Consolidation and rotation

The US stock market followed a bumpy-but-positive January with a bumpy-and-negative February as tariff uncertainty, inflation, and concerns about a slowing economy kept a lid the market’s “animal spirits.”

That said, the market ended last month just a little more than 3% below its record high. Also, while the major indexes extended their consolidations, there were signs that new market leadership could be emerging, as the megacap stocks that have driven gains in recent years continued to underperform.

The S&P 500 hit a record high as recently as February 19 before selling off sharply. But it staged a strong rally on the final day of the month, despite falling to within 0.2% of its lowest close of the year after a contentious meeting between President Trump and Ukraine President Volodymyr Zelenskyy:

Mixed inflation. While the mid-February Consumer Price Index (CPI) and Producer Price Index (PPI) reports showed hotter-than-expected inflation, the PCE Price Index—the Fed’s preferred gauge—gave a cooler reading on the final day of the month.

Consumer cracks? Some of the market’s larger stumbles last month involved the US consumer: surprise drops in consumer sentiment and consumer confidence, a decline in retail sales, and a downbeat earnings forecast from Walmart (WMT). While the defensive consumer staples sector was the S&P 500’s strongest link last month, the “risk-on” consumer discretionary sector was its weakest.

Less than Magnificent. At the end of February, only one of the “Magnificent 7” stocks (Meta) was up for the year, and only two (Apple and NVIDIA) were among the top-10 contributors to the S&P 500’s year-to-date return. NVIDIA’s post-earnings sell-off late in the month underscored the cohort’s weakness.

Bond yields declined in February. The benchmark 10-year Treasury yield fell more than it has in any month since December 2023, ending February down 36 basis points (0.36%) at 4.19%.

US stocks lagged global markets. As the US market struggles with its various headwinds, some investors may be considering foreign stocks for the first time in a while, according to Morgan Stanley & Co. analysts. China and Europe were bright spots last month, with the former benefiting mostly from DeepSeek and the latter from hopes for peace in Ukraine. Of the two, the analysts think the China story may have “stronger legs.”¹

In fact, many of the European market’s “high-level positives” may already be priced in, according to Morgan Stanley Wealth Management. Also, the analysts remain concerned about the risks of tariffs and a “generational US policy shift toward Europe and NATO.”² But they note that sustained euro strength vs. the US dollar would support the Europe trade.

The tariff picture didn’t reduce market uncertainty last month. In addition to pursuing a policy of “reciprocal tariffs”—that is, taxing imports from all other countries at the same rate they tax US imports—President Trump said it would implement the Mexico, Canada, and China tariffs he initially announced in late January. Morgan Stanley & Co. economists expect tariffs on China to increase substantially this year, but they think other tariffs either won’t happen or will be temporary. That said, they “can't ignore the potential global effects of a reciprocal tariff.”³

Insight of the month: The Fed, optimism, and euphoria. While most investors are impatient for lower interest rates, Morgan Stanley & Co. strategists highlighted a potential upside to a slow-cutting Fed. They believe the stock market’s longer-term uptrend could persist because, based on individual investor inflows and other factors, it doesn’t look like we’ve reached the “euphoria state” that often signals the end of a bull market. The analysts argue if the Fed cuts rates more slowly, it could extend the market’s “optimism phase,” while more-aggressive easing could potentially tip it into euphoria.⁴

March market history. The S&P 500 posted a positive March return in 45 of the past 68 years, and 22 of the past 34. The index’s typical March return over the past three decades has been middle of the road—1.5% overall (fifth-highest among all months), with the median positive March coming in at 3.3% and the median negative March at -2.1%.⁵

Key dates: Tariff deadline (3/4), Employment Report (3/7), CPI (3/12), PPI (3/13), consumer sentiment (3/14), retail sales (3/17), Fed interest rate announcement (3/19), consumer confidence (3/25), PCE Price Index (3/28).

Finally, there are likely opportunities at the stock, sector, and factor levels of the market, even if upside may be limited at the index level in the first half of the year. Morgan Stanley & Co. strategists continue to favor financials, software, media/entertainment, and consumer services—with an emphasis on quality across the board.⁶

^1,6 MorganStanley.com. What’s Behind the Recent Stock Tumble? 2/24/25.
² MorganStanley.com. GIC Weekly: Europe: Trend or Trade? 2/24/25.
³ MorganStanley.com. The Downside Risks of Reciprocal Tariffs. 1/20/25.
⁴ MorganStanley.com. Stock Market Outlook 2025: Can the Bull Run Persist? 2/19/25.
⁵ Figures reflect S&P 500 (SPX) monthly closing prices, 1957–2024. Supporting document available upon request.

Because of their narrow focus, sector investments tend to be more volatile than investments that diversify across many sectors and companies. Technology stocks may be especially volatile. Risks applicable to companies in the energy and natural resources sectors include commodity pricing risk, supply and demand risk, depletion risk and exploration risk. Health care sector stocks are subject to government regulation, as well as government approval of products and services, which can significantly impact price and availability, and which can also be significantly affected by rapid obsolescence and patent expirations.

Yields are subject to change with economic conditions. Yield is only one factor that should be considered when making an investment decision.