February 2025
US Economy: Sound so far.
U.S. economic data leaned positive in January, with estimated GDP growth for 4th quarter 2024 (+2.3%) narrowly missing expectations and some improvement in manufacturing and consumer data offsetting sticky inflationary signals. The ISM survey of U.S. manufacturers rose to 50.9 in an uptick started last fall, indicating expansion in 2025. Also, both personal income (+0.4 %) and spending (+0.7%) accelerated as consumer confidence remained upbeat. Meanwhile, inflation as measured by the CPI rose to 2.9%.
US Stocks: Crack in the AI story?
The S&P 500 finished January with an otherwise robust return, but the index gave back substantial gains late as DeepSeek, a Chinese AI startup, claimed its open source AI models match performance of the U.S. market leaders, but at a fraction of the cost to develop and maintain. The news led to a significant sell-off in U.S. tech stocks, particularly Nvidia (-10.6%) and others related to AI development. Still, communications (+9.1%) was the top sector as Meta up +17.7% on 21% revenue growth in 2024.
Foreign Stocks: Less tech a positive.
Non-U.S. developed markets (+5.3%) got the year off on the right foot with cheaper valuations and less sensitivity to the artificial intelligence story serving as a tailwind for Europe (+6.9%). Also, neither Europe nor the U.K. were immediately slated for tariffs by the Trump administration. Emerging markets did not perform as well, with India (-3.6%) a notable laggard on slowing growth and global trade uncertainty pushing up the U.S. dollar.
Fixed Income: Rate round trip.
U.S. interest rates initially spiked in January on concerns about inflation and U.S. deficits under Trump policies but finished lower as the AI story appeared to be less than a sure thing, driving investors toward the safety of the bond markets. The wildfires in Los Angeles contributed to some weakness in the California municipal bonds, which underperformed the national market by 0.4% in the month, but this does not appear to have broader market consequences.
Real Assets: Precious metals shine.
Commodities (+4.0%) led the real assets category for a second month on the shoulders of precious metals (+4.6%), which have performed well in light of concerns over tariffs and geopolitical uncertainty generally. Gold, in particular, had another strong month. Infrastructure equities (+2.3%) also performed relatively well with modestly declining interest rates, sticky inflation and better relative valuations all serving as tailwinds.
Alternatives: Private equity wait mode.
The private equity asset class is well known for a pattern of returns that lags public equity markets, both as markets tumble and as they soar. That pattern was certainly demonstrated in the last few years as private equity returns have generally trailed behind high-flying public equity markets. However, if history is a guide, that gap should close in the year ahead, which is likely to be a benefit to those who have added private equity in recent years.
Source of data: Bloomberg
Equities Total Return
| JAN | 3 MOS | 1 YR | |
|---|---|---|---|
| U.S. Large Cap | 2.8% | 6.2% | 26.3% |
| U.S. Small Cap | 2.6% | 4.5% | 19.1% |
| U.S. Growth | 2.0% | 9.4% | 32.2% |
| U.S. Value | 4.5% | 3.6% | 19.3% |
| Int’l Developed | 5.3% | 2.3% | 8.7% |
| Emerging Markets | 1.8% | (2.0%) | 14.8% |
Fixed Income Total Return
| JAN | 3 MOS | 1 YR | |
|---|---|---|---|
| Taxable | |||
| U.S. Agg. Bond | 0.5% | (0.1%) | 2.1% |
| TIPS | 1.3% | 0.2% | 3.0% |
| U.S. High Yield | 1.4% | 2.1% | 9.7% |
| Int’l Developed | (0.2%) | (0.1%) | 0.2% |
| Emerging Markets | 0.8% | 2.7% | 7.6% |
| Tax-Exempt | |||
| Intermediate Munis | 0.6% | 0.6% | 2.3% |
| Munis Broad Mkt | 0.2% | 0.6% | 2.0% |
Non-Traditional Assets Total Return
| JAN | 3 MOS | 1 YR | |
|---|---|---|---|
| Commodities | 4.0% | 5.4% | 9.1% |
| REITs | 1.0% | (3.7%) | 11.4% |
| Infrastructure | 2.3% | 1.1% | 21.6% |
| Hedge Funds | |||
| Absolute Return | 0.9% | 1.8% | 5.4% |
| Overall HF Market | 1.0% | 1.9% | 6.0% |
| Managed Futures | 0.5% | 3.4% | 0.9% |
Economic Indicators
| JAN-24 | JUN-24 | JAN-23 | |
|---|---|---|---|
| Equity Volatility | 16.4 | 23.2 | 14.4 |
| Implied Inflation | 2.4% | 2.3% | 2.2% |
| Gold Spot $/OZ | $2798.4 | $2744.0 | $2039.5 |
| Oil ($/BBL) | $76.8 | $73.2 | $81.7 |
| U.S. Dollar Index | 129.0 | 123.8 | 120.6 |
Our Take
The first inning of 2025 ended up being a notable one for financial markets with investors digesting a surge of Executive Orders following President Trump’s inauguration and the rising possibility of a trade war escalation, alongside the disruption of U.S. AI dominance and a pause on further interest rate cuts from the Fed with inflation elevated.
