Market Comment - February

The month of February was marked by a change in leadership in terms of sector and country allocations. Europe and China are clearly outperforming, while the US, Canada, Australia, and Brazil are lagging behind. In the US, the consumer discretionary sector was by far the weakest performer, losing 6.97%. The best performance was attributed to the consumer staples sector, gaining 5.18%. Such a strong divergence between these two sectors is meaningful and points toward large investors’ expectations that the US economy will start to weaken. The message is further confirmed by the fact that other defensive sectors started to outperform (Utilities +1.73%, Healthcare +1.43%), while other cyclical sectors continued to underperform.

The worst performer among industry groups was Semiconductors, losing 8.90%, another cyclical sector. The intermarket analyses of the US stock market are not looking pretty. While the US Dollar Index lost only 0.83%, the current strength of Europe against the US is clearly showing that large US investors are leaving their domestic market to place assets outside of the US. Whatever their motivation may be, a strong incentive may be found in the big valuation gap between Europe and the US. The US stock market is trading at historic overvaluations, while Europe is trading at much cheaper levels.

Looking at the US bond market, the 2-Year Treasury rate tumbled below 4.00%, also motivated by weaker economic expectations. Our quantitative model projects a potential drop to around 3.30%. If so, the US Central Bank will have to cut rates by 100 basis points from current levels. This would confirm the sector analyses, which have strong indications for a weakening US economy. Unfortunately, the setup for the long end of the yield curve looks much less attractive. It is not unusual for the yield curve to rise during rate cuts, as short-term rates fall faster than longer-dated rates. Still, during risk-off events, investors are looking for safety, hence buying longer-dated debt. However, during the last two rate-cutting cycles, the Federal Reserve applied quantitative easing programs. Currently, longer-dated bonds simply do not look very attractive. Whether we head back to the same monetary policy regime remains to be seen.

Our trend study for inflation suggests that, for the next couple of months, inflation should go down. This would support rate cuts from the Fed, as well as from the ECB. This would certainly support asset prices as well. However, the trend also suggests that inflation will hit a low point in 2025 and rise from there until 2028. While the rise in European equities may look welcome, on a long-term basis, the setup does not look healthy. The price action is rather pointing toward an endgame than the beginning of a new bull market.

What all major economies, with some exceptions in emerging markets, have in common is the fact that they continuously build debt. There was a time when debt was paid back. That was a long time ago. In today’s world, debt will never be paid back. It is rolled over, and simultaneously, more debt is added. In the end, this is making our financial system more fragile.

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