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FEBRUARY 2025 MARKET INSIGHTS

January was an interesting month in the markets and in our nation. We witnessed the peaceful hand off of power from the Biden administration to the Trump administration and then the gloves came off! President Trump and his team hit the ground running with everything from tariff threats to tightening border security to attacking government spending. This now leaves us in a “now what” situation.

As we review the markets from last month, the Bloomberg 500 index was up about 3.0% during January1. Small cap stocks as represented by the Bloomberg 2000 returned 2.6% for the month1. In looking at market styles, the Bloomberg 1000 Growth Index returned 2.7% for the month and the Bloomberg 1000 Value returned 4.3%1. In January, large cap and value were the winning combination for domestic stocks. The Bloomberg World ex-U.S. returned 3.4% for the month, so the dominance of U.S. over international stocks continued into the month of January1.

The bond market, as represented by the Bloomberg Aggregate Bond Index, returned 0.50% during January1. The Bloomberg 1-3 Year Government/Credit Index represents the short-duration segment of the bond market, returned 0.46% during the first month of the year1. From a yield perspective, we came into 2025 with the 10-year Treasury yielding 4.57% and we ended the month at 4.54%. The return of broader fixed income market indices was mainly driven by income and a little spread tightening1. The 2-year Treasury note started January at 4.24% and ended the month at 4.20%1.

Through most of last year we were focused on the two main drivers of the markets. The first was the Presidential election with all of the palace intrigue that came from the Democratic Party with the removal of Biden as the candidate and the installation of Vice President Harris. There were all of the lawsuits aimed a Trump, but we surmise that the legal bazookas leveled at Trump may have actually helped him more than hurt him. We then saw pardon palooza from both sides with newly minted preemptive pardons! We Americans have ingenuity! I am not looking to be four years older, but I will be interested to see how the media handles any preemptive pardons initiated by an outgoing President Trump! We shall see.

The other major fixation coming out of 2024 into 2025 was focused on Fed rate cutting action. This is a bit of a simplification, but it highlights the situation. The Fed has a dual mandate to keep inflation in check and to maintain full employment. After fumbling on the transient inflation notion, the Fed aggressively raised the Federal Funds rate to thwart inflation. As inflation receded from over 9% to around 3%, it seemed that the trend was the Fed’s friend, and they could begin preemptively cutting the Fed Funds rate in order to maintain full employment. This was a fine idea while inflation was trending lower…until it was not. Three rate cuts led to a 100-basis point reduction in the Fed Funds rate and now we are on a pause.

As most things regarding statistics, one needs to look beneath the headlines to grasp the essence of the situation. A significant portion of the job creation last year came from an increase in government jobs and an increase in health care workers. Let us start with the government jobs. If the DOGE (Department of Government Efficiency) starts to reduce government employment, that pillar that supported last year’s employment gains is not much a pillar. Within healthcare, we have heard anecdotally that there was a significant increase in home healthcare workers. I have the utmost respect for the people that provide dignified care for our nation’s seniors. That said, these are not the highest paid jobs in the economy so an increase in this segment does not bode well in terms of materially increasing aggregate spending across our economy. It is on the basis of these two issues that we are watching to see what happens with employment because that may dictate how the economy tracks as we move through 2025.

As I write this on February 3rd, Mexico has already received a one month pause on tariffs as Mexican President Claudia Sheinbaum announced that she will deploy her military to help secure the border between our two countries. Whatever one’s opinion of President Trump, he said he wanted to secure the border and the aggressive stance he took caused the reaction he was looking for from the Mexican President. Trump is scheduled to speak to Trudeau of Canada to hopefully secure similar concessions. We do need to figure out an effective immigration system because the U.S. needs workers at every level of the economy. I will leave it to the more politically astute to comment on the “how,” but I will stand firm on the need to see a reasonable immigration policy established. A welded shut door is not the answer, but the free-for-all that existed, particularly at our southern border, was not an optimal situation for us either.

This morning the ISM manufacturing index moved strongly higher from 50.1 last month to 51.2 this month and this indicates that manufacturing is expanding at a growing rate. New orders for manufactured goods and employment both increased however, the prices paid index increased as well. This means that manufacturing saw increased demand and hired more people while raising prices. This type of action will likely keep the Fed on the sidelines…for now.

From here, we think the tug of war between inflation and economic activity will be taking up most of the Fed’s attention. If the economy slows and inflation declines, one can reasonably see the Fed reducing the Fed Funds rate. However, if inflation reignites, this data driven Fed will be as likely to increase rates quickly to shave off another bout of inflation. Stay tuned!

 

[1] Source: Bloomberg

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