By any measure, the second quarter of 2025 has been a volatile experience for investors as global financial markets made dramatic swings, largely in response to a highly uncertain economic policy environment.
On April 2nd, the administration announced sweeping new global tariffs, significantly exceeding consensus expectations, which had the immediate effect of unsettling financial markets, sending the S&P 500 to the brink of bear market territory. In the two trading days that followed, the S&P 500 fell 10.5%. The S&P 500 recovered most of those initial losses by the end of April, ending the month down just 0.8%. By the middle of May, the S&P 500 recovered further and turned modestly positive for the year. The chart below highlights just how significant the spike in U.S. economic policy uncertainty has been, with current policy uncertainty readings ranking among the highest in the last 40 years. Volatility remains elevated as market participants weigh new policy developments and assess impacts across the broader global economy.
A natural behavioral response to greater uncertainty is to become more pessimistic about the future and to be more defensive. Indeed, the University of Michigan’s April 2025 consumer sentiment index reading is among the lowest measures of the last 40 years. The contrarian would view these two dour signals as being positive for the markets. Historic market data does support this view, as prior low points in consumer confidence and high points in policy uncertainty have both been followed by subsequent above-average 12-month returns for the S&P 500. While we don’t know how these factors will resolve in the current environment, it does seem likely that volatility will continue.
Strategies to Mitigate Risk
Given this volatile backdrop, investors naturally consider whether any shifts in portfolio strategy are warranted. Periods of heightened volatility offer a good time to take a step back from the daily news headlines to revisit core planning and investing frameworks, which puts current events into context while also promoting optimal decision-making focused on long-term goals and objectives.
As a part of the planning process, we organize and catalogue many aspects of our financial lives. We inventory assets, which may include rental properties, farms, timberland, business interests, or investment assets. We catalogue income streams, which may include a host of different sources, including trust distributions, earned income, investment income, or pension plans. We incorporate insurance policies, estate documents, entity titling as well as taxation. In total, we consider a wide range of variables, many of which can and will change over time.
One of the key benefits of planning is that we can synthesize many data points into a singular cohesive analysis. Although we incorporate a lot of detail into the process, planning serves to move beyond the day-to-day to see the big picture more clearly and to highlight the most important risks and opportunities. As a part of our process, we stress test plans and model a wide range of potential outcomes, which helps us assess our current financial strategies and to promote greater likelihood of accomplishing our financial goals -- even in volatile economic and market environments.
Risk Tolerance and Asset Allocation
The financial planning process informs our investment recommendations as well. Developing a good understanding of expected needs from portfolio assets over time as well as a strong understanding of personal risk tolerance are key factors in developing our asset allocation recommendations. Asset allocation stands apart as the most important variable to consider when evaluating expected risk and expected return from portfolio assets. Given its importance, managing allocations throughout market cycles is a key tactic we use to manage risk throughout volatile markets.
Over time, portfolio allocations naturally “drift “with market fluctuations. The chart above illustrates just how much of an impact this can have on an investment portfolio. A traditional 60% equity, 40% fixed income portfolio, invested in January 2019, would have migrated all the way to a 70/30 portfolio after just three years, leaving an investor with a meaningfully higher exposure to stocks than was originally intended, which adds more risk over time. Rebalancing portfolio allocations back to established targets is a key tactic we use to mitigate risk throughout volatile markets.
However, rebalancing back to our fundamental stock/bond targets is just one element of the process. We also consider movements within categories of stocks and bonds as well. For example, returns for growth stocks have outpaced their value style peers for most of the last decade, which would cause similar drift among these asset categories. A similar dynamic has been at play for U.S. equities versus non-U.S. stocks. Fixed income category allocations can also shift over time. A regular review of asset class as well as asset category allocations is a prudent risk mitigation strategy.
In addition, maintaining adequate cash reserves, raising cash in advance for short-term needs, and using sensible debt instruments are all balance sheet strategies that can help investors navigate volatile markets. In terms of portfolio construction, we know that we cannot predict volatility in the markets, and as a result, focus on investing in best-in-class companies, with diversification across economic sectors, investment styles, and geographies in order to build durable, resilient portfolios that can weather the economic storms that will inevitably arise over the course of market cycles.
We Are Here to Help
We are closely monitoring current policy and market developments and will continue to work to position client portfolios to balance risks and support your long-term investment objectives and financial goals. We appreciate the opportunity to serve our clients and are here to help. We invite you to please reach out to us with any questions.