New Trade Tensions Send Stocks Lower

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

Markets ended the week lower amid new trade tensions between the United States and China. President Trump on Friday took to Truth Social to announce an additional 100 percent tariff on products from China and export controls on all critical software, saying he was responding to an “extremely hostile letter” in which China stated it would impose large-scale export controls on virtually all products.

Uncertainty about tariffs’ longer-term impact cloud the economic and market picture. As of the end of September, the estimated overall average tariff rate was 17.9 percent, the highest level since 1934. The economy’s resilience to this point has been partly a result of imports, inventories and consumption being pulled forward earlier this year in anticipation of the tariffs’ implementation. We believe tariff effects may continue to emerge in the coming months.

Minutes from the Federal Reserve’s September meeting reflect the prevailing uncertainty about the economy and where it is headed. The Fed cut rates at that meeting, and the minutes show that most policymakers agree it would be wise to cut rates further over the remainder of the year. However, policymakers disagreed about whether there should be two or three rate reductions this year, and a handful said they would have supported a decision to keep rates unchanged, fearing that cuts could embed long-term inflation into the economy.

The federal government shutdown that began on October 1 continued last week. The shutdown’s economic impact is significant: With about a quarter million federal employees missing out on paychecks this week and another 2 million expected to lose paychecks next week, the shutdown is likely shaving 0.1 to 0.2 percent a week off the U.S. gross domestic product (GDP).

It has also brought government-produced economic data to a halt. Already this month, the Bureau of Labor Statistics (BLS) has not published its highly anticipated jobs report. As we discussed in last week's commentary, the lack of robust, up-to-date data makes it harder for policymakers to pinpoint the biggest risks to the economy and determine the best path for interest rates. In a sliver of good news, the BLS announced this week that it would bring back some workers so they can produce a Consumer Price Index report by October 24, in time for the Federal Reserve’s October 29 meeting.

Of course, government data doesn’t tell the whole story. The data we track continues to indicate a combination of rising inflation and a faltering labor market. However, headline economic growth appears to be remaining robust for now, with the GDPNow forecasting model from the Federal Reserve Bank of Atlanta estimating GDP growth of 3.8 percent for the third quarter. Yet this same period saw cooling job growth, lower labor force participation and weakening job demand. These trends won’t continue forever; sooner or later, either the labor market will rebound or economic growth will slow. “You can’t have negative job growth and 4 percent GDP growth,” Christopher Waller, governor of the Federal Reserve Bank of New York, told Squawk Box Friday. That economic equation is not sustainable, he added.

With the government closed, the most notable economic data out last week was the latest University of Michigan preliminary Consumer Sentiment report. Its findings are consistent with the unusual nature of today’s economy, in which inflation fears are rising while the labor market is weakening. It also calls into question whether consumer spending, which has been fairly robust in recent months, will maintain its strength.

Sentiment was largely unchanged from September, falling from 55.1 to 55.0. These numbers are historically low, with most consumers feeling a general lack of optimism about the economy. “Pocketbook issues like high prices and weakening job prospects remain at the forefront of consumers’ minds,” the report noted. “At this time, consumers do not expect meaningful improvement in these factors.”

The percentage of households expecting the unemployment rate to rise over the next year dipped slightly, from 65 percent to 63 percent. The figure remains historically elevated, at a level that traditionally has been coincident with rising joblessness. In a related finding, nearly 23 percent of consumers believe their husband or wife will lose their job in the next five to 10 years, only slightly below the figure at the height of the pandemic in 2020. Meanwhile, year-ahead inflation expectations remain unusually elevated at 4.6 percent, a slight downtick from last month’s 4.7 percent. Expectations for annual inflation over the next five years—which Fed officials watch closely—stayed unchanged from September at 3.7 percent, representing an increase from 3.4 percent in July. Besides this year’s March through June period, these are the highest inflation expectations since 1993.

Interestingly, consumer pessimism does not extend to the stock market. The median value of respondents’ stock holdings reached a record $305,000. We continue to note that the rise in equity markets since the beginning of 2023 has been driven by a narrow and concentrated group of stocks: Only 28 percent of the companies in the S&P 500 beat the index in 2023, 32 percent in 2024, and 38 percent in the first three quarters of 2025, compared to an average of 49 percent since 1973. The past two years mark the narrowest advances on record, tied with 1998 and 1999. A similar story played out at that time, with internet stocks playing the role AI stocks have recently. In fact, the technology sector’s percentage of the S&P 500’s market capitalization this quarter surpassed the level last reached in 1999.

The past few weeks have witnessed an uptick in investors noting the connections between the current market and the market of 1999. We believe there are echoes, as we discussed in our recent quarterly market commentary. But we continue to think the emotionally charged discussions in the media miss the most important lessons. First and foremost, investors should avoid the urge to concentrate in any one part of the market and instead should stay diversified across many asset classes while maintaining an intermediate- to long-term view. We believe market leadership will broaden, much as it did 25 years ago, as the benefits of artificial intelligence spread throughout the economy, boosting the fortunes of companies across industries. Consider that more than 60 percent of stocks outperformed the index each year between 2000 and 2002, and more than 50 percent outperformed in 2003 through 2005.

We also see opportunities to invest in Small- and Mid-Cap stocks, enhancing our conviction that the market is likely to broaden. These sections of the market have cheap relative valuations, which historically have corresponded with leadership over intermediate- to longer-term time periods. In the 25 years since 1999, Small- and Mid-Cap stocks have outperformed the Large-Cap S&P 500 by 2.0 percent and 1.8 percent, respectively, on an annualized basis.

Whatever happens in the coming weeks and months, we advise investors to stay the course with a long-term, diversified strategy.

Wall Street wrap

Due in part to the government shutdown, last week was unusually light on economic data relevant to investors. The most salient data came from the University of Michigan preliminary Consumer Sentiment Report, which we cover in the commentary above. As we wait for the shutdown to end and more government-backed data to be released, we’ll be closely monitoring data from other sources. Additionally, third quarter earnings season gets underway with the big banks headlining the list of companies reporting.

The week ahead

Tuesday: The NFIB Small Business Optimism Index will be released. This index perked up in 2025. After spending all of 2022 and 2023 and the first 10 months of 2024 under the 50-year average of 98, it has exceeded that level in eight of the past 10 readings. We will be watching to see if that trend continues, and we will be looking for clues on sales trends, price pressures and employment.

Wednesday: The Federal Reserve will release its Beige Book, which summarizes anecdotal information about current economic conditions gathered in each district in advance of Fed meetings. The August Beige Book showed little or no change in economic activity in most districts, with flat to declining consumer spending as wages failed to keep up with rising prices. Employment was weak, with firms hesitant to hire workers given weaker demand and employers in multiple districts reducing headcount through attrition. Given the lack of other data, the contents of the Beige Book may play an important role in the Fed’s decision-making framework at its next meeting.

Thursday: The National Association of Home Builders will release its Housing Market Index. High mortgage rates have weighed on the housing market. This index has spent 23 of the past 25 months under 50—a reading that indicates contraction—with historically low readings of 32 the last two months. We will be watching to see if the recent move lower in interest rates increases homebuilder optimism.

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