February Market Report

Severance

Dystopian reality television shows are all the rage right now, and one of the most popular is Severance on Apple TV. You might wonder why a television show about people losing their jobs and receiving severance pay would be so popular. Well, you would be wrong about what severance means in this situation, but you might be right in questioning why the show is so popular. Actually, Severance is a show about a team of office workers whose memories have been surgically (via an implant) divided between their work and personal lives.  It is one of those shows that you may decide is not for you after watching it initially, but end up getting sucked in, hoping all along that it does not get cancelled, leaving a huge cliffhanger at the end. In many ways this describes the current investing environment – lots of noise that needs to be siphoned through to determine what is worth paying attention to and what is just noise. With the changes in Washington, there is a lot of economic activity right now that everyone wants to opine about. It is that analysis and opinion sharing that is creating the noise and, potentially, confusion for investors. News around government spending, regulations, tariffs, and more have spurred endless arguments about their effectiveness generally and, more specifically, their effect on the economy and markets. Without getting caught up in the frenzy, we will try and work through a few of these items to help determine how one might want to invest in this environment.

Financial Markets

It would not have come as a surprise if the downward pressure the markets were feeling at the end of December continued into January, especially with the uncertainty that was coming from the changes in the political landscape in Washington. But even with the rapid and often head-spinning news, you may find it surprising to learn how well the markets did in January.  The markets rallied and even broadened out from just the Magnificent stocks, as the S&P 500 Equal Weighted index added 3.50% during January versus 2.78% for the standard market cap-weighted version of the index. Domestically, the Dow Jones Industrial Average led the way with a gain of 4.78% in January while the international index, EAFE, outshone all domestic indices by adding 5.21% for the month. Small and mid-cap indices and the NASDAQ all added value as well. Even the Bloomberg US Aggregate Bond index gained ground as it added 0.53% in January. So, while the mood may have been uncertain or downbeat, the markets had a very good month.  Maybe they were able to sever the noise from reality and focus on the future (or, perhaps, investors were paying attention to “positive” noise only, and did not truly pay attention to all the data). Given the less than exuberant mood out there, I would say that investors were paying attention and acting appropriately, but only time will tell if they, and me, are right. For additional data, please see the end of this commentary.

The Economy

The economic mood was less than robust in 2024 and that helped usher in a new administration in Washington. Was that mood based on reality or noise? Like most things, it depends upon your point of view. If you had a job (most people did, as evidenced by the low unemployment rate), received a reasonable increase in your wages (again, most people saw hourly wage gains last year), had a home (here things diverge a bit as younger people felt shut out of home ownership due to mortgage rates and other costs, while older people generally had lower mortgage rates and thus lower costs), you probably felt pretty good about the economy.  But unfortunately, many did not, as they were hit harder by inflation, especially in the prices of things that met their daily needs such as insurance, food, fuel, and rent. So, severing the noise from reality was a bit harder in 2024, as it depended upon who you were talking about. But when the feeling that a rising tide (economic growth) did not raise all boats (people), the subdued mood was understandable. The new administration will have to battle this mood and work to provide more for everyone, and the best way to do this is through the private sector and not the government. Hopefully, we will see that goal attained in 2025. The U.S., and its exceptionalism, should continue to outshine other economies and markets in 2025.

GDP (Gross Domestic Product) -  Any changes in economic activity ultimately lead to changes in our country’s gross domestic product. Last year, considering expectations heading into the year, was solid but not necessarily great. Initial estimates for the fourth quarter show GDP increasing at a rate of 2.3% which was within range of most estimates. For the full year, GDP showed an increase of 2.8% versus 2.9% in 2023. Again, not bad, but not great either. Several factors led to the growth, including consumer spending (primarily in healthcare and vehicles – both recreational and motor and their parts) and government spending. Unfortunately, our growth continues to be subpar, and that is due to the dramatic size and growth of the federal government, especially non-defense spending. In 1965, that spending amounted to 9.5% of GDP, in 1973 it had grown to 12.5%, 15.2% by 2007, 17.5% in 2016, and it now stands at 20.4% of GDP. The annual level of GDP is more rangebound now than it was 40 or 50 years ago, but it is also generally lower than it was then. What is the difference? Go back to growth in government spending and you get your answer. Increasing government spending robs the private sector of its ability to innovate, create jobs (many times at higher salaries than government work), be productive, and create wealth. In other words, government spending limits the economy’s ability to grow. So, any noise you hear about the growth of the government and whether that is good, should be limited, and needs to be combed through and evaluated based on what that spending does or does not do. Expectations vary on whether we will face a recession this year, but do not be surprised to see slower growth as compared to the past couple of years.

