February 2025 Market Outlook

By Brian Andrew, CFA® – Chief Investment Officer

I spent time in NYC this week, attending a research conference, hosted by a $680 billion global asset manager. The conference was held at the New York Stock Exchange. The meeting started with a market history about the exchange and then ringing the opening bell. I stayed at the Wall Street Hotel, on the site where, in 1790, a group of 25 individuals signed the Buttonwood Agreement (beneath a buttonwood tree) which began the long history of trading securities on Wall Street (the actual agreement is encased on display at the Exchange). Hearing the history, I was reminded how remarkable the system of capital allocation is in this country and how much the markets have seen over the span of time.

We heard from the organization’s head of government affairs, Chief Interest Rate Strategist, municipal bond portfolio managers, Director of Equity Research, a stock portfolio manager and their head semiconductors analyst who had a lot to say about the artificial intelligence (AI) trend. Attendees were from across the country and we discussed market trends, politics and how our firm’s clients are being affected by the news.

Government Affairs

Listening to someone who actually understands how laws are made and the machinations of Washington D.C. provided perspective on current political events. I was surprised to learn that this Administration has issued fewer Executive Orders (59) than the Clinton Administration (364) though it is only the first month.

On the subject of tariffs, she explained that the Administration is using an approach which requires a review of the impact of new tariffs by the Office of Management and Budget before implementation. This approach takes time and provides an opportunity for negotiation and evaluation of a tariff’s impact.

As investors, we want to model the potential for price inflation. A tariff’s impact can be both on consumers and companies. When importing goods, a company paying a tariff may choose to pass the additional cost onto its customers or reduce its profit margin.

Knowing who is affected and being able to track the potential impact on profits affects our stock allocation decisions. The portion passed onto consumers can impact inflation in certain sectors and we’ll want to understand that impact.

We use software tools to do this modeling. As news about tariffs comes out we understand the potential impact before it is actually seen. We also have the ability to model a potential increase in inflation, its effect on interest rates and the subsequent effects on our bond portfolio.

We cannot predict the future nor what the Administration may do. We can however, understand the impact of proposed policies on our portfolios and the assets within them.

Interest Rates

It may seem to you that we obsess about the level of interest rates. That is because through time, they impact asset prices, not just bonds, but also the value of stocks, real estate and other commodities as well as affecting the cost of capital for consumers and corporations alike.

This Chief Interest Rate Strategist discussed the impact of interest rate movement to help us manage client portfolios. The organization uses a simple model based on the Federal Reserve’s two primary objectives; full employment and price stability.

He explained that should inflation (price stability) remain below 2.5% and unemployment below 5% then our economy will likely continue to grow at a reasonable pace of 2% and interest rates will drift lower (the 10-year Treasury is 4.5% and could fall to 3.5%). However in their view, what’s more likely is that inflation remains above 2.5% and unemployment approaches 5% in which case interest rates won’t move much from here.

This scenario is similar to our own. For most clients, we can continue to have bond portfolio average maturities of 4-4.5 years and emphasize the bonds that provide yields above which we earn in Treasuries such as corporate bonds and mortgage backed securities. Remember, after several years of very low interest rates, we can now earn 5-6% on those types of securities without taking too much maturity risk. Most importantly, they reminded everyone that bond returns tend to settle in at the level of the starting yield so we’re looking at better outcomes given where rates are today.

The municipal bond manager emphasized the fact that tax-exempt bonds of this nature are particularly attractive now for clients who are investing money that produces taxable income.

Research And Stocks

The Director of Equity Research and stock portfolio manager spoke together. They noted that their firm has over 200 analysts following almost 1000 companies very closely. Insights from these individuals provides valuable information to the portfolio managers who are responsible for picking the stocks that go into their mutual fund portfolios and ultimately into our client portfolios. I often say when asked how many people are on our investment team that while we have 10 working at Merit there are 1000’s across all the investment organizations we partner with.

We discussed large and small company stocks. They noted that some large company stocks will benefit from continued investment in technology and artificial intelligence infrastructure, and those that will use this new technology to improve productivity. He said this period could be similar to the 1990’s when personal computers and the internet led to productivity improvement nearing 4% per year, strong economic growth and a reduction in federal deficits as tax receipts grew from this strong economy.

The research director said themes of U.S. exceptionalism (i.e an economy performing better than most developed countries with a technology base well ahead of most) and reshoring of manufacturing aided by tariffs and increasing overseas costs could produce benefits for smaller companies.

In our view this is true, though we believe we need to see more evidence of corporate profit growth among small companies before adding to that part of the market. The burgeoning economy and global beneficiaries from that growth, for now, are the larger organizations we emphasize in stock portfolios.

Artificial Intelligence

The technology analyst provided great perspective on this theme. He noted that we are moving from the stage where large language models (LLM’s) are learning to reason and that while this will improve the use of AI dramatically it will take time. It will also take increased infrastructure which is why the likes of Microsoft, Alphabet and Amazon are spending 10’s of billions of dollars building out the cloud and computing power necessary to run more sophisticated models. As a semiconductor analyst, he predicted that we could see a doubling of the $530 billion chip market in 4 years!

He also provided examples of how AI use is improving outcomes for researchers and engineers allowing them to already plan buildings and infrastructure development in less time. We’re also seeing improvements in the effectiveness of health care research such as in the pharmaceutical industry. These are examples of the productivity gains I referred to earlier.

Our portfolios have investments in all of these areas and we will continue to monitor this long-term theme’s progress and how the portfolio managers we use invest in it on our clients’ behalf. Imagine, starting the session learning about the history of capital markets trading in 1790 and then discussing the benefits of artificial intelligence and how to deploy our clients investments to benefit. Certainly a worthwhile excursion to gain greater understanding of how best to position your portfolios.

If you have any questions, don’t hesitate to reach out to your Merit financial advisor for personalized guidance.

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