Slowing Growth, Tariffs and Inflation Weigh on Stocks

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

Economic data over the past week has raised concerns about a slowing economy and sticky inflation. The numbers weighed on Wall Street and sent stocks lower last week, while yields on Treasurys fell (yields and bond prices move inversely to each other). Ongoing discussions about tariffs added to concerns about inflation for both businesses and consumers. Indeed, final results from the University of Michigan February consumer sentiment survey show that roughly 40 percent of those surveyed independently mentioned tariffs when being interviewed. In January, just more than a quarter of those surveyed brought up the topic and, before the presidential election, only 2 percent noted them.

As concerns about trade policy have grown, so have inflation expectations. The latest results show inflation expectations for the year ahead jumped one point to 4.3 percent, marking the highest reading since November 2023. Perhaps more importantly, expectations for inflation in the coming five to 10 years also rose, coming in at 3.5 percent, up 0.3 percent from January’s final reading. The growing concern about prices appears to be seeping into consumers’ overall outlook as well as their expectations for their personal financial situations. Consumer sentiment overall fell to 64.7 this month, down 6.4 points from January. Expectations for personal finances also fell. The majority of respondents are now expecting that any income gains they make will fall short of offsetting an uptick in inflation.

This marks the second consecutive month of deteriorating sentiment. However, it is too early to tell if this is a sign that inflation expectations have become unanchored. Given the dynamic nature of tariff proposals, the latest readings could change depending on how policy eventually shakes out. “A spike in inflation expectations is not necessarily a cause for concern, but if these views persist, it could become problematic for policymakers. Consumers broadly anticipate that tariff hikes will lead to higher inflation, but policy uncertainty means that their views are subject to change,” Survey of Consumers Director Joanne Hsu said in comments released with the survey results.

As we noted in last week’s commentary, the recent uptick in the Consumer Price Index was already set to complicate the Fed’s ability to cut rates in the near term. The latest data on consumer expectations, in our view, further complicates the case for future cuts. Other data out last week only adds fuel to the fire, suggesting the pace of economic growth continues to slow. Indeed, in the minutes from the latest Fed meeting, members who expect the disinflation process to continue pointed to “well-anchored inflation expectations” as one of the reasons for their optimism. While market-based indicators suggest medium- to long-term inflation expectations have remained steady, unanchored consumer expectations could create a self-fulfilling feedback loop, driving prices higher.

To be sure, last week’s data offers a single snapshot of the economy and as such is incomplete. However, the deterioration in sentiment for businesses and consumers, particularly after the post-election surge, highlights how quickly market narratives can change. Given that uncertainty is likely to persist for longer than many may have anticipated at the start of the year, we believe diversification continues to be an important element in developing a robust portfolio for longer investment horizons. Diversification is an all-weather approach that allows investors to have exposure to asset classes that may perform well even as others lag, regardless of the economic backdrop. Indeed, we have already seen broadening in the market this year as previously overlooked asset classes, such as International Developed and Emerging Market equities along with commodities, perform well on a relative basis.  

Wall Street wrap

Signs of a slowing economy? Preliminary data from the latest S&P Global Purchasing Managers Index (PMI) showed the pace of growth continued to slow in February, with services dipping into contraction and manufacturing notching a second month of expansion. The latest preliminary data, which tracks both the manufacturing and services sectors, shows that the Composite Output Index came in with a reading of 50.4 (levels above 50 signal growth), down from January’s final reading of 52.7 and the lowest reading in 17 months.

Manufacturing PMI came in at 51.6, up 0.4 points from January and the highest level in eight months. The Manufacturing Output Index rose two points to 53.8, marking the highest reading in 11 months. However, the report noted that many manufacturers also reported that the rise in production and demand was in part linked to front-running potential cost increases or supply shortages linked to tariffs. As a result, it is unclear whether the expansion in the sector marks an inflection point or is a temporary response to the threat of tariffs. Meanwhile, the Services Business Activity Index fell to 49.7, down 3.2 points from January and the lowest level in 25 months. The services sector has been the resilient part of the economy, while manufacturing has struggled, so this contraction raises some concerns. New orders were mixed. Service providers recorded the slowest growth in demand in 10 months, while orders for manufacturers expanded for a second consecutive month as a result of the sharpest rise in 11 months.

