February 2025 Commentary

Daniel Kahneman’s Thinking, Fast and Slow isn’t just a deep dive into human decision-making, it’s required reading at top business schools, ensuring that MBA students understand how cognitive biases shape our choices before they even step foot in the classroom. Kahneman, a Nobel Prize-winning psychologist, revolutionized the understanding of decision-making by showing how the way information is framed can lead to drastically different conclusions, often influencing behavior more than the facts themselves. That concept couldn’t have been more relevant in February, a month where market volatility was driven as much by perception as by reality.

The S&P 500 finished the month down -1.4%, led lower by a risk-off sentiment that weighed on the Technology sector (-1.4%) and even more significantly on Consumer Discretionary stocks (-9.4%). The latter was particularly hard-hit due to fears of tariffs, though at this point, they are more "phantom" than real. The newly elected Trump administration has loudly signaled aggressive trade policies, but so far, the only actual tariff enacted has been a 10% levy on Chinese imports. Despite the lack of concrete actions, markets have been reacting as if a full-scale trade war is already underway. It’s a textbook example of how framing and narrative shape investor behavior, leading to risk aversion and sector-wide sell-offs.

And if all of that wasn’t enough to put the market on edge, even Punxsutawney Phil saw his shadow, adding to February’s collective jitters. Whether it was tariffs, inflation concerns, or the overwhelming negative sentiment that has permeated financial headlines since the start of the year, it seemed as though investors, much like Phil, were scared back into their burrows.

But before we let the doom-and-gloom headlines take over, it’s important to recognize the positives that emerged beneath the surface. Corporate earnings remained strong, reinforcing a fundamental anchor for equities. Bond yields declined, signaling that at least the bond market sees inflation as under control. Corporate credit spreads, often a proxy for risk, hit all-time lows, suggesting that financial markets aren’t pricing in major concerns. And despite the volatility, equity markets still reached new all-time highs. As we dig into the month’s economic data, it’s clear that while fear casts a long shadow, there are still reasons for cautious optimism.

February kicked off much like the rest of 2024, showing resilience in the job market, but with signs of gradual cooling. The U.S. economy added 143,000 jobs in January, a slowdown from the previous two months and below economists’ expectations of 169,000. However, revisions to November and December data revealed 100,000 more jobs than initially reported, reinforcing that the labor market remains solid. The unemployment rate edged down to 4%, coming in better than the 4.1% forecasted, and continues to hover near historically low levels.

This report also marked the final employment update of the Biden administration before newly elected President Trump takes the reins. With policy shifts on the horizon, including the prospect of new tariffs and corporate tax cuts, labor market dynamics could change in the months ahead. While the Labor Department reported that the Los Angeles wildfires and extreme cold weather had no measurable effect on employment data, some economists pointed to a dip in leisure and hospitality payrolls and only a modest increase in construction jobs as indirect signs of disruption. Looking forward, the fires may yet have an impact, as 0.5% of California’s population was under evacuation orders. Meanwhile, annual revisions to past employment data revealed a mixed picture as job creation in the year through March 2024 was lower than initially reported, but the overall number of employed Americans was higher than previously estimated.

If the jobs report offered a reassuring look at economic resilience, inflation data painted a more complex picture, though, how this information is framed matters. January often delivers higher inflation readings, and this year was no exception. Consumer prices rose 0.5% from December, the sharpest increase since August 2023 and well above economists' forecast of 0.3%. The annual inflation rate ticked up to 3%, up from 2.9% in December. Core inflation, which strips out volatile food and energy prices, climbed 0.4% month over month, marking its fastest rise in nearly two years. A notable culprit? Egg prices surged over 15%, the steepest monthly jump since 2015, driven by a bird flu outbreak.

Federal Reserve Chair Jerome Powell acknowledged the inflationary pressures in a congressional hearing following the report, stating “We are close, but not there on inflation… So we want to keep policy restrictive for now.” His comments reinforced the idea that rate cuts are unlikely in the immediate future.

