Download as a PDF
U.S. equities experience a sharp sell-off
February was a turbulent month, with U.S. equities breaking their longest winning streak in almost 60 years, triggered by indications of increasing inflation and investors’ worries that the Federal Reserve (Fed) might raise interest rates more often than previously expected. Some of the major equity indexes, including the S&P 500 Index and the Dow Jones Industrial Average, moved into correction territory during the sell-off earlier in the month. Turbulence persisted throughout February, as markets recovered some of their early losses, although they finished the month in the red. Volatility spiked with the Chicago Board Options Exchange Volatility Index (VIX) jumping to its highest reading since August 2015 and its greatest ever one-day increase (see Exhibit 1).
After 15 consecutive months of positive returns, February was the first negative month for the S&P 500 Index (-3.69%). Small caps (measured by the Russell 2000 Index) and mid caps (measured by the S&P 400 MidCap Index) posted similar losses of -3.87% and -4.43%, respectively, for the month. From a style perspective, growth stocks (measured by the S&P 500 Growth Index) held up better than value stocks (measured by the S&P 500 Value Index), losing -2.02% in February, while value lost -5.48% for the month.
Ten out of 11 S&P 500 sectors were negative for the month, with Information Technology as the only positive sector for the month (+0.10%). Energy (-10.82%) was the weakest sector in February due to a drop in oil prices, followed by Consumer Staples (-7.76%) and Telecom Services (-7.06%).
Overseas stocks had a down month too1
International equity markets also experienced a sell-off in the beginning of the month as all major regions were negative in February. Developed international equity markets (measured by the MSCI EAFE Index) lost -4.50% in February. Following a 7.20% gain in January, Eurozone equities (measured by the MSCI Euro Index) lost -5.93% in February. This was the indexes’ worst month since the Brexit vote in June 2016.
Aside from leveraged finance, no bright spot in U.S. fixed income.
Most domestic fixed income markets had negative performance for the second month in a row due in part to rising U.S. Treasury yields. This upward trend in yield resulted from speculation of a more hawkish Fed as well as a potential increase in the pace of rate hikes. This, coupled with accelerating inflation fears, positioned fixed income markets for a negative month. The broad U.S. fixed income market (measured by the ICE BofA Merrill Lynch U.S. Broad Market Index) lost -0.94% in February. U.S. Treasury bonds (measured by the ICE BofA Merrill Lynch Treasury Master Index) were down -0.79% for the month, with yields rising across the whole yield curve in February. Two-year U.S. Treasury rates, which are more sensitive to central bank policy, rose to 2.25%, their highest level in almost a decade (see Exhibit 2), while the 10-year U.S. Treasury yield increased to 2.86%, its highest level in four years.
Part of this year’s yield increases can be attributed to an increased issuance of government bonds to fund the growing budget deficit, as well as from the Fed shrinking its balance sheet. The $1.5 trillion tax cut by the Trump administration is expected to boost the budget deficit over the next few years.
Investment grade corporate bonds (measured by the ICE BofA Merrill Lynch Corporate Master Index) underperformed U.S. Treasurys in February, losing -1.50%. The spread between corporate and U.S. Treasury yields widened slightly in February. Municipal bonds (measured by the ICE BofA Merrill Lynch Municipal Securities Master Index) slightly outperformed U.S. Treasurys, down –0.43% in February. A significant slowdown in municipal issuance has helped prevent deeper losses this year. The leveraged loans sector (measured by the Credit Suisse Leveraged Loan Index) was the only bright spot, up 0.18% for the month.
Fed outlook and interest rate path
The Fed expressed greater confidence in its growth forecast and inflation outlook. At the end of the February, Chair Jerome Powell indicated in testimony to Congress that the Fed could be open to more than three interest rate hikes this year.
The Standard & Poor’s 500 Index (S&P 500) is a capitalization-weighted index of 500 stocks. The Index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
The Chicago Board Options Exchange Volatility Index (VIX) shows the market’s expectation of 30-day volatility. It is constructed using the implied volatilities of a wide range of S&P 500 Index options.
The Russell 2000 Index measures the performance of the small-cap segment of the U.S. equity universe. The Russell 2000 Index is a subset of the Russell 3000 Index representing approximately 10% of the total market capitalization of that Index. It includes approximately 2,000 of the smallest securities based on a combination of their market cap and current index membership.
The Standard & Poor’s 400 MidCap Index is a capitalization-weighted index of 400 publicly-traded companies with a medium amount of market capitalization.
The Standard & Poor’s 500 Growth Index (S&P 500 Growth) is a capitalization-weighted index of 500 stocks that exhibit strong growth characteristics.
The Standard & Poor’s 500 Value Index (S&P 500 Value) is a capitalization-weighted index of 500 stocks that exhibit strong value characteristics.
The MSCI EAFE (Europe, Australia, Far East) Index is recognized as the preeminent benchmark in the U.S. to measure international equity performance. It comprises 21 MSCI country indexes, representing the developed markets outside of North America. Returns are in U.S. dollars.
The MSCI Euro Index captures large-cap representation across the 10 Developed Markets (DM) countries in the European Monetary Union. With 124 constituents, the index covers approximately 70% of the free float-adjusted market capitalization of the EMU. Returns are in U.S. dollars.
The ICE BofA Merrill Lynch U.S. Broad Market Index tracks the performance of U.S. dollar denominated investment grade debt publically issued in the U.S. domestic market, including U.S. Treasury, quasi-government, corporate, securitized and collateralized securities.
The ICE BofA Merrill Lynch Treasury Master Index measures the total return performance of U.S. Treasury bonds with an outstanding par that is greater than or equal to $25 million.
The ICE BofA Merrill Lynch U.S. Corporate Master Index is an unmanaged index comprised of U.S. dollar denominated investment grade corporate debt securities publicly issued in the U.S. domestic market with at least one year remaining to final maturity.
The ICE BofA Merrill Lynch Municipal Securities Master Index measures total return on tax exempt investment grade debt publicly issued by U.S. states and territories, and their political subdivisions, including price and interest income, based on the mix of these bonds in the market.
The Credit Suisse Leveraged Loan Index tracks the investable market of the U.S. dollar-denominated leveraged loan market. It consists of issues rated “5B” or lower, meaning that the highest rated issues included in this index are Moody’s/S&P ratings of Baa1/BB+ or Ba1/BBB+. All loans are funded term loans with a tenor of at least one year and are made by issuers domiciled in developed countries.