Following a strong beginning to 2025, February saw a decline in the narrative of US exceptionalism. Increasing doubts about the impact of the US administration’s policy agenda negatively influenced both corporate and consumer sentiment, leading to renewed concerns about economic growth. The emerged concerns weighted on global equity markets over the month, resulting in a total return of -0.7%, according to the MSCI world index. Uncertainty over economic and political policy has reached a new high according to the Global Economic Policy Uncertainty (GEPU) Index. However, markets as a whole are still remaining relatively steady. The VIX, a measure of market volatility, or panic, remains below 30, which is widely considered to be the marker of heightened volatility. While global economic growth is expected to slow this year, the expectation remains far from a recession, with the United States still on track to grow just over 2% in 2025. However, the decline in the S&P 500 in the last eight days of February wiped out the post election rally.
In Canada, the implementation of tariffs levied from the US remain the major theme. Their impact will largely depend on their ongoing scale. Tariffs will reduce the competitiveness of Canadian exports, prompting U.S. companies to look for alternative suppliers. Since exports to the U.S. make up about 20% of Canada’s GDP, they could have a material negative impact on the economy. The TSX might be less affected because sectors that heavily export to the U.S. have a smaller presence in the index. Fourth-quarter GDP growth increased to 2.6%, outpacing the Bank of Canada’s 1.8% forecast. This growth was largely fueled by a 5.6% rise in consumer spending, the highest since the second quarter of 2022. From this, it seems we are seeing the Bank of Canada’s interest rate cuts have their intended impacting on the economy. Additional cuts are likely if US tariffs, which were enacted this week, don’t get reversed.
Goldman Sachs’ economists have modeled the effects of tariffs and counter-tariffs across different scenarios for various countries. Their analysis indicates that, for the United States, the primary risk lies in inflation rather than growth, due to the country’s relatively low reliance on international trade. Conversely, for the rest of the world, particularly Canada, the risk is more significant for growth than for inflation. This theoretically places the United States in a stronger position. However, the timing is particularly unfavorable for inducing stagflation, especially given the recent uptick in U.S. inflation over the past three months.
Internationally, European equities outperformed other geographical regions due to optimism of a potential ceasefire between the Ukraine and Russia. Emerging Markets outperformed their developed market counterparts. They achieved a 0.5% return, according to the MSCI EM index, thanks to Chinese tech stocks. The weakening US dollar also provided support, with the broad dollar DXY Index declining by 0.7%, enhancing returns of dollar-denominated global indices.
In Commodities, cold weather and temporary supply shortages drove up US natural gas prices, which helped offset the decline in crude oil prices from rising production in non-OPEC countries and relatively weak demand growth. Gold ended in the month with modest gains. Aggregately, the Bloomberg commodity index returned a muted 0.8% for the month.
Equities
European equities emerged as the top-performing major equity index. The MSCI Europe ex-UK Index climbed by 3.4%, driven by optimism of a potential ceasefire. European financials continued their robust performance, delivering higher returns on equity than their US peers. Additionally, European defense stocks saw significant gains, benefiting from an increased focus on domestic production, and posted impressive returns of 9.3%. Real estate investment trusts benefited from a drop in yields. Strong performances from US and dollar denominated European real estate contributed to the Bloomberg global REIT benchmark’s 2.6% rise, making it the top-performing major asset class for the month
February saw a 1.1% rise in Asian shares, tracked by the MSCI Asia ex-Japan index. This was primarily driven by an impressive 11.7% increase in Chinese equities, in US dollar terms. The broader Chinese tech sector thrived on the excitement surrounding DeepSeek, and high-profile meetings between Xi Jinping and senior business leaders hinted at a more favorable regulatory environment. Japan stood out as an exception, with the TOPIX index dropping by 3.8% over the month. The yen-sensitive market faced difficulties as the currency appreciated by 2.8% against the US dollar.
Global small cap stocks, tracked by the MSCI World Small Cap index, which usually benefit from falling bond yields, recorded a 3.3% decline, making it one of the worst performing asset categories in February. They are more sensitive to economic growth expectations than their larger capitalization counterparts. Their declined highlighted the elevated levels of uncertainty and of growth concerns, overshadowing the positive effects of lower yields.
US equities faced challenges stemming from small caps and concerns about the lofty valuations on mega cap tech companies. Apprehensions about the sustainability of their earnings led to a 2.8% decline in global growth stocks, also despite the drop in yields. This was tracked by the MSCI World Growth Index. The Russell 2000, the major index for smaller cap companies in the US, saw a decline of 5.3%. The Communication Services sector saw declines of 6.3%, while the Consumer Discretionary sector experienced a significant decline of 9.4%. There was evidence of a rotation within the index to more defensive sectors, with Consumer Staples leading the returns at a monthly gain of 5.7%. Energy and Real Estate also posted positive returns over the month but general concerns about the real estate market caused GDP-sensitive US equities to lag. The quality style and the Equally Weighted S&P 500 index saw outperformance over the broad US market.
Canada showed similar results to the US with more defensive sectors such as Materials and Utilities performing well but with also Communication Services and Consumer Discretionary ending the month with gains. Those were the only positive sectors and the broad TSX index ended the month down 0.4%. Canadian small caps also underperformed, ending the month down 2.3%.
Fixed Income
Global bonds served well as a hedge against equity losses over the month. Despite ongoing concerns about inflation, bond investors focused on US sentiment data and growth risks. Both US business and consumer sentiment declined, with services activity and small business investment dropping. Consumer confidence experienced its steepest decline since August 2021. Although the House of Representatives approved a budget blueprint, which allowed for the extension of the 2017 Tax Cuts and Jobs Act, it did not signal additional new fiscal stimulus. Treasury yields fell, and the Bloomberg Global Aggregate index achieved a 1.4% return for the month.
Throughout the month, all major fixed income indices across the geographical and credit spectrum achieved positive returns. This was largely due to declining US yields, which had a ripple effect across the market. US Treasuries, tracked by the Bloomberg US Aggregate Government bond index, led the way with a return of 2.2%. Canadian fixed income had a strong month due to tariff fears, which prompted a decline in government bond yields. The middle of the curve performed the best, with medium term ICE BofA Canada Universe capturing a 1.8% gain for the month. The weaker US dollar bolstered emerging market debt, resulting in a 1.6% return on the J.P. Morgan EMBIG index.
Investment grade spreads remained stable due to strong corporate fundamentals, leading to a 1.6% rise in global investment grade credit markets in February, tracked by the Bloomberg Global Aggregate corporate bond index. US high yield underperformed due to a slighting widening in spreads on the shorter part of the yield curve. Causing the BofA/Merrill Lynch US HY Constrained index to post returns of 0.6% for the month.
In Europe, optimism about economic growth was bolstered by growing confidence in the potential ceasefire. However, concerns about increased government borrowing to fund defense investments led to a smaller decline in European sovereign yields compared to the US. As a result, European government bonds posted a return of 0.7% for the month, tracked by the Bloomberg Euro Aggregate Government Bond Index. European spreads remained unchanged, and higher-yielding Italian bonds outperformed German Bunds.
Conclusion
February continued the emerging themes from January, with investors increasingly concerned about growth risks in the US, questioning whether high earnings expectations and elevated valuations were justified, given the backdrop of heightened political and economic uncertainty. Tariff implementation and the potential inflation and economic stagnation it will bring was a major source of distress. The strong performance of European equities underscored the value of regional diversification, while positive returns in fixed income demonstrated that bonds can once again serve as a hedge against equity. Given the ongoing uncertainty, it is crucial more than ever to maintain diversification and quality investments in your portfolio.
