The S&P 500 returned -1.96% during February, once again underperforming the S&P SmallCap 600 Index’s -0.54% return. At the sector level of the S&P 500 Index, materials and utilities were the only two sectors to post gains, returning 2.23% and 5.29%, respectively. On the downside, consumer discretionary, financials and technology all lost roughly 3% during the month. Value stocks outperformed growth stocks in both the mid and large cap segments of the market. However, small-cap growth did outperform value in February.
International markets had a bit stronger performance than the US markets. The MSCI EAFE Index fell 0.63% in local currency terms, but was up 0.70% in dollar terms (due to a falling dollar); value stocks slightly outperformed growth stocks. Among developed markets Japan and Ireland posted the strongest gains, advancing by 1.88% and 1.86%, respectively. New Zealand and Greece had the poorest performance losing 4.28% and 5.26%, respectively. The MSCI EAFE Small Cap Index returned 0.23%, and emerging markets lost 0.75%. The BRIC (Brazil,Russia, India & China) Index struggled, falling 3.39%.
In contrast to the equity markets, fixed income markets generally posted very strong returns during the month. The yield on the 10 Year Treasury fell 27 basis points from the end of January, while the yield on the 2 Year Treasury fell 29 basis points. The Lehman Aggregate Bond Index returned 1.54%, as did the Lehman Government Bond Index. Investment grade bonds and U.S. TIPS had the strongest domestic performance, returning 2.02% and 2.13%, respectively. The high yield market lagged Treasuries and investment grade issues with a 1.40% return. Mortgage-backed and municipal bonds also lagged, earning 1.23% and 1.32%, respectively. International bonds did will with the Lehman Global Aggregate Index ex U.S. returning 2.39%.
The Dow Jones-AIG Commodity Index advanced by 3.37%, due to an upturn in natural gas and oil prices. Real estate, as represented by the S&P REIT Index, lost 2.40%.
February ended with a resurgence of market volatility, marked by the largest one day drop in the Dow Jones Industrials Average since 9/11 and a roughly 10% drop in China. The VIX, an indicator of market volatility, saw an intraday high of 19.01 on February 27. This is up from the 10 to11 range it had been trading at most of the year. This increased market volatility led to a flight to quality causing Treasury yields to fall across the yield curve. The hefty equity losses have led to much speculation regarding the current state of the market. While it is impossible to know where the market is heading next, a couple of points are worth noting. First, China was up more than 100% in the last year without so much as a 2% drawdown. It could be argued that they were due for a pullback. Second, periods of sustained losses have generally been associated with rising interest rates, expanding P/Es and falling corporate earnings. None of these conditions exist today. While markets had a strong run for the last few years, given the general health of corporate profits, low interest rates and historically average P/E multiples it is hard to argue that an extended market correction is looming.