Input prices rose for both sides of the economy. Costs for service providers rose to a four-month high, with companies pointing to tariff-related charges, rising food prices and wage pressures as driving the increase. Meanwhile, costs for manufacturers spiked, with costs for raw materials rising at the fastest pace since October 2022. While both groups saw rising costs, the services side lacked pricing power with selling price inflation falling to a three-month low for the group. The difference between the rise in input costs and the decline in output prices on the services side was the largest since 2023, suggesting increased margin pressures in the services sector. Conversely, manufacturing selling prices rose by the largest amount in two years.

“The upbeat mood seen among U.S. businesses at the start of the year has evaporated, replaced with a darkening picture of heightened uncertainty, stalling business activity and rising prices,” Chief Business Economist of S&P Global Market Intelligence Chris Williamson noted in comments released with the report.

The more cautious outlook and margin pressures on the services side of the economy appear to have taken a toll on hiring, with employment contracting modestly from the month. The latest reading marks the first decrease in three months and comes on the heels of job growth hitting a 31-month high in January.

Trend in forward-looking indicators improves: The latest Leading Economic Indicators (LEI) report from the Conference Board weakened but points to some stabilization of growth ahead. The January LEI reading fell 0.3 percent after December’s final reading showed a gain of 0.1 percent. The reading is now down 1.8 percent on an annualized basis over the past six months, an improvement of the six-month annualized decline of 2.5 percent reported in December. The data paints an improving picture, albeit with still moderating growth, with the six-month diffusion index (the measure of indicators showing improvement versus declines) registering 65 percent, up from last month’s 50 percent and above a level that typically foreshadows a recession.  Although the latest readings still point to the prospect of weaker growth ahead, they mark a modest improvement; it is the third consecutive month in which both recession rules are no longer flashing red. Prior to the past three months, the last time neither of the indicators were at recessionary levels was June 2022.

Existing home sales start the year on a down note: The National Association of Realtors (NAR) reported that existing home sales in the U.S. fell 4.9 percent in January to a seasonally adjusted annual rate of 4.08 million units. Despite the monthly decline, sales were up 2 percent from year-ago levels, marking the fourth straight month of year-over-year gains.

Details of the latest sales figures show that the housing market continues to be tilted toward the high-priced units, with the upper end of the market showing strong gains as sales of less expensive units lag. Sales of properties above $1 million rose 26.9 percent from year-ago levels. Mean transactions for houses valued at $250,000 or less declined year over year. This 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. In comments released with the report, NAR Chief Economist Lawerence Yun noted, “Mortgage rates have refused to budge for several months despite multiple rounds of short-term interest rate cuts by the Federal Reserve. When combined with elevated home prices, housing affordability remains a major challenge."

The latest data shows little progress on the issue of affordability. The median price for existing homes came in at $396,900, down from the prior month but still up 4.8 percent from January 2024. The inventory of unsold homes rose to 1.18 million, up 3.5 percent from the prior month and 16.8 percent higher than in January 2024. The rise in inventory at a time when year-over-year prices continue to climb suggests that potential buyers are still waiting for lower rates due to affordability issues.

Homebuilders’ confidence retreats: Homebuilder confidence fell in February due to concerns about tariffs, mortgage rates and high housing prices. The latest reading from the National Association of Home Builders survey shows confidence dropped to 42 in February, down five points from January.  

While views of current conditions fell to 46, down four points from the prior month, sales expectations over the coming six months showed the largest erosion, dropping 13 points to 46. Throughout much of 2024, interest rates had an outsized impact on the expectations reading; however, it appears that the threat of tariffs now holds significant sway on the outlook of builders. The expectation reading for respondents who were surveyed prior to the pause of tariffs on goods from Mexico and Canada was 38. But it came in at 44 for those surveyed after the pause was announced.  

The week ahead

Tuesday: The Conference Board’s Consumer Confidence report for February 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 December. Prices overall have moved higher, albeit at a slower pace, in the past several months. We will be looking to see if home prices continue to rise despite mortgage rates holding firm.

Wednesday: 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.

Thursday: Data on durable goods orders for January 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 Bureau of Economic Advisors will release its second estimate of gross domestic product growth for the fourth quarter. Initial estimates pegged growth at 2.3 percent. We will be looking for any significant divergence from the initial reading.

Friday: The January 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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