Inflation – At times over the past few years the perception of inflation has been something that economists and investors needed to sever reality from hype. Remember, inflation was supposed to be transitory (hype or perhaps, hope?), while much of the data pointed to a more prolonged period of inflation (reality). December saw inflation tick slightly higher, albeit in line with expectations. The rate hit 2.9% as gasoline (energy) and shelter (housing) both increased. The SuperCore inflation rate, which excludes food, energy, housing, and other items increased to 3.5% in December which was higher than in 2023 (3.4%)! Maybe that is why you do not hear the Fed talking about this metric anymore. Truflation, which has been a pretty good indicator of where rates are headed, is currently at 2.19% (as of February 6^th), down from a rate of 2.70% on January 31^st and 3.11% on December 14^th.  The hype proved wrong, unfortunately. With rates remaining stickier than hoped for and the potential for some upward pressure due to tariffs, the Fed will continue to hold rates steady for now. Barring a recession, do not expect inflation to hit 2.00% this year but progress should be made, especially if the outlook provided by Truflation holds true.

Unemployment – The employment picture remains a bright spot for the economy and for the Fed. While the data has continually shown that most jobs being created are in the government or government related categories, the actual number of jobs being created is encouraging. December saw 256,000 new jobs being added and the unemployment rate fell to 4.1%. Wage growth dipped slightly to 3.9% year-over-year but is still higher than the rate of inflation (which does not help the process of cooling inflation). Both Wisconsin and Madison saw their rates tick slightly higher to 3.0% and 2.2%, respectively, but remain well below national averages. Other labor data is a mixed bag, as ongoing jobless claims remain elevated, fewer workers are leaving their jobs, fewer employers are terminating employees, and, unfortunately, fewer workers are finding jobs. The picture could improve, though, as the new administration seeks to improve business sentiment and outlook.

The Fed Watch

Sometimes the Fed seems severed from reality, and living in their own dystopian world. Some would argue they were living in a dream world when they kept rates artificially low for so long, while others argued that they should have cut rates sooner or deeper when inflation was falling last year. Most of that is just noise and the Fed has needed to work its way through the fog of uncertainty as they pursue their dual mandate of full employment and 2.0% inflation. Based on data (severing the noise from reality), they announced a pause in their rate cutting process in December and again in January. Now, though, they are fighting a new reality and that is trying to work through the noise of new government activities such as tariffs. What will the true effect of tariffs be? Higher inflation? Lower? Will they even come to fruition or will they just be negotiating tactics? All of this has added complexity to the Fed’s job. As described above, talk of tariffs and their effects is likely being blown out of proportion by political opponents in the media and elsewhere, but there likely will be some impact. Will it be enough to stymie growth or will it be offset by reduced regulation and taxes? Only time will tell, but let us hope the Fed does sever hype from reality and make the proper decisions.

Outlook/Summary

The need to sever hype from reality, or fact from fiction, is necessary more today than ever due to the influence of the media – whether social or traditional. That is not just true in politics and other aspects of our daily lives, but it is also true of investing. This point was driven home recently, by one of the analysts used for this commentary, who pulls headlines and clips from various media outlets, investment firms, and respected leaders to put together his weekly report. One of the things that makes his report so enjoyable and helpful is that he reports facts and does not let politics or other outside influences affect what he writes. That is until his latest rendition. The report took on the topic of tariffs and took a decidedly negative tone with more personal commentary than usual, and unfortunately smacks of a certain political point of view. This may not have been his intention, but it sure appears that way. While tariffs may not be helpful, they also may not be implemented or cause the damage to the extent portrayed. Like any other economic variable, tariffs and their implications will need to be monitored and factored into economic and investment models without allowing a personal or political viewpoint to affect that analysis. In other words, sever personal and/or political viewpoints from your analysis.

Perhaps we should consider the “January barometer” that portends that as January goes, so goes the markets for the year. While this would be wonderful for the markets this year, the reality of this so-called “barometer” is hard to verify. And with all the noise out there this year and uncertainty over policies coming out of Washington, this year could be more volatile than investors have come to expect.  If that proves to be true, our approach may prove beneficial to investors. Our process has not changed, as we do not time markets, but take a consistent approach that seeks to protect the downside and then seek upside returns. To that end, we will continue to pay attention to the data as we look for opportunities in both the fixed income and equity markets. Sticking to a plan, investing to the level of risk you are comfortable with, and not letting the bouncing ball or laser light drive you crazy is what we feel is the best way to be successful over time. To discuss your portfolio, call the Wealth Management division of Lake Ridge Bank at (608)826-3570. We look forward to speaking with you.

Market/Economic Data

As of January 31st, 2025…. Unemployment data is through December for national, Madison (preliminary), and Wisconsin (preliminary), inflation data is through December:

Thank you for your business – we look forward to speaking with you soon. (Note – this commentary used various articles from JP Morgan, Morningstar, the Wall Street Journal, Investor’s Business Daily, Northern Trust, CNNMoney.com, msn.com, Kiplingers.com, nytimes.com, Fidelity Investments, American Funds, LPL Financial and other tools as sources of information.