The fortunes of equity and fixed income investors diverged once again in February, as economic resilience continued to push out expectations for rate cuts.
February was a fairly good month for stock markets, with resilient economic data and relatively strong earnings reports both contributing to year-to-date gains. In contrast, fixed income markets were broadly down, with the Bloomberg Global Aggregate index losing 1.3% over February.
Within equities, emerging markets performed well, up 4.8% over the month thanks primarily to a Chinese rebound. In developed markets, Japan continued to outperform, with the Nikkei 225 Index reaching a new all-time high for the first time in over 30 years. In contrast, UK stocks lagged.
Fixed income markets came under pressure as investors continued to push out interest rate cuts further into 2024, with US Treasuries down 1.3% in February. Less rate-sensitive high yield bond markets outperformed, with euro high yield eking out an 0.4% gain.
Elsewhere, commodities lost ground, with the broad Bloomberg Commodity Index falling 1.5% over February as gas and agricultural prices continued to drop. Real estate investment trusts lost 0.1%, as expectations for slower interest rate cuts outweighed the positive impact of supportive activity data.
Earnings season continued, with five of the ‘magnificent seven’ US stocks reporting results for the previous quarter. These companies broadly met or exceeded expectations, contributing to a 5.3% gain in the S&P 500 over the month. With over 90% of S&P 500 firms having reported, nearly three quarters have beaten analysts’ earnings forecasts. Economic data also proved resilient, with the US composite Purchasing Managers’ Index (PMI) suggesting activity continued to expand over February and the US economy adding 353,000 jobs in January.
European stock markets underperformed. MSCI Europe ex-UK rose 2.8% in February, versus 4.3% for the developed market MSCI World Index. This was despite a larger than expected rise in the eurozone composite PMI in February to 48.9, a print that suggested the worst of the continent’s growth weakness is likely over.
UK stocks also underperformed and are down 1.1% year to date, following a -0.3% (quarter-on-quarter) fourth quarter GDP print that showed the UK falling into a technical recession last year. Recent earnings data from UK companies also somewhat disappointed, leading analysts to downgrade estimates for 2024 profit growth to 4.7% year on year.
The Japanese TOPIX Index rose 4.9% over the month, despite a weaker than expected fourth quarter GDP print (-0.1% quarter on quarter) which also put the country into technical recession over the second half of 2023. Further currency weakness likely helped given the export-oriented nature of the Japanese stock market: the yen fell 2.3% versus the US dollar in February.
Chinese equity markets had hit five-year lows coming into the month. However, activity data over the Lunar New Year holiday period strengthened, and the Chinese government announced a number of supportive interventions, including a cut to the 5-year loan prime rate (a benchmark for mortgage rates), curbs on short selling, and stock purchases by state-owned investment firms. The MSCI China Index consequently gained 8.6% over February.
January inflation numbers were stronger than anticipated in the US, with headline inflation at 3.1% year on year. This reduced investors’ expectations for Federal Reserve interest rate cuts over 2024 further. US Treasuries thus came under pressure, falling 1.3% over the month.
In the UK, wage growth fell less than expected in December, with total earnings (including bonuses) growing 5.8% year-on-year. This once again pushed investors to pare back their rate cut forecasts for the Bank of England, given stronger wage pressures suggest inflation might prove stickier than anticipated. UK Gilts suffered, and are now down 3.6% year to date.
In the eurozone, government bonds similarly lost ground over the month, with German Bunds down 1.4%. However, signs of green shoots for the eurozone economy helped spreads between Italian and German sovereign debt to tighten.
In credit, less rate sensitive high yield indices outperformed investment grade (IG) bonds. The Bloomberg Global Aggregate Corporate index – measuring the performance of developed market IG bonds – is now down 1.9% year to date. In contrast, US high yield has gained 0.3% over the first two months of 2024, and investors in euro high yield debt have made 1.2% over the same period.
Equity markets were supported in February by continued strength in the US economy, combined with signs of an uptick in European activity. This economic resilience, alongside signs that inflationary pressures have not yet entirely dissipated, suggest central banks will likely be on hold for a little while longer. Bond markets therefore suffered given the decreased likelihood of imminent rate cuts. Nonetheless, we think core bonds still offer compelling income, as well as diversification against an economic slowdown. Within equities, a focus on quality companies with strong balance sheets seems prudent given earnings expectations remain elevated.