April 7, 2025

Dear clients and fellow shareholders:

So much has happened in the first week of April that much of the data in our normal quarter-end letter is already outdated – and becoming more so every day.

Although March 31 seems so long ago, the U.S. stock market experienced a modest correction in the first quarter – at least as measured by the broad market indices – with sharper pullbacks in the most overvalued stocks and sectors. (A correction is a 10% price decline. A bear market is a 20% drop.) After the acceleration of price declines in the first few days of April, the tech-heavy Nasdaq Composite has now officially entered a bear market, while the S&P 500 is approaching the 20% decline threshold.

While performance over a handful of days or even a complete quarter is as much statistical noise and luck as anything else, we’ve received a number of questions about how our portfolio has reacted to this April Fool’s stock plunge. Despite the overall market decline in the first quarter, our stock portfolio actually increased 3.8% in the first three months of the year. Since the end of the quarter, from April 1 until the market close today (Monday, April 7), our portfolio has declined 6.52%, bringing our year-to-date stock portfolio performance (January 1 through April 7) to -2.1 percent.

(Your Q1 and YTD equity return may differ from these figures due to legacy positions, liquidity needs/constraints, and/or rounding.)

Very important: past performance is just that: in the past. We warn you to never project short-term results into the future – a practice we would discourage regardless of our absolute or relative performance.

A friend and client recently remarked that he was bewildered that we maintain a generally positive outlook about business prospects, asking why we aren’t afraid of a possible recession or a stock market correction. Our response: “It’s not that we aren’t afraid because we don’t think we will have a recession or market correction. We aren’t afraid because we know we will.”

We certainly don’t enjoy recessions, stock market corrections or prolonged bear markets. But we don’t lose sleep over their possibility for three reasons: (1) we know they are going to happen, (2) we know they will eventually end, and (3) we know that predicting the timing of either event is futile. Once we accept these three realities, it frees our energy to focus on things we can control, such as the quality of the businesses we  invest in and the prices we pay for them.

On days that the Dow Jones Industrial Average declines a couple thousand points, it may be tempting to fear that this may be the one time that the correction or recession doesn’t end – that maybe this time it’s different. Templeton Funds founder Sir John Templeton, the man who built a fortune on the aphorism be greedy when others are fearful, and fearful when others are greedy, cautioned against the risks of convincing yourself that things will never return to normal.

Even though the S&P 500’s price-to-earnings ratio has dropped from 23 (in January) to 20 (today), it remains above its historical average.  That is – in total – the U.S. stock market remains overpriced. That certainly doesn’t mean that every stock is overpriced, nor does it suggest that every geographic market is overpriced.

But it does mean that no one should be shocked that stock prices are generally vulnerable. In 2023 and 2024, the S&P 500 increased a total of 43%, significantly greater than the 22% increase in the earnings of the companies in the index. Last quarter we wrote about the Magnificent Seven stocks that were responsible for so much of the S&P 500’s performance in 2024. (Magnificent Seven: Apple, Microsoft, Alphabet, Amazon, Meta, Nvidia, and Tesla.) Since the first of the year, those seven stocks have declined roughly 25%, and are responsible for a significant portion of the index’s decline.

It’s important to note that the most significant price declines have occurred in the stocks that have enjoyed massive recent price appreciation – and are the most overpriced investments. It is also important to note that, despite massive investor and media consternation, both the S&P 500 and Dow Jones Industrial Average are currently about where they were a year ago.

Tariff talk

Much of the discussion we’ve encountered about the Trump tariffs lacks nuance, often sparking exaggerated reactions rooted in deeply flawed assumptions. While our original intention was to only briefly address the topic, the events of the past few days – and a growing number of client questions – have prompted us to change our plan.

One of the more thorough analyses of the potential costs associated with the current iteration of the Trump tariffs comes from Goldman Sachs. Goldman estimates that, if the tariff system as Trump announced on April 2 is fully implemented, costs for the typical American household will increase about $3,500 annually. As we noted earlier, it is easy to oversimplify the potential effect of tariffs, as any projections require assumptions about the elasticity of import prices, how consumer behavior may shift, and impacts on currency. However, if this analysis is close to correct, the first order net effect to the average American household would be a cost increase similar to increase in transportation costs (a mix of new/used car prices, gasoline and auto insurance) resulting from the Covid stimulus spending – and about 20% of the $18,000 increase in household expenses since 2020.

