From geopolitics to markets, the first quarter of 2025 has seen some seismic shifts. Chinese company DeepSeek disrupted US artificial intelligence giants, Donald Trump launched protectionist trade wars in earnest, and the future of Ukraine hangs in the balance as European governments rewrite their finances to rearm and reaffirm their commitment to regional security.

The impact on the markets in Europe and North America was visible practically every day. European defense stocks soared, while automotive stocks slumped around the globe. European and UK bond yields rose even as interest rates were cut. The price of gold rocketed to above $3,000 an ounce, another record.

US Stock Market Reverses

The US market had its wings clipped, falling into a correction with a 10% drop from its February peak. In the last three months, the Morningstar US Market Index is down 4.63% in dollar terms. The Morningstar US Large Cap Index, which measures the performance of America’s biggest companies, is down 5.08%.

As investors changed tack, money flowed back to Europe and UK markets. In dollar terms, the Morningstar Europe Index is up 11.51% over the first quarter, while the Morningstar UK Index is up 8.44%.

If you were trying to time the markets throughout this period, you likely had a rude awakening. “As geopolitics and political uncertainty increases, people may be tempted to think they have an edge in understanding the general direction of financial markets,” explains Nicoló Bragazza, associate portfolio manager at Morningstar. “However, timing the market is very complicated and comes with significant risks. Given how stretched valuations have been in certain parts of the market—especially in US technology stocks—market volatility can give investors an opportunity to rethink their portfolios and find some better-valued investments with more attractive returns.”

Tesla and Global Car Stocks

If the politics have been dramatic, negative sentiment has been contagious. US plans to slap tariffs on overseas imports have upended confidence and turned initial optimism about a second Trump administration into fear and skepticism.

The Magnificent Seven—Alphabet GOOGL/GOOG, Amazon.com AMZN, Apple AAPL, Meta Platforms META, Microsoft MSFT, Nvidia NVDA, and Tesla TSLA—constitute one of the most talked-up stock phenomena of the last three years. Today, they are vulnerable. In the last month alone, Tesla stock is down 10%, and in the year to date, it’s down more than 30%. Its fortunes are now seen as tied to CEO Elon Musk’s political influence. That was once clearly beneficial, but the market isn’t so sure about it now.

Morningstar analysts have recently maintained their fair value estimate for Tesla at $250 per share. “At current prices, we view Tesla shares as fairly valued, with the stock trading slightly above our fair value estimate but in 3-star territory,” says analyst Seth Goldstein.

Tatton Investment Management highlighted Tesla in a recent note, saying “Tesla exemplifies why the Mag7 is no monolith … Tesla’s share price … soared with Trump’s election win but fell due to backlash against Musk’s politics. Investors struggle to quantify these political benefits when valuing Tesla.”

While Japanese carmakers, especially those producing hybrids, can potentially benefit from any Tesla backlash, their market valuations are still vulnerable to global trends. This week, they felt the pressure too, with Toyota Motor TM, Honda Motor Company HMC, and Nissan Motor NSANY all falling. Morningstar analysis now suggests they are undervalued, trading in 4-star territory.

In Europe, competitors are hoping inflation falls and that lower interest rates mean consumer spending power holds up. Improving economic conditions on the continent could be useful here too. “US tariff hikes will primarily affect premium producers such as BMW BMW, Mercedes-Benz MBG, and to a lesser extent Volkswagen VOW,” says Robert Streda, senior vice president for European corporate ratings at Morningstar DBRS. “However, these companies have meaningful pricing power and therefore some flexibility to pass on tariff-related cost increases to consumers. This notwithstanding, the companies’ strong financial profiles also enable them to withstand increased costs attributable to the tariffs over the short term.”

How Have Bond Markets Performed in 2025?

In the first quarter of 2025, fixed-income fund managers had to adjust their portfolios as revised government spending and debt plans sent longer-term yields rising and prices falling.

One of the biggest bond stories of the quarter occurred in Germany, where the end of the country’s fiscal debt “brake” heralded a significant spike in bund yields. It was not the only country witnessing volatility.

“US Treasury yields exhibited volatility during this period … while rates in Europe rose substantially,” wrote Nicolas Jullien, global head of fixed income at Candriam, in a recent note. “The move was notable on the German curve, which saw a material steepening, with the 10-year seeing the strongest rise. With both fiscal and monetary support acting in their favor, European risk assets outperformed their US counterparts. Indeed, despite yields generally increasing on the credit asset class, both euro investment grade and high-yield resisted thanks to decline in spreads.”

For some, the quarter represented a unique opportunity to buy the pricing drop at the longer end of the yield curve. Other bond managers chose to sit this out. Bragazza argues there is still an opportunity here: “This has been a difficult period for bond investors, who have been frustrated by UK yields, which were on a rollercoaster in Q1. However, if we look at yields on an absolute basis, it’s clear UK yields are now quite attractive on a historical basis. Given the limited fiscal headroom the government has to borrow more money—and the higher bank rate compared to other developed markets—there is a good chance that downside is larger than upside for UK yields. This could make UK bonds quite a compelling opportunity for investors willing to hold them through the volatility.”

What is Happening to Interest Rates?

Amid all this noise, central banks are pursuing a calm, no-surprises approach. The European Central Bank continued its rate cuts, reducing rates in January and early March, as expected. The Bank of England showed more caution, cutting rates only in February. UK rates now sit at 4.5%. The ECB’s three main interest rates are all lower than that.

In the United States, the Federal Reserve kept interest rates unchanged at its most recent meeting in March. The timing of future cuts is now highly uncertain, as policymakers wait to see the effect of tariffs.

Underlying all this is a fear that predates Trump’s return to the White House and has long loomed in the minds of Western politicians: stagflation. The US has been a GDP growth engine for a long time. Tariffs mean commentators are now discussing the risk of recession.

In the United Kingdom, this fear is felt keenly. Billed as a preparatory political move to better embed defense companies in the British economy, the UK’s Spring Statement looked very much like a rewriting of the previous October 2024 budget. Some onlookers were not convinced by the upward-revised growth projections used to salve the pain. The statement was written as much to reassure bond markets as it was to reassure voters. At least bond markets were reassured for the time being.

“While this year’s growth forecast was reduced, future years’ forecasts were increased to what might be excessively optimistic levels,” says Ronald Temple, chief market strategist at Lazard. “The moves by the UK and other European governments to ramp up defense spending should benefit growth to the extent the weapons procured are manufactured in Europe. However, defense spending alone will not be sufficient to sustainably lift broader economic growth.”

As the second quarter begins, uncertainty is only increasing. The first quarter was not for amateurs. Nor will this one be.