3 factors driving market volatility: How to handle the uncertainty

Volatility across stocks has risen this year, largely due to elevated expectations and valuations for a few mega-cap U.S. companies, anxiety about tariffs and their influence on growth and inflation, falling consumer/investor confidence levels and continued elevated interest rates.

Below we look at three potential drivers of market volatility in the near term and share how investors can navigate a more uncertain landscape.

1. Tariff uncertainty

Tariffs — what effect will they have? Unfortunately, it's a question investors may be grappling with for some time, adding an element of uncertainty in the market that makes forecasting growth, profits and global trade dynamics very difficult to predict.

We’ve seen stocks struggle since tariffs have become a more pressing issue for markets and investors. But it remains to be seen, after U.S. tariffs and retaliatory responses from other countries are implemented, how long they will be in place until U.S. demands are met.

Tariff actions that escalate due to deteriorating global relationships, become entrenched, create dislocations in supply chains, reduce global efficiencies, increase cost/inflation pressures or stall growth/corporate profitability are factors that could weigh on stock prices over the near-to-intermediate-term. If such an environment were to develop, we would expect to see additional selling pressure across consumer, industrial, material and technology companies, for example. For a period, this would likely pressure the overall stock market as well and sap investor sentiment.

Bottom line: Broad tariff implementations could dampen economic growth and put upward pressure on inflation, which would likely be a market negative and could contribute to added volatility. However, it’s our view that tariffs on areas like Canada and Mexico are likely to be temporary or less severe over time, rather than a longstanding shift in U.S. trade policy.

2. AI spending scrutiny

Big Tech earnings for the previous quarter were solid, but AI spending plans have investors more cautious. Profit growth for the Magnificent Seven (Tesla, Meta Platforms, Microsoft, Apple, Amazon, Alphabet and NVIDIA) in the final quarter of 2024 generally came in as expected and, in several cases, surpassed analyst estimates. However, China's DeepSeek artificial intelligence model, which allegedly was created for far less money to train/build than American AI, has recently sent shockwaves across Big Tech. This has caused mixed reactions to Big Tech profit results/outlooks during the latest earnings season. As a result, investors are starting to call into question the tens of billions in dollars Big Tech is currently spending to develop AI in the U.S. each quarter.

Although markets have somewhat discounted DeepSeek developments, and companies like Meta Platforms, Alphabet, and Microsoft have reiterated the need to spend aggressively on AI to compete, investors have begun to more closely scrutinize the near-term profit outlook, given high expectations, elevated valuations and massive capital expenditure plans. That said, we believe a reset in expectations, and possibly more volatility across Big Tech this year, is healthy longer term and likely warranted, given how far this select group of stocks has run since the end of 2022.

Bottom line: We believe the AI secular trend remains intact, profit growth for Big Tech should remain strong in 2025 and some volatility should be expected in these stocks, though it shouldn't detract from their longer-term opportunities to profit from the early stages of AI expansion.

3. Elevated interest rates

Will higher interest rates and/or delayed Federal Reserve policy rate cuts start taking a bigger bite out of U.S. growth? While government bond yields have come down off their recent highs, interest rates remain elevated, and investors predominantly expect the next Fed rate cut not to happen until the June meeting.

U.S. economic growth forecasts and S&P 500 earnings estimates for 2025 remain solid. And as such, the elevated rate environment has currently taken a backseat to Big Tech and tariff concerns. But with core inflation still hovering above the Fed's +2.0% target, U.S. unemployment sitting at just 4.0% in January and growing investor concerns about the trajectory for U.S. government spending/debt levels, it stands to reason that rates could be stuck in a higher-for-longer environment this year, barring further weakness in stocks, and a flight for safety in government bonds over the near-term.

Though this is an under-the-surface issue at the moment, a higher rate environment could eventually start stressing smaller companies looking to refinance debt, further slow consumer/business borrowing and make future corporate profits look less attractive when discounted back to the present (which often uses risk-free rates like the 10-year U.S. Treasury yield).

Bottom line: Rising government bond yields and less room for Fed cuts this year added to the stock volatility seen in December and early January. For now, investors appear to be looking past this risk from a day-to-day perspective as yields and Fed expectations have settled into their current state. Nevertheless, macroeconomic developments that send rates higher (e.g., tariffs, sticky inflation, stronger growth, increased fiscal deficits), or further delay Fed easing, could quickly see stock volatility rise.        

So, what's an investor to do?

It’s normal for investors to feel anxiety when faced with unknowns in the economic and market landscape. Here’s how you can navigate this uncertain environment:

•  Avoid reacting to the news cycle. Stand still and let tariff, Big Tech and interest rate developments play out over the near term. Investors should expect headlines to stay fluid on these subjects and, in some cases, undetermined. Making investment decisions on still-unknown outcomes increases the risk of being wrong or offside if developments shift in the opposite direction.
• Follow your regularly scheduled investment strategy. If your portfolio has the proper asset allocation based on your risks and goals, then we believe you are well positioned to navigate this period of uncertainty.
• Leave your investment decisions to the professionals. If you use mutual funds or active managers in your portfolio, let them make the investment decisions about how to navigate individual stocks, bonds, sectors and industries when it comes to these developments.
• Consider securities that can benefit from the current environment. If you own individual stocks, bonds, ETFs or other securities in your portfolio, ensure you are comfortable owning these securities in varied market environments. Consider investments that focus on shareholder yield, which tend to be higher quality companies that can navigate several types of environments. Income-producing stocks and/or strategies are another way to stay invested, but in a way that may produce less volatility over the intermediate term.
• Connect with your Ameriprise financial advisor. If you’re concerned about the current investing landscape, reach out to your Ameriprise financial advisor. They can provide personalized insights about how evolving market conditions could potentially impact your portfolio.