At the same time, a relatively strong U.S. economy and the current administration’s seemingly pro-business agenda warrants a balanced view of the upcoming year. With policies that appear conflicting in their economic impacts, at the very least 2025 is likely to be one marked by volatility.
Here are a few considerations that are top of mind:
- Revised rate expectations: The level and directionality of interest rates is likely at the center of the most severe economic and market scenarios for 2025. In fact, the steepness of the yield curve will likely be the dominant factor dictating whether the bull market in equities continues. Higher interest rates and a steeper yield curve imply higher inflation, higher cost of capital, lower consumer spending and lower equity valuations.
- Leadership and U.S. exceptionalism: Despite global uncertainties, what’s being called “U.S. exceptionalism” could continue to manifest among developed economies. The Trump administration’s pro-business stance could enhance America’s competitive position, while the country’s robust innovation ecosystem and geopolitical advantages reinforce its standing. However, a potential devaluation of the dollar due to fiscal irresponsibility, U.S. political dysfunction, the potential for declining innovation, or shifting geopolitical dynamics could erode America’s relative advantages.
- Trump administration policies: The administration’s telegraphed policies take a page from prior conservative administrations giving us a bearing if not a road map. In the short term, the fiscal policies could be a tailwind to growth at the possible expense of accelerated inflation and larger deficits. Also, the threat of tariffs may be a successful trade negotiation tool (albeit potentially eroding trust with our historically friendly trading partners and allies). That could lend support to U.S. equities, but it may create headwinds for interest-rate-sensitive investments like bonds.
- A new challenger in the AI arena: It didn’t take long before one of the foundational elements of U.S. exceptionalism was tested in 2025, with DeepSeek foretelling greater competition in the space. Optimistically, a lower-cost AI solution may mean the global economy realizes the promised productivity gains sooner than previously thought. Additionally, there’s an argument to be made that creating lower-cost AI training will improve ROI especially for software and internet companies as well as companies outside of tech.
- Financial market complacency. Financial markets look expensive in many areas and unanticipated developments, like the DeepSeek development, could relieve equity markets of both enthusiasm and their lofty valuations in dramatic fashion. Additionally, the threat of tariffs being directed at others such as the European Union, Asia and Latin America, could create an overhang on markets for a sustainable period of time.Such an unexpected shock to the system is always possible but be more likely during periods of higher uncertainty, where we find ourselves today. Some of our diversifying portfolio exposures are likely to hold up a bit better than others if we experience equity and/or bond market volatility from either expected or unexpected sources.
Thoughts on Portfolios
As you may already know, we do not trade based on headlines and definitely not those of the political variety. Market sentiment can shift quickly (as this past week yet again showed), and attempting to time decisions from Washington is a high-risk strategy. Since the future is unknowable, LNW portfolios are built in context of full market and economic cycles, balancing risks and opportunities across different scenarios – good and bad. As such, we infuse portfolios with a broad set of exposures that complement each other to navigate both short-term volatility and long-term structural changes in the geopolitical, macroeconomic and global trade landscapes.
