Markets Rise as Investors Bet on Business-Friendly Policies

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities notched a second consecutive week of gains during a light week of economic data. The surge reflected market optimism toward expected business-friendly policies from the new Trump administration. Indeed, the latest Investor Optimism Index from the American Association of Independent Investors shows that bullish sentiment about market performance in the coming six months jumped by 18 points to 43.4 percent this past week from a pre-inauguration level of just 25.4 percent on January 15.

While much of the rise in equities was based on policy expectations, the economic reports out last week offered a mix of optimism and caution for investors. The latest S&P Global Purchasing Managers Index (PMI) report (which we further detail later in this commentary) showed a downtick in the pace of growth for the economy as a whole but also some signs of a more balanced growth dynamic in the future. Likewise, S&P Global’s PMI report for the eurozone released last week showed unexpected expansion in the eurozone economy. The reading highlighted that as of now, the threat of tariffs has not caused a drag on economic activity. The surprising strength of the eurozone report resulted in the dollar index declining by 1.75 percent, which propelled the MSCI EAFE index to gain over 3 percent for the week.

As regular readers of our commentary will know, we believe a return to a more balanced economy is needed for the growth cycle to continue and for the markets to move sustainably higher. While we were encouraged by the rebound in manufacturing captured by the report, the data also showed an uptick in inflation for both businesses and end customers. This price data is consistent with what we’ve seen in the most recent PMI surveys from the Institue for Supply Management and highlights a concern we discussed last spring.

In May of last year, we wrote that the impact of every factor that goes into rising prices carries a greater impact later in the business cycle. That’s because late in a business cycle, capacity is stretched thin, and even minor upticks in demand can create a ripple effect on prices as businesses compete for resources—including workers and raw materials. And while the latest Consumer Price Index (released earlier this month) showed some progress in restarting the disinflationary process, last week’s PMI report and final numbers from the University of Michigan’s Consumer Sentiment survey remain a concern. The final reading of the Consumer Sentiment survey shows long-run inflation expectations rose, up 0.2 points to 3.2 percent. This reading is at the upper end of the range that has been in place since COVID and marks just the third time in that period that expectations have reached the 3.2 percent level. Prior to the pandemic, long-term inflation expectations hadn’t been this high since 2011. In fact, since August 1996, when expectations were at 3.3 percent, there have been only two months that have seen higher readings—May and June 2008, when expectations called for 3.4 percent inflation over the long term.    

Year-ahead inflation expectations jumped from 2.8 percent in December to 3.3 percent this month, marking the highest level since May 2024. In comments released with the report, Survey of Consumers Director Joanne Hsu noted, “Concerns over the future trajectory of inflation were visible throughout the interviews and were tied to beliefs about anticipated policies like tariffs.” Worries about higher prices appear to be factoring into attitudes toward the timing of purchases of big-ticket items, with many survey respondents making unsolicited comments about buying in advance of future price hikes.

Given the Fed has noted that inflation expectations are an area of focus as it seeks to bring inflation sustainably back down to 2 percent annually, we believe the Federal Open Markets Committee will hold rates steady at its meeting this week. Indeed, the market pricing suggests that the Fed may not cut rates again until June of this year. Going forward, we expect the Fed will take a data-driven approach to decisions.

Wall Street wrap

Strong start to earnings season: Earnings season kicked off recently on a positive note. While it’s still early, with just 15 percent of companies reporting, the numbers have been strong. Approximately 80 percent of the businesses that have released results have beaten consensus estimates for the period. Perhaps more importantly, earnings forecasts have also moved higher—this after last year’s strong earnings growth. Encouragingly as it relates to the market broadening, U.S. Small-Cap companies have experienced the strongest upward revisions on full calendar-year earnings for 2025.

Earnings momentum is vitally important for the current market advance to continue, and the pace of earnings revisions has a powerful influence on where market leadership is found. If small and mid-sized companies continue to guide expectations higher, it could serve as a catalyst for renewed interest in these overlooked asset classes.

This week, we will get some insights on the direction of earnings and expectations for Mega Caps, as Tesla, Microsoft, Meta and Apple are scheduled to release results. Given the outsized role these companies have had on market returns as well as investor expectations of strong growth from this group, we expect these earnings releases will have an outsized impact on market performance. This once again highlights the risks we see from the significant weight these businesses carry in overall market performance.

Improved balance: The S&P Global PMI offered some early signs that the economy may be finding some balance.

The latest report shows that U.S. business activity eased in January but with both services and manufacturing expanding. The latest preliminary data, which tracks both the manufacturing and services sectors, shows that the Composite Output Index came in with a reading of 52.4 (levels above 50 signal growth), down from December’s final reading of 55.4.

While total growth slowed, the latest reading is noteworthy because it is the first time in six months that manufacturing was in expansionary territory. Manufacturing PMI came in at 50.1, up 0.7 points from December and the highest level in seven months. The Manufacturing Output Index rose 0.5 points to 50.2, marking the highest reading in six months. Meanwhile, the Services Business Activity Index came in at 52.8, down four points from December and the lowest level in nine months. Both sides of the economy also saw growth in new orders, with manufacturing inching into expansion territory with a reading of 50.6 while the services side of the economy registered a healthy 54.9 reading.

