There were several headwinds for domestic equities in February.
On the economic front, while inflation decelerated slightly, consumer spending pulled back and consumer confidence fell to an eight-month low, raising investor concerns. Ongoing geopolitical issues, including trade tensions and tariffs, also added to market uncertainty and increased volatility. Sparked by the news of a new AI model from China (DeepSeek) at the end of January, stocks in sectors that enjoyed significant gains in 2024 riding the artificial intelligence theme experienced sharp declines in February. The question being asked “Is all of this money being spent on AI overdone?” The pattern of returns relative to market capitalization was not linear in February. Even within the S&P 500 index, an asymmetry in returns across market capitalization deciles in February was evident with the very smallest stocks posting the most negative average return among the 250 smallest stocks, while the largest 50 stocks had the most negative average return among the 250 largest stocks. In other words, the 50 largest stocks and the 800 smallest stocks within the Russell 1000 index underperformed while stocks with a market capitalization in the middle of the pack performed the best. Value beat growth across all market capitalizations in February; by 3.3% for the S&P 500, by 4.0% for the Russell 1000, and by 2.9% for the Russell 2000. This was the second consecutive month of value beating growth. While dynamic, growthier stocks were the leaders in January in an up market, defensive stocks were the leaders as the market contracted in February. From a sector perspective, consumer staples (up 5.7%), real estate (up 4.2%), and utilities (up 1.7%) were among the leading S&P 500 sectors for the month, consistent with defensive, less volatile stocks outperforming in a down market.
International equities continued their outperformance from January through the end of February with international developed equities returning 1.4% and emerging market equities returning 1.21% for the month. International equities differ from their U.S. counterparts as international equities are much more value-orientated when compared to the U.S. As value continues to outperform growth year-to-date (YTD), international stands to benefit from the rotation that has been at play this year. European stocks are outperforming the S&P 500 YTD. Mega cap technology-related stocks (that have struggled to start the year) and European financials are off to a great start. Despite the recent outperformance, international equities continue to trade at a discount to their U.S. peers. Non-U.S. equities are benefiting from central banks cutting rates and economic data that is holding on so far. The Bank of England cut interest rates this year and some of their committee wanted a bigger cut. Overall, it sent dovish ripple effects across markets resulting in another bounce higher in broader European equities. International equities remain one of the best performing asset classes year-to-date.
As domestic equities fell in February, bonds performed well. The 10-year Treasury bond yield on January 31st was 4.57% and rose at the beginning of the month to close at 4.63% on February 12th. From that point, the 10-year yield fell over 40 basis points as the bond market began to fully price in two quarter-point interest rate cuts by the Federal Reserve for 2025, reflecting expectations of a weaker economic outlook. Risk-adjusted total return scenarios for fixed income continue to look attractive as yields today continue to pay higher than what we have seen over the last 5 to 10 years.
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