A wave of uncertainty socked the U.S. stock market in February, short-circuiting an early-year rally and saddling most mutual fund and ETF investors with monthly losses.
A slew of emerging headwinds — ranging from fears of consumers pulling back on spending to growing unease about President Donald Trump's tariff plans — dragged the average U.S. diversified equity fund down 2.78% in February. For the year, the average fund is up 0.55%.
The biggest losers in February were domestic growth funds, with portfolios that invest in smaller stocks taking the brunt of the sell-off, according to Lipper Refinitiv data. Small-cap growth funds cratered 6.72%. Midcap growth funds fell 6.13%. And large-cap growth funds declined 3.66%.
Among large caps, some of the nation's biggest growth funds with heavy exposure to technology suffered the most. American Funds Growth (AGTHX), whose top-10 holdings include all of the Magnificent Seven stocks, fell 3.77% in February. And Fidelity Contrafund (FCNTX) — which owns six of the seven megacap techs plus Berkshire Hathaway, Eli Lilly and Netflix in its top 10 — dipped 1.8%.
On the bright side, diversification helped offset some of the pain. A benchmark index that tracks U.S. investment-grade bonds rallied 2.2%, extending its 2025 gain to 2.74%. And stocks that trade in developed overseas markets also gained, with the MSCI EAFE index rising nearly 1% to boost its year-to-date gain to 5.81%.
Bonds Offer Support Beyond Stock Market
Investors with a chunk of their portfolio invested in bonds benefited from the ballast that fixed-income investments offer. General U.S. bond funds rose 1.85% in February. But the big winner was general U.S. Treasury funds, which jumped 3.36%. Treasury yields, which move in the opposite direction of price, fell down to 4.21% from 4.55% at the end of January.
The Vanguard Total Bond fund (VBMFX), which invests in virtually all U.S.-issued bonds, rose 2.08%. Pimco Income (PIMIX), a multisector bond fund, jumped 1.84%.
Tariff-related market volatility is lifting bonds, says Leslie Falconio, head of taxable fixed-income strategy for UBS Global Wealth Management.
"Over the longer term, prolonged tariffs are a hit to economic growth," said Falconio. "The bond market is experiencing a flight to quality given the current pocket of vulnerability in the stock market. The Atlanta Fed now sees GDP falling into negative territory in the first quarter of 2025. And uncertainty remains as to how long tariffs will persist and what retaliatory measures may ensue."
Foreign Stocks Are Great Again
International diversification also paid off. The average world equity fund gained 0.73%. European region funds rallied 3.41%. Value funds fared best on the world stage. International large-cap value funds jumped 3.68%, and international small- and midcap value funds rose 1.62%.
Francis Gannon, co-chief investment officer at Royce Investment Partners, says fears of tariffs proved disruptive for U.S. markets in February.
The benchmark S&P 500 index fell 1.3% on a total-return basis in February, trimming its 2025 gain to 1.44%. The technology-packed Nasdaq composite suffered the most, falling 3.91% and leaving it down 2.31% for the year. The Dow Jones Industrial Average fell 1.58% on a price basis, trimming its year-to-date gain to 3.05%.
Trump Tariffs Hit The Stock Market Hard
While Wall Street got a reprieve early in February when Trump paused the implementation of tariffs focused on Mexico and Canada for a month, concerns lingered. Market sentiment soured, volatility picked up, and risk-taking was reined in as investors took a wait-and-see approach.
"The market hates uncertainty, and especially uncertainty like this, which has been rapid and chaotic," said Gannon. "Obviously, I don't know if these tariffs are here to stay or are temporary. The longer they are in place, the worse this could be."
Tariffs are viewed as a negative by Wall Street, as they are likely to add upward pressure to inflation and be a headwind to economic growth, says Josh Jamner, senior investment strategy analyst at ClearBridge Investments.
A growth scare also swept through Wall Street, according to Gannon, as readings on consumer confidence and Main Street sentiment fell and the potential fallout from tariffs was priced in. The Atlanta Fed's forecast for a 2.8% drop in first-quarter GDP also fanned fears of an economic downturn.
"Trump turmoil raises odds of a recession," Edward Yardeni of Yardeni Research wrote in a report this week. "The pain of (Trump's) decisive actions is being felt now, while the benefits of his other policies are further out." Yardeni places chances of recession at 35%.
Stock Market Jitters Heat Up
Market trepidation proved prescient. On March 4, Trump went ahead with 25% tariffs on Mexico and Canada, as well as an additional 10% levy on China. Wall Street now fears a full-scale trade war, although there's always the chance Trump will strike a deal with trading partners to soften the blow.
It's clear that Wall Street was pricing in some of this added risk in February as the tariff deadline neared. How it will impact financial markets in the future will depend on how much bad news is already reflected in stock prices and how long the tariffs will remain in effect, Gannon says.
"It's a question of what's priced into the market at the moment," Gannon said.
Damage In February
The damage in February centers on the growing uncertainty surrounding Trump's tariffs and other policies. So-called risk-on trades that focus on fast-growing tech stocks and bets on consumer spending were the biggest losers. Science and technology funds plunged 5.58%, wiping out gains for the year, according to Lipper Refinitiv. And consumer goods funds, or those that invest in companies that sell discretionary goods, declined 3.05%.
More defensive mutual funds held up better. In fact, they rose in value as investors moved to safe havens. Consumer goods funds, which own sellers of everyday products like cereal and tissue paper, jumped 2.15%, extending their 2025 gain to 3.51%. And utility funds, a classic defensive stock play as everyone needs to turn the lights on and run their appliances, rose 1.92%, putting it up 3.81% on the year.
Playing Defense
Defense was the calling card for leaders in the stock ETF space as well. Of the top 20 U.S. diversified stock ETFs this year, the top performers in February were portfolios with an emphasis on dividend-paying stocks and companies with low volatility scores.
For example, the First Trust Morningstar Dividend Leaders ETF, which invests in companies that have historically maintained consistent and sustainable dividend payouts, gained 5.66% in February, according to Morningstar Direct. Franklin U.S. Low Volatility High Dividend Index — whose top holdings include established names such as IBM, Coca-Cola, Johnson & Johnson and McDonald's — rallied 5.13% in February.
In the ETF sector space, leaders included iShares MSCI Europe Financials, up 8.59% in February; Global X Defense Tech, up 6.66%; and iShares U.S. Consumer Staples, up 6.63%. China ETFs were also in recovery mode with Roundhill China Dragons ETF rallying 14.98% and iShares China Technology advancing 11.5%.
Again, diversified portfolios paid dividends in February. For example, the Vanguard Total Bond Market ETF gained 2.16%, outpacing Vanguard Total Stock Market, which lost 1.89%.
Keeping An Eye On Jobs
Looking ahead, Gannon says he'll be watching the February jobs report for signs of employment weakness in the wake of the new administration's firing of federal workers to reduce the deficit. He's also following the Federal Reserve's next move on interest rates more closely. Due to signs of economic weakness, the market is now pricing in three rate cuts this year, up from one when Trump took office.
"I wonder if we're going to start hearing more rumblings about the number of Fed eases this year," said Gannon.
Gannon, who is a small-cap investor, sees an opportunity for beaten-down small-company shares amid all the uncertainty. Despite the small-cap Russell 2000 stock index entering correction territory in February, he sees bullish days ahead.
The inflection point or catalyst for small caps, says Gannon, will be a pickup in earnings. By the second half of 2025 he expects small-cap earnings growth to outpace that of large-cap stocks.
"That's a really good thing," said Gannon. "The market is going to broaden out."