However, the impact of this tax hike has the potential to be amplified by a number of factors including, but not limited to, potential retaliation, weakening business sentiment, and supply chain disruptions.  The risk with this type of “shock therapy” approach to the economy is that the second order consequences and negative feedback loops are notoriously difficult to anticipate or forecast accurately. (See the unintended and unexpected consequences of Covid lockdowns for one recent example.)

Further complicating the situation is that S&P 500 earnings estimates remain optimistic, valuations are stretched, and profit margins are elevated.

There are two prevailing theories regarding Trump’s approach to trade policy.  One suggests that he genuinely believes in the long-term value of tariffs, while the other is that he views them as a tactical instrument used to pressure trading partners into more favorable deals. Though these perspectives differ in motivation and ultimate objective, they are not mutually exclusive – both are likely true to some degree.  During his first term, President Trump used tariffs as leverage in negotiating a trade agreement from China. At the same time, he has consistently expressed a deep-rooted belief in tariffs, once famously referring to the tariff as “the most beautiful word in the dictionary”.

Because tariffs are often used as a negotiating tool, the uncertainty surrounding their timing, scope, and scale can amplify their leverage by introducing fear and doubt into the equation. However, this same uncertainty poses a significant challenge for large U.S. businesses—many of which operate globally or rely heavily on foreign-sourced inputs. In the corporate world, uncertainty tends to breed caution: investment slows, hiring pauses, wage growth stalls, and consumer demand softens. There is real merit to the view once expressed by John Maynard Keynes that “the best tariff is the one that’s known.” In other words, tariffs are far more manageable when they are transparent and predictable, allowing both businesses and governments to plan and respond with greater confidence.

Thus far, this tariff plan is neither.

Some portfolio repositioning

We have used these market fluctuations to add to three of our existing positions in accounts that were underweighted in those positions. (It is possible that we did not purchase additional shares of one or more of these stocks in your account, due to preexisting position sizes, liquidity needs or other reasons specific to your individual situation.)  In March we purchased additional shares of Cigna (CI) and Bank of Butterfield (NTB) in those accounts that were underweighted in those positions. Then on April 3, we purchased additional shares of Synchrony Financial (SYF), another position that we already held in the portfolio.

In late 2024, we made the decision to liquidate long-held positions in Goldman Sachs (GS), First Horizon (FHN), KKR & Co. (KKR), and CVS Health (CVS). At the time, we only sold those positions in tax-deferred accounts, such as IRAs, where capital gains taxes were not an issue. Because of the significant gains in those positions, we postponed until January the liquidation of those stocks that were held in taxable accounts, pushing the capital gains on those sales into 2025. Not only did we sell these positions at prices significantly higher than our cost, we sold them at prices higher than where they are today.

The net result of these transactions is that our cash position has increased – something that creates opportunity, especially right now.

Intra-year declines are normal

When the S&P 500 increases more than 20% in consecutive years, it is tempting to become complacent and forget that the stock market is a more volatile place than those two years might suggest. Over the past 40 years, the S&P 500 has experienced an average intra-year decline of 14%,  even in years that ultimately produced positive returns by year-end. (See the years 2023 and 2020 in the adjacent table for examples.) Over the past 40 years, we’ve averaged having a bear market about every seven years – every one of which eventually ended and saw stock prices set new all-time highs. Over the past 40 years, we’ve averaged having a bear market about every seven years – every one of which eventually ended and saw stock prices set new all-time highs.

On a CNBC segment this morning, Jim Cramer made a very animated and passionate argument about his expectation for the stock market’s performance this week. We are so amazed when presumably serious people make micro-market forecasts that we didn’t even notice which direction Cramer is convinced stocks are headed the next four days. Once we accept that no one can consistently and accurately predict short-term movements in stock prices, it gives us the freedom to ignore those who peddle this kind of pablum. If the short-term fluctuations have you worried, call or email with any questions you have. And don’t forget that you can always check your performance in the Black Diamond app.

And finally, remember that we invest in the same stocks for ourselves that we do for you, so your stock performance is our stock performance.