AI Fears, Iran Conflict Fuel Market Volatility

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

A light week in economic data brought no shortage of action in the final week of February as investor worries over hotter than expected inflation data and the sustainability of the artificial intelligence (AI) trade contributed to the Nasdaq’s worst monthly performance in nearly a year. The tech-heavy index finished the week down 0.95 percent and down more than 3.3 percent for the month, while the S&P 500 ended the month down 0.76 percent. The silver lining was another pullback in interest rates that pushed the 10-year Treasury to 3.94 percent, the lowest level since October 2024, while the two-year Treasury fell to the lowest level since August 2022.

The sell-off began on Monday as a widely circulated—and completely speculative—blog post from Citrini Research titled “The 2028 Global Intelligence Crisis” described a doomsday scenario in which autonomous AI eliminates jobs and triggers a broader downward economic spiral. The “research report” may have been purely a work of dystopian fiction, but it was enough to spook markets while raising more legitimate questions over how AI will reshape the economy and the hundreds of billions of dollars required to sustain its technological infrastructure.

While we acknowledge that AI will likely disrupt companies and industries just like other technological innovations have throughout history, we also believe it will lead to increased productivity that will not only create new jobs but also increase our overall standards of living. We also believe that in the long term, AI winners will shift to other areas of the economy, with the benefits ultimately accruing a broader set of companies that use it to increase the productivity of their workers and profitability of their companies.

In the short term, however, there will inevitably be more uncertainty ahead, as military conflict in Iran, continued growing fears over heightened risk in private credit markets and a hotter than expected reading on Producer Price Index (PPI) inflation for January—which showed wholesale prices rising faster than economists anticipated—weigh on investor sentiment. Not even strong earnings from Nvidia on Wednesday could quell the tech pullback, as the information technology sector of the S&P fell 2.2 percent, leaving it down 3.9 percent for the month and 5.5 percent for the year. Interestingly, we note that the sector is now down 11.3 percent from its October 29, 2025 high.

With technology representing 33 percent of the S&P 500, the recent pullback has weighed on its overall return. However, it’s important to note that the broad-based index has been flat since its October high, leaving other sectors to do more of the heavy lifting. Interestingly, 68 percent of the 500 companies listed on the S&P 500 have beat the index return since October 29. Meanwhile, the equal-weighted S&P 500, which takes out much of the concentration risk, is currently up 9.4 percent after closing at an all-time record high on Friday. Similarly, Small- and Mid-Cap stocks are up around 10 percent, while international developed stocks have risen 12.9 percent—further signs of the market broadening that we have consistently forecasted as the benefits of lower interest rates and AI filter beyond tech and into new sectors.

This is the delicate balance that we have been pointing to, not only in the markets but also in the economy. Interest rates have pulled back sharply, which has likely helped alleviate some of the pressure on more rate-sensitive companies and consumers as the bifurcated market that has defined the past three years grows increasingly less segmented.

Indeed, the 10-year Treasury dropped below 4 percent to 3.94 percent on Friday, falling well below its recent peak of 4.8 percent in January 2025 in a signal of economic broadening as investors move beyond “safe-haven” government bonds and into riskier, more growth-oriented assets. The two-year Treasury fell as low as 3.37 percent, the lowest level since August 2022, when the Federal Reserve was in the midst of its most aggressive interest rate-raising campaign in four decades in an effort to curb post-pandemic inflation, which peaked at 9.1 percent in June.

While rates have been pushed lower amid cuts from the U.S. central bank, this dynamic could shift at any time. While the lower interest rate environment has helped broaden the markets and economy, it is also the product of weakness in the labor market—which could threaten to hinder economic growth should the scales shift too far in one direction. Meanwhile, inflation continues to hover above the Fed’s 2 percent target, a reality further cemented by last week’s hotter than expected PPI data as service sector companies pass along costs to consumers at the highest pace since 2009.

Recent core Personal Consumption Expenditures (PCE) data showed that cost inflation rose 3 percent year over year in December 2025, an acceleration from the 2.8 percent rate seen in November and October and unchanged from the 3 percent year-over-year rate at the end of 2024. It’s also only slightly below the 3.1 percent reached at the end of 2023, meaning that the Fed has made essentially no progress toward reaching its 2 percent inflation target over the past two years. Should inflation reignite, the Fed could opt to raise interest rates in an effort to slow economic activity and prevent inflation from becoming entrenched.

These contrasting realities highlight the delicate balance currently facing financial markets and the global economy. U.S. and Israeli strikes on Iran added to that uncertainty over the weekend and into Monday, prompting retaliatory strikes and raising fears of a prolonged regional war. Oil and gas prices have seen their biggest jumps in years due to the effective closure of the Strait of Hormuz, a key chokepoint for 20 percent of the world's oil. Brent crude jumped over 8 percent in early trading on Monday. Meanwhile, equities and U.S. futures slid as investors attempted to de-risk.

However, we implore readers not to panic-sell, but to lean on diversification and a long-term outlook.In times of market volatility, the primary tool for managing this risk continues to be a well-balanced basket of assets. By maintaining a disciplined, long-term focus and following professionally crafted asset allocations, investors can remain aligned with their specific financial goals.

We believe that as markets broaden beyond a few narrow leaders, diversification will serve its traditional role in risk management while potentially enhancing returns. We expect previously underinvested areas of the U.S. and global markets to provide stronger relative performance moving forward.

