Market Volatility: What to Watch in Q2 After Big Swings in Q1

Ivanna Hampton: Welcome to Investing Insights. I’m your host, Ivanna Hampton.

We’re kicking off a new series to help investors navigate market volatility. Morningstar strategists and authors will deliver timely insights, trends, and tips. These episodes will pop into your podcast feed at least once a month.

Let’s begin with my conversation with Morningstar Inc. senior markets reporter Sarah Hansen. Sarah investigated several market trends from the first quarter of 2025. We discussed how tariff fears were unsettling in the short term but why long-term outlooks remain optimistic.

Thanks for joining me, Sarah.

Sarah Hansen: Thanks so much for having me. Glad to be here.

What’s the Difference Between the Stock Market and the Economy?

Hampton: Market volatility has rattled Wall Street, while consumer confidence has dipped on Main Street. The stock market and economy may appear the same, but they’re not. Can you explain how they’re different?

Hansen: Absolutely. So this is one of those classic distinctions that comes up all the time on Wall Street and in the financial world. So, the US economy is the total picture of all the goods and services produced and consumed in the United States. And then the stock market is a collection of publicly traded shares of companies. Those two things, as you mentioned, are not the same thing, and they can sometimes paint conflicting pictures. So, a lot of economic data, like GDP growth, consumer data, labor market data, will tell us what we know about the economy right now or even a few months ago because it can be reported with a lag. And then the stock market is more of a forward-looking machine. Expectations about the state of the world and the state of earnings in the next couple of months, the next year are usually baked into stock prices, so the market anticipates future moves.

Another distinction is that not everybody participates in the stock market the way that everybody participates in the economy. But the two things, the stock market and the economy, are interrelated even though they’re not the same. And some people have argued that they’re more related than they used to be. Stocks can certainly be vulnerable to changes in the economic outlook. We saw a lot of that over the last couple of months. Big bounces or big dips on economic data on inflation or jobs coming out as investors kind of tried to digest what it meant for the stock market and for the economy more broadly. And then there’s also something called the wealth effect, which is when stocks are doing really well, households feel it. They feel that boost, and it can stimulate spending, and that does impact the economy more broadly. The reverse can also be true. When the market is sliding, households get a little nervous, consumers stop spending, and you can see some retrenchment there.

How Stock Market Trends in 2025 Have Shifted From Last Year

Hampton: Thank you for that. Well, let’s get into recent trends. The stock market looked very different in the first quarter than it did at the end of last year. What changed?

Hansen: You’re right. This was a big change from 2024 to the first few months of 2025. The bull market has really stumbled. Stocks overall have fallen more than 4% since the start of the year. After spending the better part of the last two years just climbing and hitting record after record, we actually hit correction territory in March. That’s a drop of between 10% and 20% off the most recent peak. And at the same time, we’ve seen a pretty big rotation start to take hold. So, the tech stocks and the growth stocks that performed really, really well faltered in the first few months of 2025, while value stocks and defensive stocks like healthcare and energy really outperformed.

And then, international markets also outperformed, especially China and Europe, while the US market struggled. And then overall, as stock prices fell, valuations fell, too. So, the market is looking cheaper than it did at the end of last year. And then, final point, I think maybe the biggest thing that investors probably noticed is volatility day to day. We saw bigger swings in the market on economic data, on policy news—bigger moves day to day and week to week.

Worries About Changes Fanning Market Volatility

Hampton: Sarah, what caused all those changes?

Hansen: There’s a lot at play, and, unfortunately, there’s no one easy answer. One of the big things at play here is policy from Washington. For a lot of last fall, investors were really optimistic that policy changes under the Trump administration would boost growth and boost stocks. So, that’s things like deregulation and tax cuts. But this year, we’re contending with big changes to trade policy in the form of tariffs. Investors are nervous that tariffs will weigh on economic growth and also they could exacerbate inflation, at least in the short term. Inflation is not nearly as high as it was a couple of years ago, but it’s still higher than the Fed would prefer. And so that’s still weighing on sentiment a little bit. And the other element on tariffs is just uncertainty. We are still not looking at the full picture. There are more announcements to come, and so investors are digesting that.

And then there are other signs of an economic slowdown, too. Consumers are getting a little nervous. We’re seeing sentiment change and deteriorate. GDP growth was expected to slow down before tariffs, so we’re digesting how much more we’ll see it slow. And then marketwise, we’ve seen changes in the tech trade, in that artificial intelligence trade that powered stocks higher for two years. We’ve seen it stumble. Valuations for those companies were sky-high, what analysts called priced to perfection at the end of last year. And so they were really vulnerable to a pullback. You remember the DeepSeek news from January, although that feels like a very long time ago, now, it actually wasn’t. And then so all of that together is contributing to what analysts call a risk-off environment. That’s a word that we’re hearing again, and it’s just a period of caution for investors where they’re pulling back from riskier things and seeking safer assets, safer bets for a while.

