Investment Commentary – February 10, 2025

Executive Summary

Non-U.S. equities are benefiting from central banks cutting rates and economic data that is holding in ok. The Bank of England cut interest rates last week, and some of its committee members wanted a bigger cut. Overall, it sent dovish ripple effects across markets, resulting in another higher bounce in broader European equities. Otherwise, Eurozone data was on the weaker side, from retail sales missing to German industrial production. The MSCI Europe index earnings growth is tracking 3.8% year-over-year, but the 2025 estimates have drifted to 6.6%. European stocks are now outperforming the S&P 500 by over 4% YTD. The two drivers being underweight, mega-cap technology-related stocks (that have struggled to start the year), and European financials are off to a great start. European financials are up 10%, which is 20% of the index. Last week, Chinese equities soared back vs. the U.S.  Regardless, both Chinese equities and Copper prices surged to close out last week. Overcoming a weaker market close in the U.S. The markets may be hoping that new China stimulus headlines will come.

Equities

The S&P 500 returned -0.2%. Markets worried about the impacts of tariffs, while economic data showed a fall in consumer sentiment amid concerns over inflation. A mixed jobs report showed a slowing, yet healthy labor market with rising wages, reinforcing the market’s sense that the Fed will be in no hurry to further cut interest rates. Consumer discretionary (-3.1%) and communication services (-2.1%) were the worst performing sectors in the S&P 500; consumer staples (+1.6%) and real estate (+1.3%) were the leaders. EAFE markets returned +0.2% gains across all major geographies. EM markets returned +1.4%, with gains in China (+4.8%) amid optimism around AI and technology.

From a valuation perspective, U.S. markets (other than midcaps) trade above +1 standard deviation based on historical forward P/E ratios as the S&P 500 is at +2.1 and the NASDAQ is at +1.1. For the next 12 months, EPS growth for S&P 500 is expected to be 10.9% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 19.0% (vs. 10.7% annualized over the last 20 years). All U.S. indices, including the S&P 500 (U.S. Large Cap), NASDAQ, Russell Midcap (U.S. Midcap), and the Russell 2000 (U.S. Small Cap) trade at or above their 20-year averages based on forward P/E ratios while the MSCI EAFE (Non-U.S. Developed Market Equities) and MSCI EM (EM Equities) are inline.

Fixed Income

Investment-grade fixed-income sectors posted positive returns as rates fell at the long end of the curve. Municipals returned +0.6%, U.S. AGG returned +0.4%, and U.S. IG returned +0.4%. HY bonds returned +0.0% as did bank loans. EM debt returned +0.2%, as the U.S. dollar fell 0.3%.

Rates

The yield curve flattened as rates rose at the short end and fell at the long end of the curve. The recession-watch 3M-10Y spread compressed 9bps to +16bps. The 2Y-10Y spread compressed 13bps to +20. Rates fell slightly in other developed markets other than Japan. The BTP-Bund spread is at 1.10%. 5-year breakeven inflation expectations rose 5bp to 2.62% - their highest level since March 2023 (vs. low of 1.88% on Sept 10); 10-year breakeven inflation expectations were unchanged at 2.43% (vs. recent low of 2.03% on Sept 10); the 10Y real yield fell 4bps to 2.07%. The market now expects between one and two cuts in 2025 vs the Fed’s guidance of two cuts. At year-end 2025, the market expects the Fed Funds rate to be 3.9% vs. the Fed’s guidance of 3.75%-4.00%.

Currencies/Commodities

The dollar fell 0.3%. The commodities complex rose 0.3%, while energy prices fell 0.5% for the week. Brent prices fell 2.7% to $75/bbl. U.S. natural gas prices rose 8.7% while European gas rose 8.2%, both due to weather forecasts.

Market monitors

Volatility rose for equities and for bonds (VIX = 17, MOVE = 93); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) fell from 7 to -10 as investor sentiment dipped.