February 2025 Capital Markets Perspective

Following a rough patch in December, capital markets sprung back to life in the first month of the year, with every major asset class posting gains. The ‘Everything Rally’ occurred amidst mostly strong earnings reports and healthy economic data releases. The December jobs report showed an addition of 256,000 jobs, blowing past expectations for only 165,000, and the January data indicated yet another 143,000 jobs were added, while initial jobless claims hit a multi-year low. Deutsche Bank pointed out that this has been the second longest streak of payroll gains since 1939. And with those employment gains the unemployment rate dipped to 4%, with wages growing faster than economists expected, indicating Americans’ buying power continues to advance.

While 4Q Gross Domestic Product (GDP) came in below expectations (2.3% vs. 2.6%) on a decline in inventories, consumer spending increased once again. The manufacturing sector also showed improvement, as the ISM Manufacturing PMI came in at 50.3, just above the threshold indicating expansion. Overseas the growth picture has been far less rosy; Eurozone fourth quarter GDP was flat. That lackluster growth environment led the European Central Bank to lower rates by another 25 basis points (bps).

But while U.S. investors have been celebrating economic gains, they’ve also been increasingly worried about the inflation outlook. The Consumer Price Index bottomed out in September and has been rising ever since, with the December print coming in at 2.9% YOY. The University of Michigan’s consumer survey shows that Americans expect inflation one year from now to be 3.3%, and the 2-year breakeven rate has risen from about 1.5% in the fall to almost 3% now. The BofA global fund manager survey suggests that the biggest tail risk is that inflation causes the Fed to hike again, which is not something that has been on investors’ minds for some time. That same survey indicated that fund managers see both above trend growth and inflation globally over the coming year. All of which helps to explain why the futures market is not pricing in rate cuts for either March or May at this point.

What happened in the markets in January?

EQUITIES: FOREIGN STOCKS SNAP BACK

Both international large caps (+5.3%) and small caps (+3.5%) outperformed their U.S. counterparts by a substantial margin in January, getting a bit of a currency boost as well. And U.S. small caps edged out large caps, returning 2.9% vs. 2.8% for the S&P 500®. As earnings season begins to wind down, and with about two thirds of companies reporting thus far, S&P operating earnings grew by a little over 4% for the quarter and by almost 15% compared to the same period last year. On a GAAP basis, those same numbers are about 9% and 19% but will of course change as the remaining companies post earnings. Margins continue to impress, as estimates currently stand at 12.2%. If that number holds, it will be the first time the 12% threshold has been exceeded since 2021.

From a factor perspective, momentum and quality were among the best performers, while high dividends and low volatility stocks underperformed. At the sector level, communication services (+8.9%), healthcare (+6.7) and financials (+6.4) led, while tech and media lost ground, returning -2.7% and -4.2%, respectively. Nvidia’s DeepSeek scare put pressure on the tech sector in general and on chip manufacturers, specifically. Lastly, emerging markets (+1.8%) and REITS (+1.0%) both posted gains, but trailed all the other major equity asset classes.

A valuation composite calculated by Hussman Strategic Advisors, which combines P/E, P/B, P/S and P/Dividends has reached an all-time high, surpassing even the Dot Com bubble. But what the catalyst may be that causes sentiment to shift at this point is anyone’s guess.

BONDS: THE YIELD CURVE SETTLES DOWN

Rates across the curve remained surprisingly stable for the month, with the 10-year Treasury ending exactly where it began at 4.6%. Similarly, option adjusted spreads for investment grade corporates also finished where they started at 0.82%, while spreads for high yield bonds tightened by 24 bps. With that as the backdrop, bonds enjoyed a decent month. The bond market advanced by 0.6%, as did longer dated Treasuries. Leveraged loans gained 0.7%, while TIPS and high-yield bonds returned 1.3% and 1.4%, respectively.

COMMODITIES: WIDESPREAD ADVANCES

Commodities enjoyed a solid January, increasing by almost 4%. Further, each of the major sub-groups ended in the black, led by precious metals, which gained 7.6%. Gold futures were up 6.7% as the spot price reached a record high of $2,911 per troy ounce. This surge was driven by investors seeking safe-haven assets amid global economic uncertainties and geopolitical tensions.

Agricultural futures were next in line, advancing by 4.8% with coffee (+18.6), soybeans (+15.1%), and cocoa (+14.7%) all registering strong gains, the latter due to ongoing supply deficits stemming from adverse weather conditions in key producing regions.

Within the energy complex, despite demands from the new administration for both the Saudis and American producers to ramp up production, those requests have so far fallen on deaf ears and Brent crude futures gained 2.9% with WTI crude futures adding 2.2%.

Industrial metals remained relatively stable, with prices holding steady. Lead, zinc, and nickel were down, while copper and aluminum saw increases.

How are Frontier strategies positioned?

ALLOCATION CHANGES

Due to the complexities of attempting to generalize about allocation changes across our Core, Specialty, Tax-Managed, Conservative Income, Active ETF, and Faith-Based Strategies, and the additional difficulties of properly conveying how those asset allocation changes flow through to trade level activity, we are instead directing clients to our monthly trade summaries, which describe in detail what trade activity occurred by strategy, and why.

Focusing on our Core Strategies, relative to their long-term asset allocations, which serve as policy portfolios guiding our dynamic allocation decisions, we favor U.S. and international small caps, emerging market equities, managed futures, floating rate loans, TIPS, and cash/short term bonds. We are generally underweight U.S. and international large cap stocks, REITs, commodities, and both high-yield and high-quality bonds at the asset allocation level, but differences between the asset allocations and actual exposure at the fund level can and will occur. At the beginning of February, our asset allocation models added exposure to TIPS within most strategies by making modest reductions across a number of asset classes.   

Expected returns for most asset classes declined during the month, with the largest decreases for international and emerging market equities. However, those equity asset classes remain highly attractive relative to their own histories and to U.S. large cap stocks. On the fixed income side, the biggest moves in terms of return expectations were to TIPS, which increased, and high yield bonds, which fell on continued spread compression.

PERFORMANCE ATTRIBUTION

The outperformance of international large caps, international small caps, and U.S. small caps relative to U.S. large caps was beneficial to both absolute and relative returns. However, our overweight to emerging market equities was a negative, as they trailed all other equity asset classes. Within fixed income, our preference for floating rate notes was additive to our more conservative strategies – they outperformed quality fixed income – but our underweight to high yield was detrimental; high yield outperformed all other fixed income sectors. Finally, our underweights to REITs was a positive, while avoiding commodities had a mildly negative effect.