Managing through Market Volatility amid Policy Uncertainty

John Hillenbrand, CPA

Summary Points:

• The first quarter of 2025 has demonstrated how rapidly policy uncertainty can transform market dynamics, creating both challenges and strategic opportunities for disciplined investors.
• The US economy entered 2025 firmly in mid-cycle territory, with solid employment, moderate but positive real GDP expansion, moderating inflation, and normalized interest rates following the Fed's initial cuts.
• The new administration’s policies concerning tariffs, government spending, taxation, immigration and foreign policy have caused growth concerns at the consumer, corporate and investor levels. These concerns have caused an equity market selloff and rotation starting in mid-February out of higher-beta and volatile companies into more defensive, stable sectors and some foreign equity markets.  
• Although near-term economic risks have increased, the economy began Q1 in a position of considerable strength, and the Federal Reserve maintains substantial flexibility to respond appropriately to any slowdown. Our ongoing policy analysis suggests the underlying economic fundamentals should weather moderate policy disruption without significant long-term deterioration, though sector-level volatility is expected.
• In this time of uncertainty, we focus on higher-quality companies with strong cash flows and reasonable valuations, especially in lower beta and tariff risk areas. We are also focusing on longer-term themes of US infrastructure growth and productivity improvement through technology. We believe these areas should outperform regardless of policy volatility.

We started the year with the view that the US economy was demonstrating classic mid-cycle characteristics. Forward-looking sentiment indicators suggested continued expansion, corporate earnings were growing at a healthy pace, and the Federal Reserve had successfully engineered an initial easing cycle without disrupting market stability. The yield curve had returned to a modest positive slope, suggesting monetary policy was approaching the neutral rate. We expected positive returns for the year, but we remained vigilant for changes in policies and growth drivers.

As the first quarter progressed, the market's focus shifted dramatically toward the potential economic implications of the new administration's policy agenda. Tariff proposals have been more comprehensive than anticipated, government spending reduction targets more aggressive, and immigration policy changes more substantial. These initiatives, combined with uncertainties surrounding tax reform and debt ceiling negotiations, created ripple effects across financial markets, as well as consumer and corporate sentiment. The related high-beta equity market sell-off and rotation to historically lower-risk areas continued from mid-February to the end of the quarter. We have yet to see how Congress addresses tax and deregulation policies, the annual budget and the debt ceiling. These policies, if enacted as described, could have a positive effect on economic growth, potentially offsetting the near-term effects of these other policies.

Although economic surprises have turned slightly negative, especially on the soft data, confidence has waned, and a variety of sectors are showing some stress, the overall picture at this point remains one of decelerating but continued growth. Consumer spending has remained relatively resilient, supported by the substantial wealth effects from rising asset prices over recent years. The wealth accumulated by older demographics—who control much of the equity and housing wealth—provides a cushion against short-term negative sentiment. Additionally, employment remains strong, though recent government layoff announcements suggest the beginning of fiscal austerity measures.

In periods of policy uncertainty like we're experiencing today, we emphasize several key criteria in security selection:

• Strong and improving free cash flow generation
• Demonstrated pricing power and margin resilience
• Clear competitive advantages
• Balance sheet strength
• Valuations with positive risk/reward scenarios
• Long-term thematic support

Two longer-term themes that we believe could outperform in this environment include:

• Companies effectively deploying AI and automation to drive productivity gains, with particularly those showing discipline in capital allocation and clear returns on AI investments.
• US infrastructure beneficiaries with proven execution capabilities and pricing power, especially those with existing competitive advantages being reinforced by policy shifts.

While policy-induced volatility creates near-term disruption, it accelerates competitive differentiation—precisely the environment where our fundamental research process and multi-asset flexibility provide the greatest advantage. We remain vigilant to evolving risks while positioning the portfolio to benefit from longer-term structural opportunities that transcend short-term uncertainty.

Our approach emphasizes quality companies with sustainable advantages, reasonable valuations, and alignment with enduring economic trends. This balanced strategy seeks to provide both downside protection during periods of heightened uncertainty and participation in the eventual recovery as policy clarity emerges.