Market Rotation?
INVESTMENT COMMITTEE COMMENTARY February 2025
After posting strong returns in January, U.S. stock indexes fell back in February. Investors worried about lower economic growth potentially coming from tariffs, inflation, and rising geopolitical tensions. However, foreign developed and emerging market equities and U.S. real estate investment trusts (REITs) had positive returns for the month. Uncertain U.S. economic growth expectations contributed to falling Treasury bond yields leading to strong bond returns for the month. The Federal Reserve (Fed) remains on hold for further rate cuts but some cuts are still expected in 2025.
The S&P 500 fell by 1.3% in February. This came despite, according to FactSet, the S&P 500 reported earnings growth of 17.8% in the fourth quarter, the highest growth since the fourth quarter of 2021. This disconnect is due to how Trump Administration policies are impacting investor expectations. Of the S&P 500 companies reporting earnings, 77.0% exceeded earnings per share expectations, about equal to the five-year average. During earnings conference calls, 221 of the S&P 500 companies mentioned “tariffs.”
U.S. mid-cap and small-cap stocks declined 2.8% and 5.4%, respectively, while foreign developed and emerging market stocks were up 1.5% and 0.4%, respectively. Also notable were U.S. REITs that gained 4.6% due in part to strong performance in the data centers property sector.
Bonds had positive monthly performance. The yield on 10-year Treasury bonds dropped from 4.58% to 4.24% in February. This was the lowest rate in over two months and was principally due to concerns that tariffs and government spending cuts may hurt the economy. Also, shorter-term two-year Treasury notes closed February at 3.99%, down from 4.22% a month earlier. As a result of the falling interest rate environment, the Bloomberg U.S. Aggregate Bond Index rose by 2.2% for the month. Other bond sub-indexes were also positive including U.S. Treasury Inflation-Protected Securities (TIPS) and high yield bonds which had February total returns of 2.2% and 0.7%, respectively.
Market Rotation?
The asset classes that dominated performance in 2024 are not currently exhibiting the same dominance in 2025 as different asset classes are stepping up with strong performance. Last year’s performance was significantly driven by well-known large cap growth companies, commonly known as the “Magnificent 7” (Apple, Microsoft, Nvidia, Meta, Alphabet (Google), Amazon, and Tesla). In February, there was a notable change in performance leadership. While a month is a short time frame, it seems markets are struggling with how to navigate a combination of high valuations and numerous uncertainties arising from trade tariffs, economic growth, DOGE spending cuts, and taxes. Outcomes remain unclear.
The following chart from Morningstar illustrates the performance differences where U.S. equity outperformers and underperformers have switched.
Morningstar also highlighted the recent outperformance of international stocks. Lower valuations now favor non-U.S. stocks, and more investors appear to be recognizing the diversification benefits of having a non-U.S. equity allocation. U.S. stocks have outperformed international equities for over 15 years and investors may be reevaluating this long-term trend.
Charles Schwab investment strategists Liz Ann Sonders and Kevin Gordon noted that some investors are changing their approaches in 2025. Hedge funds, for example, have been actively reducing their holdings in the technology sector. The majority of the Magnificent 7 companies are trailing the S&P 500 index so far this year. This is true even as Magnificent 7 companies are generating solid earnings but where exceptional earnings growth is necessary to maintain high market prices. Stronger performance seems to be broadening, especially in defensive sectors.
It is too early to know whether the market rotation trend is long-term or whether it is temporary. However, we know that no asset class outperforms forever as there is always market uncertainty at any point in time. That is why we continue to encourage broad diversification and portfolio rebalancing while remaining cautious in holding concentrated and high valuation stocks.
If you have any questions, please consult your JMG Advisor.
Important Disclosure
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Market Segment (index representation) as follows: U.S. Large Cap (S&P Total Return); U.S. Mid-Cap (Russell Midcap Index Total Return); Foreign Developed (FTSE Developed Ex U.S. NR USD); Emerging Markets (FTSE Emerging NR USD); U.S. REITs (FTSE NAREIT Equity Total Return Index); Foreign REITs (FTSE EPRA/NAREIT Developed Real Estate Ex U.S. TR); U.S Bonds (Bloomberg US Aggregate Bond Index); U.S. TIPs (Bloomberg US Treasury Inflation-Linked Bond Index); Foreign Bond (USD Hedged) (Bloomberg Global Aggregate Ex US TR Hedged); Municipal Bonds (Bloomberg US Municipal Bond Index); High Yield Bonds (Bloomberg US Corporate High Yield Index).