Frequently we’ve highlighted the strength in services and weakness in manufacturing as a clear example of an economy out of equilibrium. While it's too early to tell if the latest report marks a step on the road toward balance, future sentiment readings suggest that respondents believe growth can continue. Service-sector confidence eased modestly from the prior month but came in at the second highest level in the past year. Manufacturing optimism came in at the highest level since March 2022, thanks to the steepest increase in 50 months.

Bullish expectations also showed up in employment readings, which rose at the fastest pace in the past 30 months. The latest rise in employment was driven by strong hiring in the services sector, although manufacturing also saw robust hiring with job gains rising to a six-month high.

While the report painted a mostly healthy picture of the economy, it also highlighted the threat posed by inflation in a late-stage economy that is experiencing growth. The latest data shows that input costs and selling prices rose in January with factory input costs climbing at the fastest pace since August 2024. Costs on the services side of the economy also increased after reaching a 10-month low in December. The higher input costs were passed along to consumers, with average selling prices for manufactured goods rising by the largest amount in 10 months and services costs accelerating at the fastest pace since September of last year.

“Higher input cost and selling price inflation was broad-based across goods and services and, if sustained, could add to worries that a combination of robust economic growth, a strong job market and higher inflation could encourage a more hawkish policy approach from the Fed,” Chief Business Economist of S&P Global Market Intelligence Chris Williamson noted in comments released with the report.

Forward-looking indicators weaken: The latest Leading Economic Indicators (LEI) report from the Conference Board weakened and continues to point to lackluster growth ahead. The December LEI reading fell 0.1 percent after notching a 0.4 percent rise in November—the first positive monthly reading for the measure since February 2022. The reading is now down 2.5 percent on an annualized basis over the past six months. The data paints a mixed picture of strength, with the six-month diffusion index (the measure of indicators showing improvement versus declines) registering 50 percent, unchanged from last month and above a level that typically foreshadows a recession. The Conference Board says that when the six-month diffusion index falls below 50 and the decline in the overall index is 4.4 percent or greater over the previous six months, a recession is likely imminent or underway. For context, the diffusion index first fell below 50 in April 2022, and the overall reading first exceeded the negative 4.4 percent level in June 2022. Although the latest readings still point to the prospect of weaker growth ahead, it marks a modest improvement and is the second consecutive month in which both recession rules are no longer flashing red. Prior to the past two months, the last time neither of the indicators were at recessionary levels was June 2022.

Existing home sales for the year lowest in decades: The National Association of Realtors (NAR) reported that there were 4.06 million existing home sales in the U.S. during 2024, marking the lowest calendar-year total since 1995. Despite the slump in units sold, the average selling price reached a record high of $407,500. This is the third straight year of declining home sales, which has previously happened only during prior economic contractions. While the sales figures for existing homes had been lackluster for much of 2024, the fourth quarter showed an inflection in activity. Existing home sales rose 9.3 percent in December from year-ago levels to a seasonally adjusted annual rate of 4.24 million units. The December pace was the highest since February 2024 and marked the third consecutive month of unit sales gains.

Details of the latest sales figures show that the housing market is still highly bifurcated, with the upper end of the market showing strong gains while sales of less expensive units lag. Sales of properties above $1 million rose 34.9 percent from year-ago levels. Mean transactions for houses valued at $250,000 or less declined year over year. Additionally, just 24 percent of sales were to first-time home buyers, marking the lowest rate on record. The bifurcation in the housing market has been a persistent trend we’ve seen in which higher interest rates are weighing on less-affluent consumers but having a less significant impact on wealthy households. The median price for existing homes was little changed at $404,400 in December but is up 6 percent from year-ago levels. The inventory of unsold homes fell to 1.15 million, down 13.5 percent from the prior month but 3.1 percent higher than in December 2023. The supply of existing homes for sale remains below the more normal 1.75 to 2.15 million prior to the pandemic.

The week ahead

Monday: The U.S. Census Bureau will release data on new home sales for December. We’ll be looking at this data to assess the impact the recent rise in mortgage rates has had on demand for newly built homes.

Tuesday: Data on durable goods orders for December will be released to start the day. We’ll be watching for signs of the direction of business spending in light of signs of an uptick in economic growth.

The Conference Board’s Consumer Confidence report for January comes out in the morning. Given the Federal Reserve’s ongoing focus on the employment picture, we will continue to focus on the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find and those who report challenges in finding work.

We’ll be watching the S&P CoreLogic Case-Shiller Index of property values covering November. Prices overall have moved higher in the past several months. We will be looking to see if home prices continue to rise despite mortgage rates holding firm.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following its monthly meeting. We expect the Fed will hold rates steady, and we will be listening for indications of whether the Fed believes risks to its dual mandate of price stability and full employment remain in balance.

Thursday: The Bureau of Economic Advisors will release its first estimate of gross domestic product growth for the fourth quarter. Estimates call for overall economic growth to clock in at 2.7 percent after last quarter’s 3.1 percent. We will be looking for any significant divergence from consensus estimates.

Friday: The December Personal Consumption Expenditures Price Index from the Bureau of Economic Analysis will be out before the opening bell. This is the preferred measure of inflation used by the Federal Reserve when making interest rate decisions. We’ll be monitoring to see if the latest data shows signs of stalling in the disinflation process.

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