Investment Commentary – February 24, 2025

Executive Summary

The S&P 500 hovered near its all-time highs, while the bond market ended the week with gains (price up / Yield down) as weaker-than-expected retail sales rekindled hopes for Federal Reserve rate cuts. A rally in Treasuries drove the 10-Year Yield below 4.5%, marking its fifth consecutive week of gains—the longest streak since 2021. U.S. retail sales saw their steepest drop in nearly two years in January, signaling a sharp pullback in consumer spending following a strong year-end surge in 2024. Meanwhile, inflation data that is stronger than expected may, oddly enough, help risk markets, as some investors believe it may compel President Donald Trump to scale back potential trade tariffs. With few major economic data releases on the calendar, the highlight will be the FOMC meeting minutes from the Fed’s first meeting of 2025, set for release on Wednesday. In short, investors need to find direction following last week's conflicting inflation and retail sales reports.

The combination of monetary, fiscal, trade, regulatory, immigration and DOGE policies will determine the future growth and inflation direction.  In the meantime, fourth-quarter EPS growth is close to 15%, and sales growth is approaching 5%, implying margin improvement and resilience.  However, stocks have moved sideways since December when the 10-year Treasury crossed 4.5%.

Equities

The S&P 500 returned 1.5%. Markets breathed a sigh of relief, and the dollar fell against developed market peers as President Trump announced reciprocal tariffs but delayed implementation. Treasuries rebounded from their worst slide since December after two hotter-than-expected inflation reports but amid signs that the core Personal Consumption Expenditures index may come in better than expected. Information technology (+3.8%) and communication services (+2.0%) were the best performing sectors in the S&P 500; healthcare (+1.3%) was the key laggard. EAFE markets returned +2.7%, with Europe (+3.4%) leading. EM markets returned +1.5% with gains in China (+7.4%) amid continued 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 +2.2 and the NASDAQ is at +1.2. For the next 12 months, EPS growth for S&P 500 is expected to be 10.7% (vs. 6.9% annualized over the last 20 years). For the next 12 months, EPS growth for NASDAQ is expected to be 25.8% (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 mixed returns as rates fell slightly except at the long end of the curve. Municipals returned -0.3%, U.S. AGG returned +0.2% and U.S. IG returned +0.4%. HY bonds returned +0.3% while bank loans were flat. EM debt returned +0.3% as the U.S. dollar fell 1.2%.

Rates

Rates fell slightly except at the long end of the curve. The recession-watch 3M-10Y spread was unchanged at +15bps. The 2Y-10Y spread widened 1bp to +21. Rates rose in other developed markets. The BTP-Bund spread is at 1.09%. 5-year breakeven inflation expectations rose 3bps to 2.65% - their highest level since March 2023 (vs. low of 1.88% on Sept 10); 10-year breakeven inflation expectations rose 1 bp to 2.44% (vs. recent low of 2.03% on Sept 10); the 10Y real Yield fell 3bps to 2.04%. 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 1.2%. The commodities complex rose 1.0%, while energy prices rose 1.1% for the week. Brent prices were flat at $75/bbl. U.S. natural gas prices rose 12.6% while European gas fell 7.6%, both due to weather forecasts.

Market monitors

Volatility fell for equities and for bonds (VIX = 15, MOVE = 86); the 10-year average for each is VIX=18, MOVE = 78. Market sentiment (at midweek) fell further from -10 to -19 as investor sentiment dipped.