The Tariff Tango: Why Bonds and Global Equities are Dancing to a Different Beat in Q1 2025

The first quarter of 2025 was a masterclass in economic policy as a performance art. The U.S. government's aggressive tariff escalations—particularly targeting China—created a chaotic dance of trade tensions, market volatility, and asset mispricing. But for contrarian investors, this chaos is a treasure trove. While the S&P 500 stumbled to its worst quarterly performance since 2022, Treasury bonds and international equities surged, driven by safe-haven demand and dollar weakness. The divergence in valuation metrics now presents a clear path: allocate to long-duration Treasuries and overweight non-U.S. equities to capitalize on a market recalibration.

The Bond Market's Contrarian Play: Yield to Safety

The Treasury market is having its moment. In Q1 2025, the yield curve's “belly” (3–5 year securities) fell sharply as investors flocked to perceived safety amid tariff-driven uncertainty.

. This flight to safety rewarded holders of longer-duration bonds, even as short-term bond funds like the Saturna Short-Term Bond Fund lagged.

The case for long-dated Treasuries is twofold:
1. Policy Uncertainty as a Safe-Haven Catalyst: The volatility of U.S.-China tariff negotiations (peaking at a 145% combined duty rate in April before a May truce) created a persistent demand for low-risk assets.
2. Duration Advantage: As yields compress further in the mid-curve, longer-dated bonds (e.g., 10-year or 30-year Treasuries) offer better protection against inflation and geopolitical shocks.

Equity Markets: The Tech Wobble and International Outperformance

While the S&P 500 fell 4.27%, the real story was the geographic divergence. International equities—especially in Europe and emerging markets—soared. The MSCI EAFE Index gained 7.01%, outperforming the S&P 500 by over 10 percentage points. The underperformance of U.S. tech giants like Nvidia (NVDA) and Microsoft (MSFT), which are heavily exposed to trade-sensitive supply chains and AI overvaluation concerns, contrasted sharply with gains in firms like MercadoLibre (MELI) and Iberdrola (IBE).

The valuation gap is stark. U.S. tech stocks, particularly those tied to AI infrastructure, face skepticism over whether their growth justifies current valuations. Meanwhile, international equities are benefiting from two tailwinds:
1. Dollar Weakness: A declining U.S. Dollar Index (DXY) reduced the cost of foreign investments for U.S. investors.
2. Policy Divergence: While the U.S. raises tariffs, countries like Japan and Germany are easing trade barriers and boosting fiscal spending.

The Dollar's Decline and Gold's Rise: A Contrarian's Double Play

The U.S. Dollar Index (DXY) fell 3% in Q1, its weakest quarter since Q3 2023, as tariff wars and geopolitical risks eroded its safe-haven status. This decline amplified returns for gold miners like Agnico Eagle Mines (AEM), which saw its stock rise 15% as gold prices hit a 12-month high.

A weaker dollar also benefits non-U.S. equities indirectly. For instance, European firms like SAP (SAP), which derive 60% of revenue from outside the U.S., saw their earnings power increase as the euro strengthened.

Valuation Divergence: Equal-Weighted Indices and the Megacap Exodus

The S&P 500 Equal-Weight Index (-0.67% in Q1) outperformed its cap-weighted counterpart, signaling a rotation away from megacap tech and into broader sectors. This shift suggests investors are pricing in risks like AI overvaluation and tariff-driven profit pressures. Meanwhile, equal-weighted international indices—less exposed to U.S. trade dynamics—continue to outperform.

The Contrarian's Playbook: Reallocate Now

1. Long-Duration Treasuries: Buy 10- or 30-year Treasury ETFs like TLT or TBF to lock in yield and duration advantages. The recent flattening of the yield curve suggests further compression in mid-term rates, benefiting long bonds.
2. Overweight Non-U.S. Equities: Target ETFs like EFA (MSCI EAFE) and VXUS (MSCI All Country ex-US) for geographic diversification. Emerging markets (e.g., EEM) offer additional upside if China-U.S. trade talks stabilize.
3. Hedged Equity Exposure: Use currency-hedged ETFs like HEFA (MSCI EAFE hedged to USD) to mitigate dollar volatility.

Final Word: Embrace the Mispricing

The Q1 2025 market chaos has created a rare opportunity to profit from mispriced assets. While U.S. tech and consumer stocks grapple with tariff-driven headwinds, Treasury bonds and international equities are pricing in the worst-case scenario. For contrarians, this is the time to buy what's hated and sell what's loved.

The tariff tango may continue, but the dance floor is now tilted toward bonds and global equities. Investors who pivot now may find themselves in the right position when the music changes.