First Quarter 2025: A Sputnik Moment (For Diversification)

In our 4th quarter review, we discussed how the U.S. stock market had become heavily reliant on just a handful of giant technology companies, often called the “Magnificent 7.” This concentration meant that the whole market could suffer if those few companies’ shares stumbled. That’s precisely what happened in the first quarter of 2025. 

In late January, a Chinese artificial intelligence (AI) startup called DeepSeek launched a powerful, low-cost AI tool. This challenged the belief that only the most prominent U.S. tech firms could lead in AI. In the immediate aftermath of the DeepSeek release, chip-maker Nvidia (NVDA) lost nearly $600 billion of market value, and the collective losses of the Magnificent 7 overwhelmed the positive return from 493 other companies in the S&P 500 index, dragging it into negative territory in the first quarter (Figure 1):

Figure 1

Source: JP Morgan Guide to the Markets, 3/31/2025

 Indeed, the quarter also marked U.S. stocks’ worst start since 2022 (the tech-heavy Nasdaq index declined more than 10%), even as most other segments in our clients’ allocation posted positive returns (Figure 2).

Figure 2

Fortunately, our typical portfolio is diversified across non-U.S. stocks and bonds (the categories in green this quarter in Figure 2). This broader mix helped cushion the blow; most clients even posted small gains during the first quarter.

This recent outperformance from international stocks, which benefited from the dollar weakness, was notable and is counter to the trend for the last decade and a half, a time during which U.S. stocks have consistently done better (Figure 3).

Figure 3

Source: Charles Schwab & Co.

 There are a couple of points to take away from the above chart. One is that market returns tend to be cyclical. The other is that the length and depth of these cycles are impossible to predict and can test our patience.  

Nonetheless, our prevailing view remains that diversification across various markets and securities offers a 'free lunch,' enabling investors to potentially improve long-term returns while mitigating downside risk. 

The End of American Exceptionalism?

The U.S. has many structural advantages, making it an attractive place to invest and supporting the dollar in its status as the world’s reserve currency. These include: 1) highly developed, liquid, and efficient capital markets 2) strong institutions and corporate governance 3) political and economic stability (a perceived “safe haven” relative to many other parts of the world) and 4) a world-class university system conducting cutting-edge scientific and technological research responsible for countless discoveries and inventions that spawned commercial applications (and multi-billion-dollar startup companies), transforming societies around the globe.

Another tailwind for the U.S. economy has been our increasingly large budget deficits, especially during the COVID-19 pandemic. The U.S. spends more on government services than it takes in via tax revenue (Figure 4). This gap is eagerly filled with foreign investors' capital. This allowed the Federal Reserve to maintain near-zero interest rates from 2009 to 2016, and again from 2020 to 2022, bolstering business investments and dramatically lowering borrowing costs for U.S consumers (and taxpayers). This, in turn, further expanded our trade deficit as we imported more equipment and goods from the rest of the world.

Figure 4

Source: JP Morgan Guide to the Markets, 3/31/2025

These long-term macroeconomic and fundamental tailwinds combined after the Great Financial Crisis with the emergence to global dominance of a truly remarkable set of U.S. technology companies to drive moderate U.S. economic but spectacular stock market outperformance (relative to most other developed countries). It was indeed fifteen years of American financial exceptionalism.

That narrative was unlikely to continue ad infinitum. And so the first quarter ushered in a new U.S. presidential administration with significant policy shifts aimed at reducing trade deficits. The financial markets’ reaction has been volatile and largely negative, especially since the announcement of widespread import tariffs.  

As investors, we must be pragmatic. Our job is not to like or dislike the policies implemented by the current administration or any other; rather, it is to navigate turbulence in our clients' best long-term interest so they can reach their financial goals. We want your portfolios to be like seaworthy ships that sail on regardless of the storms. 

This century has already been marked by dramatic events (9/11, the Great Financial Crisis, and the COVID-19 pandemic) with lasting and profound economic and societal repercussions. More will come in the next 25 years. 

