Volatility in the first quarter increased dramatically ahead of President Trump’s highly anticipated tariff plan. That volatility accelerated at the start of the second quarter, as tariff announcements were significantly worse than expected. The market underestimated Trump’s determination to reshape global trade, and the market may still be underestimating the potential impact. This ongoing uncertainty will likely remain the key driver of volatility in the coming months.
Due to these developments, I strategically adjusted the portfolio to reduce potential volatility, especially in companies with significant exposure to China, a primary target of Trump’s policies. Specifically, I reduced our holdings in Apple (NASDAQ:AAPL) and Intuitive Surgical by approximately one-third, bringing each position back to a 5% weighting within the portfolio.
China has already blacklisted Illumina (NASDAQ:ILMN), significantly impacting its stock price. Fortunately, Illumina’s role in our portfolio is much smaller than that of Apple and Intuitive Surgical. I proactively made these reductions to mitigate the risk of waking up to news that either Apple or Intuitive Surgical had also been blacklisted, given their previously overweight positions.
During the quarter, I also reduced our Microsoft (NASDAQ:MSFT) holding back to a 5% weighting. Media reports indicate Microsoft may scale back its Artificial Intelligence spending. More significantly, Microsoft’s fiscal calendar begins a new year in July, raising the possibility that it may reduce its capital expenditure plans in fiscal year 2026, potentially disappointing the market.
However, the company did give better-than-feared results and solid guidance. It may have been a mistake to have lightened the position, but it will be something I will know for sure with time.
Given the substantial gains in Apple, Microsoft, and Intuitive Surgical (NASDAQ:ISRG) over the past year, these adjustments will inevitably result in sizable capital gains. However, my investment strategy prioritizes managing actual gains and losses rather than potential tax consequences.
Regrettably, the reduction in Microsoft and Intuitive Surgical occurred late in March, and the adjustments in Apple did not take place until April. Consequently, we underperformed the S&P 500 total return in the first quarter, declining by 6.46% versus a decline of 4.27% for the index.
President Trump has consistently discussed tariffs since the 1980s. Having watched many of his interviews dating back to his youth, his views on trade have remained remarkably consistent for nearly 40 years. Whether these views comport with current economic reality remains to be seen.
The market is likely to remain very volatile, as the true impact of tariffs has yet to be fully realized. I believe the market underestimates the risk that President Trump will only moderately dial back his tariff plans. While the imposed tariff percentages might decrease somewhat, they will certainly not fall to zero and, in most cases, will remain above the established 10% floor.
Additionally, there may be continued pressure on China. China is currently in a weakened economic state. Trump may be weaponizing these tariffs to inflict more financial hardship on the export-driven economy and slow down the Chinese military expansion.
Another challenge for markets is that earnings estimates for 2025 are declining, lowering the expected growth rate for this year for the S&P 500 to 9.5%. Although this is not a poor growth rate, considering the current P/E ratio is 20.7, earnings appear expensive when adjusted for growth, trading at more than twice the growth rate.
Lower margin expectations are driving the decline in earnings at this point, which makes sense given the current environment. However, margins for 2025 were probably too high to begin with, and so the risk is that margins will compress even further, perhaps even more so than what was seen in 2024, when they were 12.5% from their current 13.1%.
With sales estimates at $1,987 per share in 2025 and gross margins at 12.5%, implied earnings would be approximately $248 per share. This suggests earnings estimates could decline an additional 4% to 5% from current levels, assuming margins remain stable at 2024 levels. However, with tariffs now in place, predicting where margins will settle in 2025 becomes increasingly challenging.
Sales estimates for 2025 are also declining, with growth now expected to be less than 5%. This adds another layer of uncertainty, as slowing economic growth due to tariff impacts could lead to margin compression as well as further declines in sales estimates, potentially pushing earnings even lower.
With all of this going on, it doesn’t appear to be an ideal setup for the stock market. The problem is that markets don’t move in a straight line; they have many twists and turns. Sometimes these twists and turns work out, and sometimes they don’t.
Being cautious didn’t benefit us in 2021, but it greatly helped us in 2022, allowing us to add strong positions to our portfolio, such as Shopify (NASDAQ:SHOP), Amazon (NASDAQ:AMZN), Intuitive Surgical, and Boeing (NYSE:BA). Caution again didn’t help us in 2024, and it’s simply too early in 2025 to determine if caution will pay off this year.
In any event, I will continue to manage the portfolio actively – and with due caution – adjusting as necessary to best position us for future performance.