Flight to Quality in Uncertain Times
Monthly Market Commentary
By Kensington Asset Management Team
Market Volatility Rises Amid Trade Uncertainty
February saw heightened volatility as investors reassessed the economic impact of newly imposed trade tariffs. The S&P 500 declined by -1.42%, with the Nasdaq 100 falling -2.76% and the Russell 2000 Small-Cap Index down -5.45%. While the market had initially assumed tariffs were a bargaining tactic, the confirmation of their implementation triggered a swift correction
The broader concern is the inflationary pressure tariffs create, increasing consumer prices and dampening demand. Paired with government cutbacks and immigration crackdowns, labor demand is also expected to slow. Treasury Secretary Bessent has indicated these policies are part of a broader effort to curb excessive government spending and economic over-reliance on stimulus, a “detox period” designed to tame inflation and normalize interest rates. However, markets question whether this approach will push the economy into a recession.
Despite these risks, some investors see potential offsets. Possible corporate tax cuts, regulatory rollbacks, increased oil production, and new trade agreements could help counterbalance headwinds. Additionally, European markets have outperformed in early 2025, reflecting a shift in global capital as the US steps back from international leadership.
Fixed Income: Flight to Quality in Uncertain Times
Bond markets posted strong gains in February, driven by a flight to quality amid equity weakness. The 10-year Treasury advanced 5.64%, the 30-year gained 3.09%, and Bloomberg US Corporate Investment-Grade Bond Index rose 2.04%. Bloomberg US Mortgage-backed Securities Index also performed well, climbing 2.55%, while Bloomberg US Corporate High-Yield Bond Index lagged at 0.67%, reflecting investor caution toward riskier assets.
Despite the decline in yields, recession signals remain mixed. The 10-year yield has stabilized around 4.0–4.25%, suggesting an economy slowing but not contracting (chart below). However, a drop in the 2-year Treasury yield, historically a precursor to Fed rate cuts, suggests growing expectations of economic weakness.
Source: Investing.com
Credit spreads have begun widening, an early signal of potential stress in corporate debt markets. While not yet at crisis levels, the trend warrants close monitoring. If high-yield bonds continue to underperform, it could indicate deeper concerns about economic growth and corporate balance sheets.
Federal Reserve: Navigating Policy Challenges
Fed Chair Jerome Powell faces one of the most complex policy landscapes in recent history. The central bank remains committed to data-driven decisions, but trade disruptions and shifting consumer behavior complicate its outlook.
Labor market indicators remain relatively stable, with non-farm payrolls meeting expectations and job openings showing resilience. However, consumer sentiment has weakened. The University of Michigan Consumer Sentiment Index fell 10% year-over-year, while the Conference Board’s Consumer Confidence Index posted its largest monthly drop since August 2021.
Inflation data has shown mixed signals. The core Consumer Price Index (CPI) rose 0.2% month-over-month, while the core Personal Consumption Expenditures (PCE) index increased 0.3%. Despite these modest gains, long-term inflation expectations have surged, with the Conference Board survey showing a jump from 5.2% to 6.0%. Similarly, the University of Michigan’s five-year inflation outlook hit 3.5%, its highest level since 1995.
With these conflicting data points, the Fed is likely to hold rates steady in the near term. Market expectations currently price in rate cuts starting in mid-2025, but the central bank may wait for greater clarity on trade policy impacts and global economic conditions before making any moves.
Market Outlook: Risks and Opportunities Ahead
Looking ahead, markets remain at a crossroads. The economic impact of tariffs, labor market shifts, and consumer sentiment declines will shape the trajectory for the rest of the year. Key risks include:
- Prolonged Trade Disruptions: Extended tariff conflicts could weigh on corporate earnings and economic growth.
- Rising Credit Market Stress: Widening credit spreads and underperformance in high-yield bonds may signal deeper economic issues.
- Fed Policy Uncertainty: The central bank’s response to evolving inflation and labor trends will be critical for market stability.
- However, potential tailwinds exist, including:
- Tax and Regulatory Adjustments: New corporate tax cuts or deregulation efforts could support profitability.
- Energy Market Stability: Increased US oil production could help keep energy costs in check, alleviating inflationary pressures.
- Global Market Leadership Shift: Strength in European and emerging markets could attract capital away from US equities, altering investment flows.
Given these factors, investors should maintain a balanced approach, emphasizing quality assets, risk management, and flexibility in portfolio positioning. Kensington’s strategies remain focused on navigating market volatility while identifying opportunities in a shifting global landscape.
Disclaimers:
Investing involves risk, including loss of principal. Past performance does not guarantee future results. There is no guarantee any investment strategy will generate a profit or prevent a loss.
This is for informational purposes only and is not a recommendation nor solicitation to buy, sell or invest in any investment product or strategy. Our materials may contain information deemed to be correct and appropriate at a given time but may not reflect our current views or opinions due to changing market conditions. No information provided should be viewed as or used as a substitute for individualized investment advice. An investor should consider the investment objectives, risks, charges, and expenses of the investment and the strategy carefully before investing.
Kensington Asset Management, LLC (“KAM”) relies on third party sources for some of its information that we believe is reliable. However, we make no representation, warranty, endorse or affirm as to its accuracy or completeness. The information provided is current as of the date of publication and may be subject to change. We are not responsible for updating this information to reflect any subsequent developments or events.
Any indices and other financial benchmarks shown are provided for illustrative purposes only, are unmanaged, reflect reinvestment of income and dividends and do not reflect the impact of advisory fees. Investors cannot invest directly in an index. Comparisons to indexes have limitations because indexes have volatility and other material characteristics that may differ from a particular strategy such as the types of securities being substantially different.
Certain information contained herein constitutes “forward-looking statements,” which can be identified using forward-looking terminology such as “may,” “will,” “should,” “expect,” “anticipate,” “project,” “estimate,” “intend,” “continue,” or “believe,” or the negatives thereof or other variations thereon or comparable terminology. Due to various risks and uncertainties, actual events, results, or actual performance may differ materially from those reflected or contemplated in such forward-looking statements. Nothing contained herein may be relied upon as a guarantee, promise, assurance, or a representation as to the future.
Advisory services offered through Kensington Asset Management, LLC, Barton Oaks Plaza, Bldg II, 901 S Mopac Expy – Ste 225, Austin, TX 78746.
Definitions:
Bloomberg US Corporate Investment Grade Index: An unmanaged index that covers the publicly issued US corporate and specified foreign debentures and secured notes that meet the specified maturity, liquidity, and quality requirements. To qualify, bonds must be SEC-registered.
Bloomberg US Corporate High Yield Index: An unmanaged market value-weighted index that covers the universe of fixed-rate, non-investment grade debt in the US. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on the indices’ EM country definition, are excluded.
Bloomberg US Mortgage-Backed Securities (MBS) Index: An unmanaged index that tracks fixed-rate agency mortgage-backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon, and vintage.
NASDAQ 100 Index: A market index that comprises of the 100 largest, most actively traded companies listed on the Nasdaq stock exchange.
Russell 2000 Index: A market index that consists of 2,000 small-cap US companies that are part of the larger Russell 3000 Index.
S&P 500: A capitalization weighted index of 500 stocks representing all major domestic industry groups. The S&P 500 TR Index assumes the reinvestment of dividends and capital gains.
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