Yet, in line with the broader theme of market volatility, February’s data delivered another twist. The personal consumption expenditures (PCE) price index, the Fed’s preferred inflation gauge, showed a more moderate 2.5% increase year-over-year, aligning with expectations. This was a welcome contrast to the hotter-than-anticipated CPI report earlier in the month. The PCE data suggests that while inflation remains sticky, it is not spiraling out of control. Importantly, the Fed has signaled it is in no rush to cut rates, opting for a wait-and-see approach before making policy adjustments.

The Conference Board Leading Economic Index (LEI) for the U.S. declined 0.3% in January to 101.5, erasing most of December’s modest 0.1% gain (which was revised upward from an initial estimate of a slight decline). However, the bigger picture shows signs of stabilization. Over the past six months, the LEI has fallen by 0.9%, a notable improvement from the 1.7% decline seen in the previous six-month period.

According to Justyna Zabinska-La Monica, Senior Manager of Business Cycle Indicators at The Conference Board, the January decline was largely driven by weaker consumer expectations for future business conditions and a slight reduction in manufacturing work hours. However, not all the data was negative. Manufacturing orders, which had been a persistent drag on the Index since 2022, have nearly stabilized, and, perhaps most importantly, the yield spread contributed positively for the first time since November 2022. In fact, only four of the LEI’s ten components were negative for the month, suggesting that while headwinds remain, they may be easing.

Despite the month’s decline, the six-month and annual growth trends of the LEI are improving, indicating milder obstacles ahead for economic activity. The Conference Board currently forecasts U.S. GDP growth of 2.3% in 2025, with stronger momentum in the first half of the year. While uncertainty remains, particularly around policy changes and market sentiment, the overall outlook suggests that the economy is on a steadier footing than many fear.

If there’s one lesson from Daniel Kahneman’s Thinking, Fast and Slow that investors should take to heart, it’s the distinction between System 1 and System 2 thinking. System 1 is fast, emotional, and instinctive, while System 2 is slow, deliberate, and analytical. In volatile times, investors often let System 1 take over by reacting to headlines, sentiment swings, and short-term market moves. But the best investment decisions come from engaging System 2 by stepping back, assessing the bigger picture, and making rational, well-anchored choices.

The recent downturn in consumer confidence surveys is a perfect example of how sentiment, rather than hard data, can drive market narratives. The University of Michigan’s consumer sentiment index dropped significantly, with expectations for future inflation rising. The Conference Board’s confidence survey painted a similar picture where consumers felt fine about their current situation but were increasingly anxious about what lies ahead. And yet, while surveys provide insight into how people feel, they are often poor predictors of actual economic activity. Hard data, like January’s solid jobs report, ongoing corporate earnings strength, and the fact that the S&P 500 hit new all-time highs twice in February, tells a different, more balanced story.

Much of the uncertainty stems from U.S. policy shifts, particularly around tariffs. Tariff announcements have created noise, but the actual implementation has been measured. The 10% tariff increase on Chinese goods is in effect, but proposed tariffs on Mexico and Canada appear likely to be delayed or watered down as negotiations continue. Investors should recognize that while trade headlines will continue to drive short-term market swings, System 2 thinking reminds us to distinguish signal from noise.

We expect the first half of the year to be more volatile for stocks due to ongoing policy uncertainty and the strength of the U.S. dollar. However, opportunities remain for investors who look beyond broad market movements and focus on specific areas of strength. A selective approach will be essential. Financials are positioned to benefit as elevated interest rates continue to support profit margins. In technology, software appears to have stronger potential than semiconductors, which are more exposed to cyclical downturns. Within the consumer sector, media and entertainment offer better prospects than traditional consumer goods as spending shifts toward services. Consumer services are also likely to outperform discretionary goods, as higher costs and tariffs create additional pressure on imported products. Across all industries, we continue to favor companies with strong earnings visibility and pricing power, which should provide stability and resilience in a market that is still navigating short-term disruptions and long-term structural shifts.

As we head into March, uncertainty will persist, with policy developments, economic data, and shifting market sentiment continuing to drive volatility. But just as the Fed remains patient in its approach to inflation and rate policy, investors should take a measured, wait-and-see stance, resisting the urge to react impulsively to every headline. Market narratives can change in an instant, but sound investment principles remain constant. Focus on quality, think long-term, and let System 2, not System 1 guide your decisions. In the end, those who don’t fear their shadows in February often find brighter opportunities in the months ahead.