Capital Markets Perspective | March 2025

Investors could be forgiven for losing track of what day it is and which version of proposed tariffs we are contemplating; information overload is taking its toll on consumers, business leaders, and investors. While the business community hopes to be freed from anti-trust scrutiny and overly burdensome regulations, the expectations that M&A and IPO activity would explode this year have not yet come to fruition. According to LSEG, the number of U.S. mergers and acquisitions in January declined by nearly 30% from one year ago, hitting its lowest level since 2015.

Consumers are likewise struggling to understand how Washington policies will impact their pocketbooks. The University of Michigan’s survey indicates that consumers believe inflation will be 4.3% one year from now and 3.5% in five years’ time (both numbers are far in excess of what the Fed is targeting). And the Conference Board’s survey shows that consumers expect the job market to weaken substantially over the next six months. Those worries led to a drop in consumer spending in January for the first time in two years. Pending home sales also dropped to start the year, hitting their lowest level on record. And the American Association of Individual Investors Bull – Bear spread indicator demonstrates that retail investors have turned quite bearish.

In contrast, the BofA Global Fund Manager survey shows that cash levels are at 15-year lows, despite the fact that close to 90% of fund managers see the U.S. market as overvalued. Something about that seems eerily reminiscent of Chuck Prince’s famous quote about needing to keep dancing.

Across the pond, the European Central Bank has acknowledged deteriorating economic conditions by completing its 6^th rate cut, bringing their Fed Funds equivalent to 2.5%. But for the moment, the U.S. market isn’t betting on additional rate cuts until June. That could change quickly if the Atlanta Fed’s 1Q GDPNow forecast of -2.4% comes anywhere close to being accurate. Chairman Powell and gang may have to act more quickly than they would otherwise prefer.

What happened in the markets in February?

EQUITIES: SENTIMENT MUZZLES PREVALING WISDOM

Two months does not exactly a trend make, but as was the case in January, February saw international large caps and international small caps outpace their U.S. peers by large margins. Chinese equities likewise continued their ascendance on new stimulus plans, adding almost 12% for the month in U.S. dollar terms. The Chinese market, which has struggled for years, is now ahead of the S&P 500® by 23% over the past six months. And that performance was sufficient to push emerging market equities into the black for the month (+0.5%).

At the sector level, consumer staples (+5.2%), media (+4.5%), and energy (+2.9) led in the U.S., while industrials        (-2.3%), communication services (-6.2%), and consumer discretionary stocks (-9.1%) suffered losses.

With changes in stock market leadership, massive valuation disparities, and near record low correlations among stocks, active managers should find the current landscape to be conducive to adding value.

BONDS: INVERSION RETURNS

A dull rate environment in January led to lively conditions in February, with the 10-year Treasury yield dropping by 44 basis points (bps) to end the month at 4.14%. With rates falling from 2-years out to 30, the yield curve inverted once again, as measured by the 10-year minus the 3-month. Spreads on high yield bonds rose by 19 bps, while spreads on investment grade corporates widened by a more modest 6 bps.

Duration instruments performed best in this environment, with long-term Treasuries advancing by 5.2%, followed by TIPS (+2.2%) and quality fixed (+2.2%). High yield bonds managed a respectable 0.7% return, while bank loans eked out an 11 bps gain.

COMMODITIES: GEOPOLITICS TAKE CENTER STAGE

Commodities added to January’s gains, returning 0.8%, but the range of outcomes was quite large, in part due to the apparent reshuffling of global alliances and the potential for an end to the war in Ukraine. Oil prices fell (Brent crude -2.5% and WTI crude -3.4%) as the removal of oil sanctions on Russia became a near term possibility, OPEC began to unwind output restrictions, gasoline and distillate inventories rose, and fears of slowing economic growth took hold amidst tariff uncertainties. But the energy complex was boosted by natural-gas futures, which advanced by about 26% to a fresh two-year high after Ontario Premier Doug Ford said the Canadian province would place a 25% retaliatory export tax on electricity it sends to homes in Minnesota, Michigan and New York.

Across the other major commodity segments, results varied from +2.8% for industrial metals to -0.1% for precious metals, and -2.3% for agricultural products.

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 March, our asset allocation models continued to add exposure to TIPS within most strategies, and to floating rate securities within our more conservative strategies, by reducing exposure to investment grade debt.   

Expected returns for most asset classes declined during the month, with the largest decreases occurring for high quality bonds and long-term Treasuries. However, expectations for U.S. small caps increased as valuations became even more attractive. And international small caps continue to offer the highest expected returns of all of the asset classes that we model; additions to that asset class in January have been rewarded thus far.

PERFORMANCE ATTRIBUTION

With the S&P 500 dragged lower by 5 of the Mag 7 stocks, our underweights to U.S. large caps were beneficial, as were our overweights to emerging markets, which were led higher by an almost 12% gain in Chinese equities (in U.S. dollar terms). The decline of the U.S. dollar added to the returns to all things foreign, accounting for about 100 bps of the return to international large caps, which generally benefitted Frontier’s relative performance. But our positions in U.S. small caps detracted from total returns, as they fell by almost 6%. Furthermore, our managed futures funds hurt performance, as did the lack of REIT exposure. Turning to fixed income, Frontier’s underweights to high yield bonds were generally additive, as investment grade debt outperformed, while our bank loan exposure hurt at a time when investors sought out duration.