Wall Street Goes Defensive as Policy Uncertainty Rattles Markets

February 2025 Monthly Market Commentary

The S&P 500 index fell 1.3% in February but still outperformed the Russell 2000 Index’s decline of 5.2%. Six of the eleven S&P 500 sectors traded higher, led by defensive sectors.
Bonds traded higher, with the U.S. Bond Aggregate increasing 2.2% for the month. Corporate investment-grade bonds increased 2.4% as Treasury yields declined, outperforming corporate high-yield’s 1.0% return.
International stocks outperformed the US amid domestic policy uncertainty. The MSCI EAFE developed market stock index increased 3.0%, while the MSCI Emerging Market Index increased 1.1%.

Market Rotation Accelerates as Defensive Plays Gain Traction Amid Policy Uncertainty

February saw a shift in investor sentiment as markets responded to softening economic data and growing policy uncertainty. Stocks traded lower across the board in a late-month sell-off, erasing most of their post-election gains, with small-cap stocks especially underperforming as the Russell 2000 declined 5.2%. The ongoing market rotation from last year’s winners to defensive sectors continued, as the Magnificent 7 mega-cap tech stocks dropped -8%, weighing heavily on the Nasdaq 100 and Large Cap Growth indices. Defensive sectors, international equities, and gold—which reached a new all-time high—stood out as relative outperformers. Meanwhile, a decline in Treasury yields lifted bonds, with the 10-year yield dropping to its lowest level since December, helping fixed income generate positive returns.

In our view, increased volatility and persistent policy uncertainty are overshadowing markets as economic growth remains resilient.

Economic Growth Holds, but Markets Face High Expectations

The late-month sell-off was not driven by a single event but rather a confluence of factors that underscored a cooling economic backdrop. Economic data underperformed expectations, with the services sector contracting and consumer confidence weakening. The decline in consumer demand, a key pillar of recent economic strength, signaled potential headwinds ahead. At the same time, renewed policy uncertainty emerged in Washington, including tariff threats and proposed spending cuts, fueling concerns that restrictive fiscal policies could further dampen growth. Tech stocks faced additional pressure after Nvidia’s much-anticipated earnings report failed to sustain enthusiasm for AI-related investments, triggering broader weakness across the sector.

Investor Sentiment Turns Cautious Amid Policy and Growth Concerns

At the start of the year, markets were buoyed by optimism around pro-growth policies, tax cuts, and expectations for lower interest rates. However, as the Trump Administration’s agenda continues to unfold, policy uncertainty is rising, leading investors to adopt a more defensive posture.

The focus has shifted from expectations of earnings growth and a strong labor market to concerns over slowing economic momentum and policy uncertainty. While volatility has increased, key areas of resilience have been defensive equities, fixed income, and gold, which suggests that investors are positioning for a more cautious environment in the months ahead.

Given the uncertainty surrounding actual White House policy, we suggest investors avoid making drastic portfolio changes. That said, our outlook has become more cautious compared to a month ago, particularly regarding inflation and consumer strength. Amidst this backdrop, we recommend taking advantage of market rotation and volatility through hedging strategies such as structured notes, buffered ETFs, and other volatility-priced products, which tend to become more attractive in environments like this.

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Disclosures
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