The broadening out of U.S. stock market returns continues, but it’s the direction of the economy that’s beginning to raise more questions. Inflation is showing signs of increasing while the first read on Q4 GDP missed expectations badly. Stock prices may be able to sustain on the back of gains from value and non-tech areas of the market, but weaker growth, a slowing labor market, and elevated inflation are the kinds of conditions that should have investors taking a cautious tone.
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Market Moves
Weekly Market Snapshot:
- S&P 500: +1.2% – market volatility ticked up a bit on Friday following the GDP and PCE data, but stocks stabilized and held on to gains.
- Nasdaq 100: +1.7% – tech stocks made a rare return to leadership this week, but the majority of the mega-cap names are still down year-to-date, acting as a significant drag on the major indices.
- Russell 2000: +0.5% – outperformance from tech & growth coincides in lagging performance from value-oriented small-caps, but this group is still gaining.
- VIX: 19.1 – volatility levels aren’t necessarily flashing warning signals right now, but they’re elevated enough to suggest there’s still lingering tension in the markets.
- Gold: +4.0% – gold prices resumed their climb in the second half of the week and are back above the key $5,000 level.
- 10-Year Treasury Yield: 4.09% – Treasury yields ticked up slightly higher following last week’s higher-than-expected inflation number, but they’re still hovering within a fairly tight range.
Drivers:
Up until Friday, there wasn’t a lot of major news to trade on, so stocks drifted higher. Market breadth hasn’t been this positive in years and is being somewhat overshadowed by the lackluster performance of the major averages. In reality, most stocks are doing fairly well this year, but you’d need to be invested outside of mega-cap tech to realize it. The magnificent 7 stocks were pulling the indices higher despite weak breadth over the past few years, but the opposite is happening now. The indices are being held lower by those stocks despite strong breadth.
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Economic Highlights
A couple of the notable themes that stood out this week:
Q4 GDP Comes in Way Below Expectations; Is the Economy Actually Slowing?
The Bureau of Economic Analysis (BEA) released its first read on Q4 GDP on Friday and it wasn’t good. The 1.4% growth rate was a significant drop from the 4.4% increase last quarter and well below expectations calling for a 3% annualized growth rate this quarter.1
The 6-week government shutdown will likely receive a lot of political blame for the slowdown, but the causes are fairly widespread. Government spending shrunk by 1% during the quarter, which was probably heavily influenced by the shutdown. Net export activity, which was expected to be a big growth driver, instead came in flat. Consumer spending held tough overall, but expectations for a larger contribution there slipped as the quarter wore on. Investment provided a minor boost.
Source: U.S. BEA
A few thoughts on this:
- The government shutdown almost certainly hurt GDP in Q4. It’s difficult to quantify, but it’s probably not as significant as feared.
- A lot of AI infrastructure spending by the big tech companies is very likely contributing to GDP growth rates over the past couple quarters. That likely continues into 2026, but could slow sharply towards the end of the year.
- Consumer spending is still holding up for now, but there are signs elsewhere that it’s being driven by more debt, not necessarily more income.
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The Fed’s Preferred Inflation Measure Shows Prices Are Increasing at a Faster Pace
The markets cheered the CPI earlier in the month that showed a surprisingly sharp drop in inflation. The PCE report, which is the Fed’s preferred inflation measure, suggested the opposite.
The headline rate ticked up to 2.9% in December, higher than expected, and hit its highest level since March 2024. The core rate moved up to 3%, its highest reading since April 2024.2
There are a couple of conclusions to make here.
First, it appears that inflation is still sticky and stubborn. But we do have to consider that the CPI report came from January and this report is for December. Next month’s PCE report could very well mirror the decline we saw in the CPI. But the core economic issues remain. Consumers are struggling with affordability and it’s still unknown when they’ll get sustainable relief.
Second, it’s going to be awfully difficult for the Fed to lower interest rates anytime soon. Recent statements from Jerome Powell have intimated that the central bank is more concerned with inflation than growth right now. That means a greater likelihood they’ll keep rates elevated to solve that issue barring a sudden collapse in economic growth.
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Trump Tariffs Get Struck Down by the Supreme Court
The odds were favoring this outcome, but we got the official decision from the Supreme Court on Friday.3
Because it was at least somewhat expected, the market didn’t have a significant reaction. But it will improve the economic picture. U.S. companies importing foreign goods should see immediate cost relief and that will improve their financial outlook. It should also take pressure off of tariff-linked inflation concerns that threatened to make things more unaffordable for consumers.
U.S.-Iran Tensions Grow; Oil Hits 8-Month High
The pressure from the White House to reach a deal with Iran regarding its nuclear could end up resulting in armed conflict over the next few weeks. The biggest fallout from this development thus far has been in the crude oil market where prices are hitting their highest level since August.
Source: Barchart.
The immediate concern would be supply shortages created by military strikes and potential sanctions. These types of geopolitical dust-ups are often short-term in nature and quickly reversed once tensions simmer down. The fact, however, that prices have been rising for the past two months suggests a longer-term supply shortage that could result in a production quota increase from OPEC+ later this year.
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The Week Ahead
A few themes to watch next week:
In Summary
For the most part, the U.S. equity markets are looking strong overall. Investors should keep watch on the latest inflation, growth, and employment data. While nothing is outright falling apart, all three are demonstrating some concerning trends. Stocks likely still have the ability to push higher based on current conditions. But there are indications of caution coming from multiple areas of the market that could turn worse if caution becomes fear.
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