Boomerang

One of the cool things about a Boomerang is that when you throw it sails out and then, in theory at least, comes sailing right back to you. Assuming, of course, that you know how to throw it. In a similar vein, if you throw a rubber ball against a wall, the ball will come back to you. Of course, the slightest variation in wind, speed, angle, etc. could send the Boomerang, or the ball, off course.  Momentum is similar. Take the bouncing ball, for example, and throw it forward against the ground. It will bounce high at first, but the energy fades the farther the ball bounces. In their own way, both the Boomerang (reverting to the mean) and the ball (fading momentum) have a story that applies to investing. The markets are driven by fundamentals (earnings, etc.) over longer periods of time and by momentum factors (market sentiment, etc.) over shorter periods of time.

This is playing out in real time as recent or ongoing policy changes in Washington are making the markets more volatile, but their lasting impact is harder to discern. Similarly, rapidly growing stocks and industries (think tech, AI, the Mag 7, etc.) have momentum on their side but what happens when that momentum stops or sentiment shifts? Think the last two years are sustainable? Well, look back to 2022 to see how the technology sector cratered in the face of slowing momentum and sentiment. Overvalued  and undervalued markets tend to revert to long-term averages over time, although the reason might not just be a sell-off or rally, but could be stronger earnings growth leading to more reasonable valuations. There is a lot of talk about tariffs right now and rightly so, but it is very interesting to see how the level of their impact on the markets tends to be shorter-lived. Part of the reason for that shorter shelf life could be that the tariffs can have a positive impact on society (think of all the new investment coming into our country largely to avoid tariffs).  While economists do not like them (and perhaps rightly so purely from an economic point of view), there can be more at play than just economics.  There is a reason why the tariffs imposed on China during the first Trump administration were not removed by the Biden administration.

We will do our normal review of the markets and economy and weave into the story of the Boomerang and bouncing ball.

Financial Markets

Uncertainty prevails in the markets right now as evidenced by the volatility taking place. December was a struggle, January proved to be an excellent month, and then stocks boomeranged figuratively back to December in February. Political issues seem to rule the day and that is not what one should base their investing on.  While economic conditions may be different this time (after all, an economic slowdown or recession will occur at some point), we have seen periods like this play out before, including as recently as late last summer. That period included a spike in unemployment, fears the Fed was not acting decisively, and other economic data that rattled investors. Yet, we rallied for much of the remainder of the year until December. Because the cause now is due in large part to policy uncertainty (will the tariffs really go into effect, are they a bargaining tool, will they only be short-lived?), there is a chance that the current volatility will not last for an extended period. Then, maybe the boomerang effect would be more like January than February.

First the negative: February saw all the major indices fall except for the EAFE (up 1.80%) and the Bloomberg US Aggregate Bond index (up 2.20%). The negative monthly returns for the other stock indices ranged from negative 0.61% for the Equal Weighted S&P 500 index to negative 5.71% for the S&P 600 index. For other data see the chart at the end of this commentary. Now the positive: Year-to-date numbers remain in the black for all indices except for the S&P 400, the S&P 600, and the NASDAQ.  In fact, the EAFE (yes, international stocks) leads the way at an eye-popping positive 7.71%! Yes, March has started like the proverbial in-like-a-lion story, but we are coming off higher numbers not lower, and that is good news. Hopefully, the short-term negative momentum will boomerang back to the positive as policy initiatives sort themselves out.

The Economy

Unlike 2024, we entered 2025 with increased optimism. Yes, the markets were/are overvalued (at least anything tech related or heavy in Mag 7 stocks) and the economy was/is showing signs of age.  But talk of reduced taxes and regulation helped buoy stocks in January and fueled optimism. While forecasts of lower taxes (personal and corporate) and regulations are likely to come true, trade negotiations led by tariffs are causing the optimism to fade somewhat. This is reflected in the equity markets and the bond markets as yields/rates are declining. This is a more historically normal relationship that has not held true at times over the past few years and helps balanced portfolios. Environmental disasters have hindered first quarter growth but may fuel future growth as spending increases as the rebuilding process ramps up. Manufacturing data was a mixed bag, but the readings are generally still in expansion territory.  Inflation has settled down closer to expectations and employment data, while soft, does not show a rising unemployment figure. As one of the economists we follow stated “With headwinds, tailwinds, and side winds hitting all at once, the data are not very clear.” 