Wall Street wrap

PPI rises as companies pass on tariff costs: Producer Price Inflation (PPI) came in hotter than expected last week, with the headline index for final demand rising 0.5 percent in January (topping analysts’ expectations of 0.3 percent) and 2.9 percent over the past year versus expectations of 2.6 percent. The monthly increase was driven mainly by higher services prices, especially wider margins for wholesalers and retailers, while goods prices declined modestly. Core PPI, the Fed’s preferred inflation gauge that excludes more volatile food and energy prices, jumped 0.8 percent for the month and 3.6 percent annually versus Wall Street’s estimate of 3.0 percent, underscoring persistent underlying inflation in the production pipeline.

The cost of final-demand services increased 0.8 percent in January, according to the report, its largest monthly advance since July 2025 fueled primarily by increasing profit margins for wholesalers and retailers. Trade services, which measure margin fluctuations between wholesalers and retailers, rose by 2.5 percent, while margins for professional and commercial equipment wholesaling surged 14.4 percent, suggesting that companies are attempting to pass along tariff-related costs to consumers.

While the January reading for PCE inflation has been delayed until mid-March due to the government shutdown, certain elements of the PPI data that flows into PCE—portfolio management costs, airfares and physician costs—rose firmly, suggesting some upside potential to PCE when it is released on March 13.

Overall, the latest reading from the U.S. Bureau of Labor Statistics suggests that price pressures remain entrenched early in 2026, complicating the Federal Reserve’s efforts to confirm that inflation is consistently moving back toward its eventual 2 percent goal.

Consumer confidence rises modestly despite labor concerns: Conference Board Consumer Confidence data for February 2026 showed a modest improvement in U.S. sentiment after a sharp downturn in January. The overall index rose 2.2 points to 91.2 from a revised 89 in January, though it remains well below its recent peaks. The Expectations Index, which captures views on short-term income, business conditions and job prospects, climbed 4.8 points to 72, while the Present Situation Index, which reflects current economic and labor conditions, edged down 1.8 points to 120. While overall confidence improved slightly during the month, the latest readings remain in a downtrend, with the current conditions index at the lowest level since March 2021, when the economy was beginning to emerge from COVID.

A key component of the report is the much-watched labor market differential, which measures the gap between consumers saying jobs are “plentiful” versus “hard to get.” In February, 28 percent of respondents said jobs were plentiful (up from 25.8 percent in January), and 20.6 percent said jobs were hard to get (up from 19.0 percent), resulting in a labor differential of +7.4 percent. While this was a slight uptick from January’s six-year low of 6.8 percent, this measure continues to trend downward from its peak of 47.1 in March 2022 (when the Fed began raising rates) and last February’s 17.6, which continues to point to potential future labor market weakness.

CEO optimism rebounds, but labor concerns remain: Last week the Conference Board published its CEO Confidence report, reflecting a significant rebound in sentiment among U.S. chief executives to start the year. The headline CEO Confidence Index jumped 11 points to 59 in the first quarter 2026, up from 48 in Q4 2025, a notable positive shift, as readings above 50 indicate more CEOs view conditions favorably than unfavorably. The quarterly survey of 142 CEOs conducted from February 3–16 found that 39 percent of executives now say general economic conditions are better than six months ago, up from 20 percent last quarter, while only 8 percent see conditions as worse.

Similarly, more CEOs reported improved conditions in their own industries, and expectations for both the overall economy and industry over the next six months shifted from slight pessimism to moderate optimism. CEOs also signaled a marked increase in anticipated capital spending, with about 35 percent of respondents planning to raise investment.

In a sign of the delicate balance between a softening labor market and inflation concerns, however, hiring intentions ticked slightly lower, with 31 percent of respondents expecting to expand workforces, which remain near the lows of this economic cycle, pointing to continued labor market concerns. Meanwhile, more than 70 percent of CEOs saw costs rise because of tariffs. Of these, some have absorbed the added cost into their margins. But a majority have either passed the tariff cost to customers or reported plans to do so in the future. This presents an upward risk to inflation in 2026, which is likely to be compounded by the weaker U.S. dollar.

The week ahead

Monday: The Institute for Supply Management’s (ISM) Manufacturing Purchasing Managers’ Index (PMI) report for February 2026 is scheduled to be released at 10:00 a.m. EST on Monday, March 2.

The ISM Manufacturing PMI unexpectedly rose to 52.6 in January, jumping from 47.9 in December and signaling a return to expansion in the factory sector after months of contraction amid a new influx of new orders and production. Meanwhile, the January ISM Services PMI stayed robust at 53.8, indicating solid growth in the services sector.

Wednesday: The ISM Services PMI report for February 2026 will be released at 10:00 a.m. EST. January’s data showed unexpectedly strong growth with a reading of 56.0 percent, much higher than economists expected. We’ll be watching to see if both indices can manage to remain in expansion territory.

Separately, Federal Reserve will release its Beige Book at 2:00 p.m. EST, around two weeks ahead of its next Federal Open Market Committee policy meeting in mid-March. The report will cover economic activity and trends from late January through February, providing qualitative insights from business and community contacts across all 12 Federal Reserve districts on economic conditions, including growth, labor markets, prices and spending, as the Fed ponders its next monetary policy moves.

Friday: Next week’s key federal employment data release is the U.S. Employment Situation report, scheduled for 8:30 a.m. EST. January’s report, which showed around 130,000 net jobs added—an improvement from late 2025—and an unemployment rate of about 4.3 percent.

In addition, the U.S. Census Bureau will release its Advance Monthly Retail Trade Report for January 2026 at 8:30 a.m. EST. Headline retail sales were flat in December after a 0.6 percent gain in November, while year-over-year retail sales increased about 2.4 percent, the smallest annual advance since late 2024, suggesting a slowing in consumer spending momentum heading into 2026.

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