Five takeaways from February’s strength
Key Takeaways:
- February showed us that if yields are rising for the right reasons (stronger growth instead of central bank rate hikes), equities can do well in that environment.
- The fourth-quarter earnings season has been strong in the U.S., suggesting that a reacceleration is underway, supporting the new highs in stocks. TSX earnings are lagging supporting our recommendation to underweight Canadian large-cap stocks.
- Bonds declined for the second straight month, but we think the rise in yields offers a good entry point for investors to consider extending duration.
- A few of the Magnificent 7 stocks have started lagging the S&P 500, potentially indicating that leadership will broaden ahead. We see opportunities to diversify equity positions.
- Fed and BoC rate cuts will help prolong the expansion and drive further gains, but markets could get choppier in the short term, as the bar of expectations is high.
Rising markets and low volatility rank high on investor’s wish lists, and over the past four months we’ve been fortunate to experience precisely that. Not only did the S&P 500 rise 5% last month, marking the fifth-strongest February gain since 1980, but also the world equity market hit an all-time high, as several key equity indexes around the globe reached record levels. This included the German DAX, the French CAC, and Japan’s Nikkei, which, after 34 years, surpassed its prior high set in 19891. The TSX remains about 2% below it’s 2022 high, but also has also participated in the rally, rising for four consecutive months1.
However, February’s market performance was not without blemishes, as bonds were pressured by a renewed rise in rates, and the benefits of diversification across different equity asset classes beyond U.S. large-cap stocks were not obvious. We believe that these blemishes are what present opportunities for investors over the balance of the year. Here are five takeaways from February’s market performance:
- Equities performed well despite the rise in rates
Unlike several periods last year when the rise in yields triggered a pullback in equities, global stocks were able to power through and advance in the face of a renewed uptrend in short- and long-term rates. We believe there are three reasons for this welcomed resilience: 1) a strong showing in fourth-quarter corporate earnings results (more on that below); 2) renewed enthusiasm around AI, sparked by NVIDIA’s outlook; and 3) robust U.S. economic growth.
On the latter, the second estimate for fourth-quarter GDP showed that the U.S. economy grew 3.2%, slightly below the 3.3% initial estimate, though consumer-spending growth was revised higher at 3%1. Despite high borrowing costs and last year’s inflation spike, the consumer has continued to spend at a robust pace, not only helping keep the economy out of recession, but also supporting above-average growth. In addition, productivity growth has accelerated, initial jobless claims remain low, and the worst of the tightening in lending conditions and contraction in manufacturing activity appears to be in the rearview mirror. In Canada, the growth trend has diverged as economic activity has lagged, but last week’s GDP release showed that growth rebounded in the fourth quarter to 1% and the domestic economy avoided a technical recession.
Back to the U.S., the outperformance of the growth-sensitive small-cap stocks in February and the breakout of the retail industry index after staying rangebound for about two years are signs that investors are starting to get more confident about the sustainability of the economic expansion. We think the optimism about the cycle is warranted, but we expect growth and bond yields to moderate in the quarters ahead. Nonetheless, February showed us that if yields are rising for the right reasons (stronger growth instead of central bank hikes), equities can do well in that environment.