Inflation, interest rates, and tariffs
What fueled the modest advance in the S&P 500 Index in January? Well, for starters, the narrative hasn’t changed that much since the calendar flipped to 2025. That is, with the exception of tariffs, which we will get to in a moment.
Fueled by higher consumer spending, the economy is expanding, as evidenced by an annualized increase of 2.3% in fourth quarter Gross Domestic Product (GDP, according to the latest data from the U.S. Bureau of Economic Analysis.
Meanwhile, corporate profits are exceeding expectations, per data from LSEG, and inflation, while still elevated, isn’t showing signs of accelerating.
The Fed catches its breath
As was widely expected, the Federal Reserve held the fed funds rate at 4.25–4.50% at its end-of-January meeting, and Fed Chief Powell signaled the Fed is in no hurry to reduce interest rates.
But he didn’t close the door to further rate hikes this year, even as prospects for future rate cuts this year are currently limited.
But last month did provide some unexpected drama. On Monday, January 27th, a Chinese start-up announced that its DeepSeek’s AI models offered performance to the world’s AI programs at a fraction of the power and energy.
Semiconductor shares tumbled, and Nvidia (NVDA $120, 1.31.25), which is one of the largest stocks in the S&P 500 Index, shed 17%, or nearly $600 billion in market cap, per CNBC.
While the Nasdaq Composite and the S&P 500 Index ended the day down sharply, the Dow closed up, according to MarketWatch.
Notably, Bloomberg reported that a majority of S&P 500 stocks ended the day higher despite the sharp decline in the S&P 500. Over the past 20 years, there has never been a positive advance/decline when the S&P lost 1.5% or more.
In other words, the selloff wasn’t simply indiscriminate selling. Instead, it was a rotation out of several tech winners and into market underperformers.
It is yet to be determined how the DeepSeek announcement will unfold for the rest of the year.
Investors take stock of tariffs
That brings us to the February 1 announcement by President Trump that he planned to enact a 25% tariff on Canadian and Mexican imports and a 10% tariff on imported goods from China. Oil would be taxed at 10%.
Canada and Mexico struck deals with the Administration that secured a 30-day pause in new tariffs on their products. China imposed new tariffs on a few U.S. products.
The prospect of such sweeping barriers to trade unsettled investors amid concerns such levies will boost prices and home and slow economic growth.
Why are investors fretting over new trade barriers?
Well, there is no modern precedent for such action, and it’s difficult to predict how a trade war, once it starts, might conclude.
You see, the market is worried that significantly higher taxes on imported goods will drive inflation higher, while the likelihood that Mexico and Canada will respond in kind with their own tariffs could sap demand for U.S. exports.
In other words, investors are concerned that we could see higher inflation and slower economic growth, at least over a shorter period. In turn, that could force investors to re-evaluate U.S. economic prospects.
Legal experts have said that the president, who referenced the International Emergency Economic Powers Act (IEEPA) for the new levies, will likely encounter challenges in court, as the tariffs are not industry-specific and instead are quite broad.
However, courts have traditionally deferred to presidents during emergencies. Thus, it’s uncertain how courts may ultimately rule.
Some analysts believe the president is enacting tariffs strategically, with no intention of maintaining them over an extended period. Others, however, point to Trump’s positive remarks about the benefits of tariffs and the necessity to generate revenue to reduce the deficit and fund his proposed tax cuts.
While the trade situation is fluid and could quickly change, the good news is that the U.S. economy is resilient and is less dependent on trade compared to many of our trading partners.
Final Thoughts
As we wrap up this month’s letter, we would like to emphasize what we discussed last month.
A diversified portfolio cannot completely shelter you from market pullback, but it can help lower volatility and has historically been the most effective path to achieve one’s financial goals.
Our approach is guided not only by our experience but also by the weight of academic research. We recognize that stocks are not immune to periods of subpar returns, but patient and disciplined investors have historically been rewarded.
I trust you have found this review to be informative. If you have any inquiries or wish to discuss any other matters, please don’t hesitate to contact me or any team member.
February 2025
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. All performance referenced is historical and is no guarantee of future results. All indices are unmanaged and may not be invested into directly.
The economic forecasts set forth in this material may not develop as predicted and there can be no guarantee that strategies promoted will be successful.
