February Market Commentary: Unwinding U.S. Exceptionalism & Stagflation Risk

Written as of March 13, 2025.

Comments from the Desk of John Nicola

In today’s market, uncertainty is the only certainty. Shifts in geopolitical dynamics, inflationary pressures, and evolving economic policies continue to shape the investment landscape. As Rob Edel, our Chief Economist highlights in this month’s commentary, the unwinding of U.S. exceptionalism and the risk of stagflation are key themes driving market sentiment. While these factors have contributed to volatility, they also reinforce the importance of a well-diversified and disciplined investment approach. 

At Nicola Wealth, our investment philosophy is built on strategic asset allocation that extends beyond public markets. The Nicola Core Portfolio Fund, designed to provide stability across various market cycles, has benefited from this multi-asset approach. By integrating private investments, real estate, and alternative strategies alongside traditional equities and fixed income, we seek to mitigate downside risks while capturing long-term growth opportunities. 

Market fluctuations and policy shifts will continue to drive headlines, but our focus remains steadfast: protecting and growing wealth through a well-structured, risk-aware strategy. While short-term challenges exist, history has shown that resilience and discipline are key to long-term investment success. 

As you read through the insights provided by our Rob Edel, I encourage you to consider the broader investment landscape and the advantages of a diversified, forward-looking approach. 

—John Nicola 
Chairman, CEO, and Chief Investment Officer 

Highlights this Month

• Global markets outperform as economic balance shifts. 
• Trump’s policy approach fuels market uncertainty. 
• Global markets respond to new realities. 
• Bond markets signal growing stagflation risks. 
• Wealthy Americans drive consumer spending. 
• Corporate earnings remain resilient despite headwinds. 

February in Review

Vladimir Lenin famously said, “There are decades where nothing happens; and there are weeks where decades happen.” Almost two months into Donald Trump’s presidency, it already feels much longer. While the scope of market challenges is vast, we’ll focus on three key issues: the unwinding of U.S. exceptionalism, surging global economic policy uncertainty under the new administration, and rising stagflation risks. Though we aim to confine our analysis to February’s events, the situation remains fluid.

In February, the S&P 500 returned -1.4%, while China’s MSCI Index gained +12%. European equities rose +3.5%, with Germany up +3.7%. Canada’s S&P/TSX followed U.S. stocks lower, slipping -0.5%. (Figure 1)

Figure 1

U.S. exceptionalism appears to be fading.

Year to date, U.S. stocks remain up 1.4%, but the unwinding of U.S. exceptionalism appeared to take hold last month. The NASDAQ, a symbol of American market dominance, fell 3.9% in February and is now down 2.3% for the year, with further declines in early March. The Magnificent 7 (UBS Magnificent 7 Index) fared even worse, dropping 5.4% in February.

U.S. stocks remain historically expensive, something investors may be coming to terms with (Figure 2). Over the past 35 years, U.S. equities have outperformed international stocks 24 times. However, in the six years they lagged, the S&P 500 ended the year an average of 6% lower than the MSCI ACWI ex-U.S. index. Notably, when trailing by more than 2.8% by mid-February, the S&P 500 has never recovered to outperform.

Figure 2

From an economic standpoint, U.S. equity outperformance has historically mirrored economic strength. Since 1990, U.S. GDP growth has exceeded that of the rest of the world in every decade except the 2000s. However, the 2025 Citi Economic Surprise Index shows the U.S. economy underperforming forecasts, while global economies are exceeding expectations (Figure 3).

Figure 3

Trump’s policy approach fuels market uncertainty. 

President Trump's policy approach is adding to economic uncertainty. His administration has signed an unprecedented number of executive orders, focusing on foreign policy and reshaping the federal government. The administration is "flooding the zone," making it difficult for political opponents, business executives, and investors to keep up.

However, trade policy is just one piece of the puzzle, government spending is also under scrutiny. Elon Musk’s Department of Government Efficiency (DOGE) has taken an aggressive stance on cutting waste, but an overly rigid approach could weaken economic growth. Historically, U.S. government spending has played a critical role in GDP expansion, and large federal spending cuts could push the economy into recession. Without the significant increases in federal debt that have historically financed government expenditures, real GDP growth would have struggled (Figure 4).

Much like spending cuts, tariffs act as a drag on the economy—potentially necessary for long-term fiscal sustainability but posing challenges for short-term growth.

Figure 4

Global markets respond to new realities. 

On the international stage, Trump’s approach has significantly reshaped geopolitical dynamics. A key moment came in early March when he held an Oval Office press conference with Ukrainian President Volodymyr Zelensky, signalling a shift from traditional Western alliances to a more transactional, interest-driven geopolitical landscape. As a result, countries are adjusting their strategies accordingly.

Germany and China have been among the beneficiaries. Despite Germany’s economic struggles stocks have rallied following a €900 billion investment in military and infrastructure. China, meanwhile, has prioritized consumer spending and technological advancements to meet its 5% growth target. These shifts have fueled renewed investor interest in both markets. 

