It has been a wild ride for the financial markets in the first quarter, with notable reversals in leadership by asset class, region, investment sector, and style, reminding investors that diversification is critical and valuation can be a helpful guide.
Unpacking an eventful three months for the markets, a number of rotations have taken place, and many market certainties on Jan. 1 seem less certain today:
Bonds Prove Their Worth. The Morningstar US Core Bond Index gained nearly 3% in the first quarter, while the Morningstar US Market Index, a broad gauge of equities, fell nearly 5%. Investors diversified by asset-class limited losses, with Morningstar multi-asset indexes holding their value.
“US Exceptionalism” Takes a Hit. After US equity market dominance in 2024 and many years prior, the Morningstar Global Markets ex-US Index rose nearly 5% even as US stocks fell. Europe was a major bright spot, with signs the continent may be emerging from its long malaise.
Value Tops Growth. While US equities had a challenging quarter overall, value stocks held up better, with a 1.1% rise for the Morningstar US Large-Mid Cap Broad Value Index relative to a 9.5% decline for the Morningstar US Large-Mid Cap Broad Growth Index. This marks a turnaround from the past two years of growth stock dominance.
AI Decline Fuels Tech Meltdown. Technology stocks fell in the first quarter, weighed down by a bear market in AI-related stocks and sharp declines in names like NVIDIA (NVDA), Microsoft (MSFT) and Apple (AAPL). The Morningstar US Technology Index was off more than 12% since Jan. 1. The AI theme was challenged by the launch of DeepSeek in late January, as well as by a “risk off” market vibe.
Flight to Safety Benefits Bonds & Defensive Sectors. Amid US stock market losses, bonds have benefited from a flight to safety and expectations that a weakening economy might lead to interest rate cuts. Within equities, investors gravitated toward areas that had previously underperformed. The value side of the market, as measured by Morningstar style indexes, vastly outperformed growth. Healthcare and energy were the best-performing equity sectors in the US market, after having lagged last year. Low-volatility stocks also outperformed.
Dan Lefkovitz – Strategist, Morningstar Indexes
“There are years when nothing happens, and quarters when years happen, to paraphrase Vladimir Lenin. Two broad groupings of investors have fared best. First, those with diversified portfolios limited their losses from stock market selloffs. Second, the first quarter has rewarded contrarian investors who pay attention to valuation. Lessons around the benefits of diversification and the importance of valuation are worth bearing in mind as investors possibly face more volatility in the second quarter.”
For a deeper dive into first quarter market dynamics, check out Dan Lefkovitz’s “How Caution and Contrarianism Paid Off for Investors During Q1” and Sarah Hansen’s "13 Charts on Q1's Dramatic Rotation in Stocks."
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