economy that was generally quite good but that had been slowing in Q4.
3. Inflation leveled off around 3%, which is too high and led to the Fed pausing their interest rate cutting cycle.
4. Negative surprise. DOGE helps to put the U.S. on a more responsible fiscal path but is an economic headwind and President Trump’s tariff policy is far more extreme than expected.
5. The combination above, but largely tariffs, has led to U.S. stocks being down 14% through early April driven by fear of a recession caused by a combination of tariffs and a negative wealth effect created by stocks declining (it’s reflexive).
6. Do not be surprised to see the stock market rally sharply but this can be followed by new declines. No one knows.
7. What can go right?
   • Investor sentiment has become very negative; one of the worst readings in history
   • Tax cuts and/or an extension of President Trump’s original tax cuts is likely
   • Regulatory barriers to economic growth are being pulled back, sparking small business confidence since the election
   • Tariff policy can be reversed, moderated or negotiated into favorable trade deals
   • Slowing growth and moderating inflation are likely to lead to a new Fed cutting cycle
   • Corporate tax cuts could lead to higher earnings for publicly listed companies
8. We do not know if a 1-2 year low has been reached in U.S. stocks, but we do not have to know to start increasing client partner equity investments. That being said, we have not taken that step yet given the starting point of the U.S. stock market as noted by the performance over the past 15 years, starting valuation and current valuation.
9. If S&P 500 earnings per share maintains the current level expected for 2025 of $280, the current P/E multiple is over 18x. Over the last 25 years there are only a few years when the index traded at a higher level as noted by the graphic below. We are not trying to “pick the bottom” but there is a material, probabilistic risk that earnings estimates decline and the multiple that investors pay for those earnings declines.
10. Stay tuned. We want to buy stocks but we want a fatter pitch.

I appreciate your continued trust and support.

Nick