Canada, on the other hand, faces a more uncertain outlook. While it has fiscal space, high consumer debt and economic uncertainty are concerns to consider. A potential trade conflict with the U.S. could further hinder growth. Business investment in Canada has lagged behind the U.S. for over a decade, and the Canadian dollar continues to struggle.

In the U.S., the market’s response has been somewhat negative. President Trump appears to be getting what he asked for, namely lower 10-year yields, cheaper oil, and a weaker dollar, but he may not like why. Along with these trends, Bloomberg highlights the deterioration of consumer discretionary stocks relative to the more defensive consumer staples sector as a sign that post-election enthusiasm is starting to wane.

Bond markets signal growing stagflation risks. 

The bond market seems to be signalling increased risks of stagflation, with falling ten-year bond yields reflecting concerns about slower U.S. economic growth (Figure 5). Real yields have taken a sharp dip, while breakeven rates—indicating expected future inflation—have edged slightly higher.

Figure 5

The manufacturing and services sectors are also concerned. BCA Research highlights that February's Purchasing Manager Indices are pointing to slower growth and increasing price pressures (Figure 6). Additionally, The Conference Board reports that consumer inflation expectations have jumped, and the Atlanta Fed forecasts U.S. GDP to shrink -2.8% in Q1. However, Societe Generale notes that part of this decline is due to a large increase in gold imports, which impacted GDP numbers. 

Figure 6

Tariffs and other administration policies have contributed to falling growth forecasts by increasing trade policy uncertainty. This uncertainty has led to declining corporate capital spending as businesses await clarity (Figure 7). While current weakness appears mainly in soft data like surveys and sentiment rather than hard economic indicators, these soft data weaknesses will likely manifest in hard data as effects materialize over time. 

Figure 7

Inflation is following a similar trend. While the downward trajectory may be levelling off, soft data, such as expectations for inflation, is starting to rise. Indices from the University of Michigan, Cleveland Fed, Conference Board, and New York Fed all showed a bump in inflation expectations last month, signaling that consumers anticipate higher prices (Figure 8).  

Figure 8

Wealthy Americans drive consumer spending. 

Given consumption is nearly 70% of U.S. GDP, the health of the U.S. consumer matters greatly. The top 10% of earners, households making about $250,000 a year, accounted for nearly 50% of total U.S. consumer spending in Q3 2024 (Figure 9). Interestingly, one might expect wage growth to drive the growing divergence in buying power, but wage growth has been decelerating at roughly the same rate for all workers. 

Figure 9

Instead of wage growth, it’s been the stock market driving increased spending among the wealthy. Bloomberg notes that stocks added about $10 trillion (or 28.8%) to American household balance sheets over the 12 months ending in September 2024, more than compensating for stagnating corporate paychecks. Additionally, stocks make up roughly 64% of the average U.S. household’s financial assets, yet 87% of stocks and mutual funds are held by the wealthiest 10% of households.

Corporate earnings remain resilient despite headwinds. 

So far, Wall Street and Corporate America have not seen any dramatic shift in the economic environment. While earnings revision breadth has started to roll over and Bloomberg notes that more companies are issuing guidance below Wall Street estimates, this pattern remains within historical norms (Figure 10).  

Figure 10

The typical path of bottom-up earnings estimates for S&P 500 companies is for them to gradually be revised lower as the year progresses (Figure 11). If anything, 2025 estimates are actually trending above the median experienced since 1985. While 2025 S&P 500 earnings estimates have slipped somewhat, 2026 estimates haven't budged. 

Figure 11

There’s always a ‘but’… 

Recession concerns are mounting. A February Bloomberg News survey of economists found that the odds of a recession in the next 12 months had risen to 25% from 20% in January. By early March, capital markets were also starting to price in a higher probability of a downturn. Five-year Treasuries and base metals suggest a 52% chance of recession, while small-cap stocks (Russell 2000) and large-cap stocks (S&P 500) are pricing in a 48% and 22% probability, respectively.

Despite elevated U.S. economic policy uncertainty and growing fears of recession, credit spreads have remained stable and near record lows (Figure 12). We suspect the large inflows of capital into credit markets, particularly into private debt, and the lack of new supply may be keeping spreads lower than expected. However, by early March, we’ve started to see credit spreads start to widen in response to the growing stagflation. 

Figure 12

Markets brace for continued volatility ahead. 

Equity markets are in a challenging position, caught between the risks of stagflation and the uncertain policies of President Trump. In a February Bank of America Fund Manager Survey, 39% believed trade wars triggering a global recession were the market's biggest tail risk, followed by the risk of inflation and Fed hikes at 31% (Figure 13). These concerns have largely played out over the past month and continue to persist into early March. 

Figure 13

Markets dislike uncertainty, and it seems that political and economic adjustments are just beginning. As a result, investors should be prepared for ongoing volatility in the months ahead. While it may be tempting to make dramatic changes to a portfolio during times like these, the more prudent approach is often one of patience and trust in a long-term strategy. 

See how Nicola Wealth’s investment pools navigated February’s market conditions in our latest Investment Returns update. Learn more: February 2025 Investment Returns