Market Insights

MARKET OUTLOOK / STRATEGY

First Quarter 2025

As 2025 began, our base case was optimistic with expectations of solid growth and earnings. Our lower probability scenario, now our base case, was for an economic slowdown driven by uncertainties around fiscal policies. What a difference a quarter has made in the environment.

In the Wizard of Oz, Dorothy and her crew travel along the yellow brick road to seek the Wizard to solve their various ills. Presently, President Trump, his cabinet and Elon Musk are taking the markets on a rapidly evolving journey whose destination is unknown. Initial actions have focused on a significant expansion of executive authority to redefine the role of government and the presidency. The dismantling of federal government agencies, aggressive undocumented immigrant deportation, reassessment of university grants and research funding, and the launching of multi-front trade wars have elevated economic risks. Investors can no longer “ease on down the road” but must now confront a wicked brew of uncertainty.

Economic policy uncertainty is extraordinarily high and will likely take a toll on economic growth. Unfortunately, more turmoil is probable and the stability that had been a mainstay of the economy, seems behind us. There are cross currents that make risk management important. The tumult out of D.C. is widespread and the multiplier effect to economic growth is unknown but could be significant. The probability we would assign to tail risks has gone up and some new ones have been added.

As fixed income investors, we get genuinely excited around the opportunity to invest in bonds that provide decent coupon income. Current interest rate levels provide an attractive investment option. If our concerns about slowing economic growth pan out, bonds will also provide some price appreciation to supplement the income component due to lower rates. If inflation expectations become unanchored, we could see higher rates. We maintain our trading range expectation for the 10-year U.S. Treasury yield at 3.50 – 5.00% for 2025.

Corporate earnings are starting from a place of strength, but projections are indicating expectations of slowing. Companies have generally shored up their balance sheets and are positioned for stormy weather. Demand for corporate securities remains strong with new issues being 3-4 times oversubscribed. Investors are attracted to high yields and the stable fundamentals of the space. We are mindful that spreads are at the tighter end of their trading range and uncertainty is high. Our security selection will be screened through a lens of modest growth and more stress.

In periods of uncertainty, we find value in diversification and use a more defensive lens in our sector positioning and security selection. We are modestly reducing our non-government sector weights and spread duration. Markets and sectors will experience higher volatility as investors determine if the wizard will be home and what will be behind the curtain. Our highest convictions given our outlook are overweights to ABS and shorter-maturity corporates as they provide attractive yields and have limited spread volatility.

We are targeting a resilient profile for the portfolio that allows it to comfortably ride out the stormy weather. We are in a period where we believe active management can add value and want to be positioned such that we can be nimble and responsive as volatility plays out. If spreads widen, we will use the opportunity to add yield to the portfolio. Meanwhile we like the additional income that comes with modest over-weights across the various spread sectors while we await future developments.