Volatile Week for Markets as Administration Digs in on Trade

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

Investors have spent the past couple of weeks searching for one of two “put options” as economic growth prospects are dimming on the back of heightened uncertainty that has been driven by tariffs and led to a deterioration in market sentiment. The first put option is the “Trump put,” which is predicated on his prior sensitivity to market movements but seems to be out of the question this term as he appears steadfast in his trade policy.

The lack of a Trump put has investors wondering when the second option, a “Fed put,” which hinges on the Fed cutting rates, might become a reality. Last week’s Consumer Price Index (CPI) data, while an improvement over prior readings, still shows that the disinflation process has stalled and—most importantly—that inflation expectations have risen. Simply put, we don’t believe the Fed can cut rates yet, and this week investors will be tuned into the Fed meeting for clues about the future path of monetary policy.

Despite Friday’s market rally, we continue to see volatile days ahead as investors digest incoming data and its impact on what appears to be a still fully valued S&P 500. But here’s the good news: Other parts of the market offer opportunities for patient, long-term investors. Valuation is important over the intermediate to long term; and while the nearer term is likely to be volatile, we continue to find opportunities.

Inflation was also front and center in Friday’s Consumer Sentiment Survey from the University of Michigan. Overall sentiment fell to 57.9 from 64.7. The main culprit: inflation. Expectations for inflation in the long run (five to 10 years) are at 3.9 percent, the highest they have been since 1993. While some have discounted this report given the partisanship that has importantly always been in it, we believe the report continues to be relevant. Since the election, Democrats’ and Republicans’ views of inflation have shifted, with Democrats rising from 2.7 percent in October to 4.6 percent in the latest report, while Republicans have moved from 3.4 percent to 1.3 percent over the same period. Although Independents have been more stable, their views of inflation are also rising. Independents were at 3.3 percent in October and then pulled back slightly to 3.1 percent in December and have now risen to 3.7 percent as tariffs have taken effect. We believe this is indicative of inflationary concerns, which are showing up in other surveys and the financial markets.

In moments of market uncertainty like we are in now, it’s important to keep in mind that historically the financial markets have risen and fallen in the short term for varying reasons. While they tend to provide strong returns over the intermediate to longer-term time horizon, short-term volatility causes some investors to overreact and sell. Investors who sell help to create opportunities for extra returns for those who stay true to their asset allocation. As we’ve said before, we believe the best way to approach market uncertainty is through diversification and staying true to your financial plan. By owning different asset classes, you’ll have exposure to investments that perform well even when others don’t, regardless of what’s going in the geopolitical or economic backdrop.

While we believe uncertainty will remain elevated for a while, we also believe there is an antidote. It lies in focusing on the long-term, looking at relative valuations and staying diversified to avoid concentrating too much on any one market segment or asset class.

Wall Street wrap

Inflation slows: The latest CPI from the Bureau of Labor Statistics showed that prices rose 0.2 percent in February, down 0.3 percent from the prior reading and below Wall Street estimates. On a year-over-year basis, the headline figure was up 2.8 percent. Core inflation, which excludes volatile food and energy costs and is the measure that the Federal Reserve focuses on, rose 0.2 percent in February, down from 0.4 percent recorded in January. Over the past 12 months, core CPI is now up 3.1 percent, on a year-over-year basis breaking just below the narrow range between 3.2 and 3.4 percent that has persisted for the past nine months. Over the past three-, six- and nine-month periods core CPI is 3.6 percent, 3.6 percent and 3.1 percent, respectively. In other words, we’re not seeing much movement.

Goods prices rose 0.2 percent for the month, marking the fifth month of the past six that prices increased. Those increases come after the measure fell during 13 of the prior 16 months. On a year-over-year basis, goods prices are essentially flat. As a reminder, easing goods prices have driven the disinflationary process over the past couple of years. Services prices rose 0.3 percent in February, down from 0.5 percent last month. They are now up 4.1 percent on a year-over-year basis compared to 4.3 percent year over year in January. The three-, six- and nine-month paces are 4.19 percent, 4.11 percent and 4.0 percent, respectively. Here again we seem to be stuck.

Because services readings include the lagging housing category, we typically look at so-called “super core” services (which exclude shelter) to get a clearer picture of current measures of price pressures on the services side of the economy. Super core services prices were up 0.22 percent for the month and are up 3.78 percent year over year. On a three- and six-month annualized basis, super core services prices are up 4.9 and 4.6 percent, respectively. This shows a trend suggesting the Fed has more work to do to bring inflation down to its goal of 2 percent.

Inflation measures by some of the regional Federal Reserve banks, designed to gauge overall trends of inflation, also show a recent uptick in prices. The Cleveland Federal Reserve’s calculation, called the Cleveland Median CPI, came in at 0.29 percent in February, down from 0.32 in January. On a three-month annualized basis, the measure is up 3.6 percent, and the year-over-year reading comes in at 3.5 percent. While the latest inflation readings are encouraging, we don’t believe this month is reflective of tariffs and needs to be taken in the context of the prior few months due to the reality that companies and consumers likely bought ahead of expected tariffs, which has impacted inflation.