Although we remain steady in our belief that the U.S. will very likely continue to offer attractive investment opportunities, this quarter was another reminder that we have a global investment opportunity set and a variety of tools available to generate investment returns over time. 

Large Cap Value (LCV) Review

(Not all Bristlecone clients are invested in our Large Cap Value Equity portfolio strategy, depending on the overall portfolio size and the client's objectives and constraints.)

The average LCV account increased slightly in the first quarter, lagging the 2.1% return for the Russell 1000 Value index, yet handily beating the -4.3% return for the S&P 500 index.  In fact, Large Cap Value stocks were the only quadrant of the U.S. equity “style box” to deliver positive returns in Q1 (Figure 5):

Figure 5

Source: JP Morgan Guide to the Markets, 3/31/205

 Within the LCV portfolio, we were modest net-sellers during the quarter. We trimmed about a third of our position in Meta (META) after two consecutive years of outsize returns had grown the position size beyond a range we felt comfortable with. Instead, we thought it prudent to recycle capital into other investments trading at more attractive discounts to our value estimate.

First, we added Occidental Petroleum (OXY) shares to our existing holdings. The stock price has declined recently in sympathy with crude oil prices, as investors discount the negative impact of tariffs on global economic growth (and by extension, oil demand). Additionally, a recent surprise announcement from OPEC+ of planned production increases beginning in May is contributing to fears of over-supply, further pressuring oil prices. While the price of oil (like many commodities) can be volatile, the big picture still seems favorable for U.S. producers such as Occidental, who are responsible for all of the net oil supply production growth over the last 5 years (Figure 6).

Figure 6

Source: JP Morgan Guide to the Markets, 3/31/205

 Second, we added to our investment in Hagerty Inc. (HGTY), an insurer of collectible automobiles, which we have owned since 2023. As a smaller operator in a very specific niche, Hagerty has a higher revenue growth rate—and lower insurance losses—than the typical auto insurer. Recent losses connected to the California fires, as well as elevated technology investments to grow its distribution platform, are expected to reduce Hagerty’s near-term profitability somewhat. However, even with these one-time expenses, Hagerty is expecting 2025 net profit growth of 30-40%. We view the stock as an above-average long-term compounder and were happy to take advantage of recent weakness to increase our position.  

As recent events have amply demonstrated, investing in stocks can be a risky endeavor in the short-term. Macro-economic factors and political tensions beyond the control of any one firm can wreak havoc on otherwise reasonable estimates of discounted future cash flows. At the same time, we also know that over more extended periods (10+ years), stocks offer the best chance at preserving an investor’s purchasing power against the constant headwind of inflation. 

In our view, the best way to balance the risk and reward of investing is to diversify broadly, minimize costs, and insist on a “margin of safety” through sound fundamental analysis of price vs. value.     

As always, we welcome any questions or comments you may have and appreciate your continued confidence in our services. 

Disclosure Brochure Offer

Securities laws require Bristlecone to make the latest version of our disclosure brochure (Form ADV Part 2A) available to clients every year. This form contains important information about our firm, such as services, business practices, potential conflicts of interest, a summary of our Disaster Recovery Plan, and Privacy Policy. 

The disclosure brochure can be downloaded on our website by clicking here or on the U.S. Securities and Exchange Commission's Investment Adviser Public Disclosure website by clicking here, but we'll be happy to mail you a copy free of charge (call 310-806-4141 or email clientservices@bristlecone-vp.com).

You may find additional information about our firm on our website and through the same Investment Adviser Public Disclosure website at www.adviserinfo.sec.gov. We must also adopt a Code of Ethics and provide a copy to clients upon request. 

Contact us immediately if you have had any changes in your investment objectives or financial circumstances. Such changes could impact how we manage your portfolio and will become part of your client file. You should contact us anytime during the year if your investment goals or financial circumstances change. Should you hold individual equity securities in your portfolio, note that you are responsible for voting proxies concerning those investments. We typically do not vote client proxies unless specifically requested.