How Tariffs Could Impact Growth, Inflation, and Consumer Prices

Hampton: A lot has happened in this quarter. You’ve brought up tariffs, and I want to time-stamp this moment in our conversation. It’s just before 11 a.m. on Wednesday, April 2. Sarah, can you get into more and talk about what’s going on with tariffs right now?

Hansen: Absolutely. We’ve had tariffs implemented already this year. We’ve had announcements from Washington, but as of today, Wednesday morning, right now, we are waiting for another announcement from Washington that’ll be this afternoon. And so, by the time this episode comes out later this week, we will know a lot more. We’re not sure whether it’s going to be a big across-the-board increase, it could be, or whether it’s going to be more targeted, more specific. We just don’t know yet. And even after the announcement this afternoon, I suspect that the details will trickle out more slowly as things evolve.

The general agreement on tariffs, even without knowing specifics for this afternoon, is that they will be a hit to growth, at least in the short term. And they do have the potential to put pressure on inflation, which has implications for the Fed, which has implications for lots of companies. And there’s little doubt that at least some of the cost of tariffs on companies will get passed on to consumers. But over the longer term, it’s still a huge question mark. It’s difficult to know how things will shake out, especially given how fluid the policy has been.

Market Volatility Sends Investors Rushing to Gold

Hampton: The current uncertainty is pushing up the demand for gold right now. What does this mean in the short term?

Hansen: We’ve seen a big runup in gold prices, and that is because investors often treat gold as a hedge for economic downturns, for when the geopolitical situation looks a little uneasy. When the outlook for the economy looks a little uneasy, investors flock to gold for safety. And so that’s why we’ve seen prices go up. It wouldn’t be surprising to see that continue. The outlook will be changing, and so we could see some changes in the gold price, too. But investors should be aware that gold is also a volatile asset. So, it can go down quickly, just like it can go up quickly.

What Are the Risks of a Recession in 2025?

Hampton: Trade tensions are leading some analysts to tweak their recession forecast. So first, how does declaring a recession work? And second, is there danger of one happening?

Hansen: Recession is a tricky concept, and it’s a scarier word that’s getting thrown around more and more. It’s bubbling up in the conversation these days. Officially, there is a definition from the National Bureau of Economic Research, and that definition is a significant decline in economic activity that is spread across the economy and lasts more than a few months. That’s a formal designation. It gets applied retroactively. So, we could be hearing, “Oh, we’ve decided that a recession started a year ago,” in a couple of months, in two years. We just don’t know. And the committee looks at a lot of data to make that call. There’s also an unofficial kind of rule of thumb, which is two quarters of negative economic growth, negative GDP growth, and we haven’t seen that yet.

But you’re right that Wall Street forecasters are raising their odds. We’ve seen forecasts rise to 30%, 40% odds of a recession this year, but that’s far from a foregone conclusion, and that outlook is fluid. What analysts do agree on is a slowing of growth in the medium or near term. But tariffs, like we talked about earlier, have really thrown a wrench in a lot of this forecasting. The Fed is on hold. People are waiting to see how monetary policy shakes out and questions about the labor market, questions about the inflation outlook, all of it will help determine that question, but right now it’s hard to say.

Why Portfolio Diversification Is a Winning Strategy During Market Volatility

Hampton: And Morningstar analysts regularly tout the benefits of portfolio diversification. This strategy recently proved its worth. What are other important things for investors to remember right now?

Hansen: You’re right. Morningstar has written about this, if there was one big takeaway from the first quarter, it’s that diversification is still a winning strategy. If you held a diversified portfolio over the last few months, not just tech stocks, not just in the big indexes, but if you really looked across the market, you probably did escape the worst of the damage. And what I would add is that in moments like this, where things feel very uncertain, where stocks are volatile and jumping around, moments like this are why you have an investing plan. It’s a lot easier to stay invested when stocks are just going up and everything is going right. But you can build a strategy for moments like this that feel a little less stable to help you stomach some of that volatility.

It’s worth mentioning, too, that there are pockets of undervalued opportunities. Morningstar strategists like value stocks, they like small caps, although small caps they say will take a little more time to work as the economic outlook evolves. And then overall, a lot of strategists are still constructive on the fundamentals for the economy, on the fundamentals for the stock market. Again, with tariffs, hard to say for sure, but we’ll get a better picture I think of companies and how they’re doing when first-quarter earnings start rolling in the next week or two. There will be plenty more on that to come.

Hampton: Sarah, we’re going to add your article 13 Charts on Q1’s Dramatic Rotation in Stocks to the show notes. It was so great talking with you today.

Hansen: Agreed. Thanks so much for having me.

Hampton: That wraps up this week’s episode. Thanks for watching and making this show part of your day. Subscribe to Morningstar’s YouTube channel to see new videos about investment ideas, market trends, and analyst insights. Thanks to senior video producer Jake VanKersen, associate multimedia editor Jessica Bebel, and digital communications specialist Kumudini Devalla. I’m Ivanna Hampton, lead multimedia editor at Morningstar. Take care.