Markets navigate shifting policy currents

The US stock market is coming off back-to-back down months for the first time since October 2023, as investors turned cautious in March amid continued tariff uncertainty and concerns about a cooling economy and sticky inflation. The April 2 tariff announcement did little to ease those concerns.

In March, the S&P 500 (SPX) retreated to its lowest levels since last September, entering correction territory mid-month when it closed a little more than 10% below its February record high. After a brief rebound, the SPX returned to test that level on the final day of the month:

The Federal Reserve lowered its economic growth expectations for 2025 while raising its inflation expectations. However, the central bank’s comments suggested it was more concerned about a slowing economy than another inflation surge—an outlook the markets appeared to embrace, at least temporarily. As expected, the Fed left rates unchanged on March 19.

“Soft” economic data was still a factor last month, as evidenced by the stock market’s March 28 sell-off in the wake of the latest consumer sentiment data, which showed a decline in confidence about the economy, along with raised inflation expectations.

But sentiment isn’t necessarily in sync with market and economic realities, according to Morgan Stanley Wealth Management’s chief investment officer (CIO). Despite a Fed on hold, negative earnings revisions for the Magnificent Seven AI market leaders, and the “uncertainty shock” stemming from the White House’s “unpredictable” agenda, there’s still a path for an economic soft landing and earnings growth in key undervalued sectors—as long as unemployment stays contained.¹

Tech and consumer discretionary stocks were the biggest decliners, while energy and utilities were the only S&P 500 sectors to post gains. It was a choppy month for fixed income, with bond yields swinging from five-month lows to a one-month high before ending March little changed. The benchmark 10-year Treasury yield ended the month two basis points (0.02%) higher at 4.21%.

International equities outperformed the US again in March. Developed markets ended the month only marginally lower, while emerging markets gained ground overall, headlined by robust rallies in Brazilian and Indian equities.

Although the April 2 reciprocal tariffs were, overall, higher than expected, they still appeared to be more of a negotiation starting point than a final destination, as Morgan Stanley & Co. analysts suspected. Uncertainty remains high, but if the announced measures remain in effect for a significant period of time, it likely means slower growth in the US—and higher inflation, at least for a while, according to Morgan Stanley & Co. economists. That combination would put the Fed in a bind, because further rate cuts would require lower inflation and continued strong economic growth.²

But tariffs aren’t the only policy area that could impact markets. For example, clean-energy stocks may be pricing in too high a probability that the Inflation Reduction Act (IRA)—which included tax credits for renewable energy—will be repealed, according to Morgan Stanley & Co. analysts. As they note, the slim Republican majority in the House of Representatives means only a handful of votes are needed to block legislation, and 18 Republican congressmen recently sent a letter urging the Speaker of the House to protect some of the IRA’s clean-energy tax credits.³

Insight of the month: Big potential for small-cap stocks? Small caps are “undervalued, unloved, and under-owned,” according to Morgan Stanley Investment Management. Having been outperformed by US large caps by 62% over the past eight-plus years, small caps are trading at a 25% discount to large caps on a forward P/E basis. As the analysts note, a similar discount in 2001 preceded 87% outperformance over the following decade.⁴

April market patterns. April has been a positive month for the S&P 500 in 49 of the past 68 years, and 26 of the past 34—more frequently than any other month during the latter period. Over the past three decades, April had a median positive return of 2.9% and a median negative return of -2.5%.⁵

Key dates: tariff deadline (4/2), Employment Report (4/4), FOMC minutes (4/9), CPI (4/10), PPI (4/11), retail sales (4/16), Q1 GDP, initial estimate (4/30), PCE Price Index (4/30).

¹ MorganStanley.com. Seeing the Forest for the Trees. 3/31/25.
² MorganStanley.com. New Tariffs, New Patterns of Trade. 3/27/25.
³ MorganStanley.com. The Other Policy Choices That Matter. 3/12/25.
⁴ MorganStanley.com. MorganStanley.com. 2025—A Pivotal Year. 3/5/25.
⁵ Figures reflect S&P 500 (SPX) monthly closing prices, 1957–2024. Supporting document available upon request.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.