Small business owner uncertainty rises: The latest data from the National Federation of Independent Businesses shows that the percentage of companies raising prices rose to 32 percent from 22 percent. Besides March 2021, when the number was rising, and May 2023, when it was falling post-COVID, you’d have to go back to 1981 to find a similar number. Simply put, tariffs are causing companies to raise prices.

Moreover, optimism among small businesses declined 2.1 points in February, with a reading of 100.7. However, the latest reading marks the fourth consecutive month of readings above the 51-year average of 98. The retreat in optimism was widespread, with seven of the 10 components measured showing decreases and three showing modest increases. Meanwhile, the Uncertainty Index rose for the second month in a row, coming in at 104 and notching the second highest reading in the survey’s history. Sales for small businesses have been in decline since June 2022, including the latest reading showing a still historically depressed 12 percent more businesses (two points better than in February) reporting declining sales than reporting flat or rising purchases. Expectations around future sales continue to be positive, but some of the optimism has faded as small business owners react to the increasingly uncertain environment. The latest results show a net 14 percent of businesses expect to improve, down six points from the prior month. For further context, the measure hit a recent low in August 2024, when a net 18 percent of businesses expected falling or flat sales in the next three months.

The portion of businesses expecting to hire in the next three months declined in February. The latest results show 15 percent of companies expect to add to payrolls, a decrease of three points from January. Those who are hiring continue to struggle finding qualified help, with 48 percent of those hiring reporting a lack of qualified candidates. As we’ve noted in the past, a scarcity of qualified workers can lead to a rise in wages. To that end, 33 percent of businesses reported raising compensation in the past three months, unchanged from January. However, the latest survey results show the portion of businesses expecting to raise wages in the next three months declined for a third consecutive month to 18 percent, down two points from January and the lowest reading since July 2024.

Should sales improve and wage growth slow, it would be a welcome relief for businesses that have endured generally slow earnings since COVID. The latest reading shows a net 24 percent of business owners have seen their earnings shrink over the past three months, a one-point improvement from January’s reading. Although the latest reading is still weak, the trend has shown some improvement since August 2024, when a net 37 percent of businesses reported shrinking earnings.

Consumers continue to worry about the future: Consumer sentiment slid 11 percent this month, down 22 points from December 2024, according to the latest consumer sentiment survey released by the University of Michigan. While the current economic conditions didn’t change much, expectations for the future weakened across the economy. Generally, consumers highlighted uncertainty around policy and economic matters.

As we highlighted above, while many discount this report due to the partisanship that has always been in it, we continue to believe in its relevance. And we’re seeing that partisanship fade in current conditions. Republicans’ sentiment rose from 55.7 to 65.4 but remain low, while Democrats’ sentiment fell from 73.9 to 62 and that of Independents fell from 68 to 65.8. All of these figures are historically low.

On the unemployment front, expectations fell to 50 from 70 for the year ahead, the highest reading since the Great Recession. And, if historical patterns hold, this may point to a further weakening of the labor market.

This quote from the report sums up the situation well: “Overall, consumers perceive a tremendous amount of uncertainty in the economy—policy uncertainty, market uncertainty, general economic uncertainty, among others. The fact that expectations worsened across the board suggests that consumers perceive more downside than upside risk for the foreseeable future; these views will likely dampen consumers’ willingness to spend or incur financial risks of their own.”

The week ahead

Monday: The U.S. Census Bureau will release the latest numbers on retail sales for February before the opening bell. Last month’s report showed a slump in sales, and we will be watching to see if consumers have continued to pull back on spending.

The Homebuilders Index from the National Association of Home Builders will be out in the morning. Confidence among builders fell last month due to concerns about interest rates and tariffs. We’ll be watching to see if builders’ optimism has eroded further as additional tariffs have taken effect.

Tuesday: We’ll get February housing starts and building permits from the U.S. Census Bureau. This data, along with the Homebuilders Index released on Monday, will provide insight into the home construction market.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following the latest meeting of the Federal Open Markets Committee (FOMC). The Fed is widely expected to leave rates unchanged. This meeting will also include updated economic and interest rate forecasts from members of the FOMC. We will be listening to Federal Reserve Chairman Jerome Powell’s post-meeting press conference for insights into how the Fed views the state of the job market and economy and what he has to say about the potential impact tariffs are having on the disinflationary process.

Thursday: The Conference Board’s latest Leading Economic Index Survey for February will be out mid-morning. Last month’s report showed some weakening after a string of reports have shown modest improvement but still point to weak economic growth ahead for the U.S. economy. We will be scrutinizing the data to see if last month’s decline was a temporary setback.

We’ll get additional insights into the housing market when the National Association of Realtors releases existing home sales for February. This report, along with the new homes data released earlier in the week, should give a clearer picture of whether the housing market is in a holding pattern due to elevated interest rates.

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