GDP (Gross Domestic Product) – With all the uncertainty over policies including an expectation of less governmental spending, the impact of the California wildfires and other environmental disasters, etc., it is difficult to forecast where GDP is headed. In fact, GDPNow is estimating that the first quarter number will come in at a negative 2.4% as of March 6^th. The negative forecast is largely due to the consumer and federal government slowdown in spending due to the reasons described. It is expected that we will see the Boomerang complete its circle in the second quarter (barring the unexpected which, of course, we can expect) and offset the potential negative first quarter results. While uncertainty reigns supreme, as of February 14^th, forecasters expected GDP to rise by 2.4% in 2025. Slowing growth, yes, recession, no, but this forecast seems ancient already. The boomerang must fight through the shifting winds to find its path and will hopefully come back from the negative GDP forecasts.

Inflation – The January CPI number rose 0.5% to 3.0% over the past year and was in line with expectations helping to ease concerns. Truflation stands at 1.30% as of March 7^th, the lowest rate since 2021. While the Truflation rate has dropped dramatically in the past few days, it is reflective of current events (negative GDP forecasts for first quarter) and is likely a brief aberration. Barring significant implementation of tariffs, the rate is expected to soften throughout the year but may not yet hit the Fed’s 2.0% target in 2025. Areas expected to see costs decline are auto insurance rates and shelter (housing) while tariffs are the primary concern for those expecting inflation to remain steady or even rise. This may be a case of the bouncing ball where inflation perhaps jumps in the short term (tariffs) only to fade as the economy slows towards 2.0% GDP growth over time.

Unemployment – The unemployment rate held steady at 4.1% in February as payrolls increased by 151,000. Gains were made in health care, financial related jobs, transportation, and other areas. Federal government jobs declined, likely a result of changes in Washington. While no one likes to see job losses, it is good to see private sector jobs lead the way. The report also showed that productivity increased in the fourth quarter and that helps the overall economy. Even though the number of jobs created was less than expected (170,000), it was higher than the revised January number of 125,000. This report is a further indication that we are not in a recession currently and it can help the Fed continue to focus on inflation. The Madison and Wisconsin data have not been released yet and the most recent report is from December that showed Madison at 2.2% and Wisconsin at 3.1%.

The Fed Watch

With all the activity coming out of Washington in recent weeks, the Fed must feel left out. The markets have been glued to any word out of the Fed’s mouth for years, but now it is as if they are relegated to the bench. Rate cuts are off the table for the time being (perhaps by summer?) and other issues (new policies) are grabbing the attention of investors and economists.  Keeping with our bouncing ball scenario, just as the ball loses steam and its ability to keep bouncing, so might the economy and that would force the Fed to act even if inflation does not immediately show signs of dropping significantly. The other element of the Fed’s dual mandate is employment and that has not been as much of a concern. Will that change, though, given a reduced federal government payroll and fewer migrants coming in? Only time will tell as to how well the economy absorbs those newly unemployed and the lack of new workers.

Outlook/Summary

Recently, I saw a graphic representation on Facebook (not referring to economics) that I think speaks to the momentum issue when it comes to investing. This first picture shows what happens when investing is based primarily on short-term momentum and not necessarily fundamentals. The ball can bounce dramatically higher but also faces steep drop-offs as the boomerang effect kicks in even though it fades over time.  

The second picture reflects a more consistent, long-term investing approach that is based more on fundamentals than momentum. It is easy to see how this approach has less dramatic highs and lows but is more consistent and persistent over time.

This second approach is one that we strive for. While it may not be as apparent in the graphics, there are negative periods as well and the reality is that the negative times can be just an inverse reflection of the pictures. We have seen this play out in real time over the past few years with dramatic highs (’23 and ’24) and dramatic lows (’22) while a more consistent approach navigated through both periods. 

We do expect this year to be more volatile, as we have already seen. Our process will not change, 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. In our opinion, sticking to a plan, investing to the level of risk you are comfortable with, and not letting the bouncing ball or short-term momentum drive you crazy 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 February 28th, 2025…. Unemployment data is through February for national, Madison (preliminary) and Wisconsin (revised) is through December, inflation data is through January:

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.

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