Global equity markets diverged in February as U.S. markets fell, especially small-cap stocks, and non-U.S. equities continued their rebound after sharp declines in Q4-2024. U.S. equity volatility has trended noticeably higher as fast-changing policies unnerve investors and create economic uncertainty. Europe and China added to gains seen in January with Europe up more than 4% and China posting 10% gains for the month. Despite the year-to-date outperformance, non-U.S. stocks still have a way to go to catch up after lagging U.S. markets by more than 20% in 2024.
U.S. interest rates turned around in February and fell back to levels last seen in mid-December. Rates, which had been rising on the market perception that economic growth was accelerating, are now falling as growth appears to be slowing. Mortgage rates are following U.S. Treasury rates lower, which may stimulate some much-needed recovery in real estate. The U.S. dollar was slightly lower for the month, as was the price of oil. Gold came off recent highs but remains a safe haven asset and store of value for Central Banks, which continue to buy the metal.
The following table contains a summary of February and year-to-date market performance:
| Index | February | YTD | Index | February | YTD |
| S&P 500 (Total Return) | -1.30% | +1.44% | MSCI All Country World (Net) | -0.60% | +2.73% |
| MSCI EAFE (Net) | +1.94% | +7.30% | Bloomberg Barclays US Agg | +2.20% | +2.74% |
| MSCI Emerging Markets (Net) | +0.48% | +2.28% | 60/40 Blend* | +0.52% | +2.76% |
For the past 18 months, Caprock has highlighted how mid-cycle economic growth is often typified by both mixed economic data and improving corporate earnings. Although conflicting economic signals can unsettle investors, history shows that stocks tend to grind higher during this phase—making premature exits from equity markets a potentially costly misstep. As a matter of investment philosophy, Caprock does not seek to time markets, but we do strive to opportunistically trim or add to investments as we periodically rebalance portfolios to their long-term strategic allocations.
Many factors go into the imprecise art of determining when to rebalance portfolios, including valuations, economic conditions, interest rates, monetary and fiscal policy, geopolitical events, statistically significant price moves, and more. One useful factor we watch is the CBOE Volatility Index, commonly known as the VIX. The VIX is a real-time market index that measures the market’s expectations of volatility for the S&P 500 over the next 30 days. It is often referred to as the “Fear Index” because it tends to spike during times of market uncertainty or distress.
The long-run average for the VIX is approximately 19.5. Markets generally rise when the VIX is below this level and generally fall when above this level. Brief spikes above the average can occasionally occur without signaling a change in market direction if the spike quickly reverses and falls back below the long-run average. This is what happened last August when after a prolonged period of below-average VIX readings, the Japanese Yen rapidly declined in value and the VIX spiked to more than 65. However, as Central Banks stepped in to calm investors, the VIX quickly moved back to the mid-teens and the S&P 500 went on to post record highs for the year.
But in February, the VIX began trending higher and has been spending more time above the average level. This condition could quickly reverse, as we have seen before, but with recent signs of economic slowdown taken together with substantial changes and disruption to the status quo in both the U.S. and globally, it is prudent to consider if the recent VIX levels are telegraphing a more durable shift in investor sentiment.
As noted in prior monthly commentaries, periods of mid-cycle economic growth can last an indeterminant amount of time, but all economic expansions eventually succumb to excesses that build up and create the conditions for recession. Among the world’s economies, the U.S. is known for being particularly dynamic and resilient. Many economists and wealth managers have prematurely predicted recession – Caprock included. Having said that, this cycle is getting long in the tooth.
As we entered the year, Caprock pointed to valuations as the greatest risk to stocks in 2025. High valuations meant that the risk of a pullback or correction was high, even in the absence of a recession. For most investors, a potential 10% pullback in stocks should not precipitate any material changes to the portfolio. This is because selling stocks incurs real costs and getting the timing right for both selling and buying back into the market is notoriously difficult. A recent analysis of markets showed that 36% of the time the stock market is 10% or more off its highs, underscoring that investors implicitly accept some amount of short-term volatility in exchange for attractive long-term gains.
Donald Trump’s return to the White House has ushered in swift policy changes and a blunt challenge to the status quo, which has added to increased market uncertainty and volatility. Some of his policies, such as reducing 2024’s 6.8% deficit spending, are widely acknowledged—even by critics—as necessary given the unsustainable fiscal trajectory of recent years. But while cutting government spending is necessary, the fact remains that it is hard and unpopular because it carries a very real short-term cost to the economy. In addition to this, markets are also grappling with federal government layoffs, uncertain tariff policies, strict border enforcement, and a myriad of other changes. Unlike August, when the VIX spiked to extreme levels, the current rise in VIX is slower and less volatile. This observation suggests that rather than the markets being concerned about a single discrete issue, there may be a growing concern that the cumulative impact of so many changes at once may be more than the economy can handle.
With that said, not all the news is bad. Interest rates have declined over the past six weeks with mortgage rates following suit. This could provide some much-needed relief to the real estate sector. The unemployment rate remains low and first-time unemployment claims are not spiking, suggesting that the job picture is intact. This supports consumer spending. Credit spreads and corporate loan defaults are low. Corporate profit margins are strong, and markets still expect companies to put up growing earnings. This is key to long-term equity appreciation. Inflation remains somewhat elevated, but off its highs, and with oil prices lower and the housing component of inflation likely to improve, inflation could come down. The Federal Reserve is still likely to cut the Fed Funds rate later this year, which could help offset any economic weakness. Finally, if spending can be redirected from low productivity uses in the government sector to higher productivity uses in the private sector, the economy would benefit.
While we do not claim to have a clearer crystal ball than anyone else, we remain vigilant—monitoring markets for opportunities as we manage client portfolios. Right now, we generally find more value in private markets and safety in public fixed income. Public equities remain a key allocation in portfolios, but we will proceed cautiously, seeking attractive entry points while leveraging our tools to optimize outcomes for clients.