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- February’s modest pullback reflected a market rotation rather than a broad deterioration, as some market sectors, including international stocks, small caps, and bonds posted meaningful gains.
- A Supreme Court ruling reshaped the legal framework for tariffs, injecting uncertainty into U.S. trade policy.
- Economic growth is moderating but remains positive, while the labor market is sending mixed signals.
- Geopolitical tensions escalated late in the month, injecting uncertainty into markets.
- For long-term investors, diversification and discipline remain essential.
Markets Pause After January’s Rally
February offered a reminder that markets rarely move in a straight line. After January’s rally pushed major indices to new highs, February saw modest volatility as investors digested a Supreme Court ruling on tariff policy, concerns about artificial intelligence valuations, mixed labor market signals, and escalating geopolitical tensions in the Middle East. Despite the volume and concerning nature of the headlines, the market pullback was limited and largely reflected a rotation in leadership rather than a broad deterioration in fundamentals. The economic backdrop remained solid: growth is moderating but still positive, inflation continues to ease, and corporate earnings remain resilient.
February’s Decline Represents a Market Rotation
February’s headline returns tell only part of the story. The S&P 500 fell 0.8% and the Nasdaq Composite dropped 3.3%, while the Dow Jones Industrial Average edged up 0.3% and the Russell 2000 gained 0.8%. International markets fared considerably better, with the MSCI EAFE advancing 4.6% and emerging markets gaining 5.5%. In fixed income, the Bloomberg U.S. Aggregate Bond Index returned 1.6% as the 10-year Treasury yield fell below 4% for the first time since November. The VIX rose to 19.9, reflecting a modest increase in market anxiety, though it stayed well within normal historical ranges.1
The takeaway for investors is that February was characterized by a market rotation rather than a broad market decline. Many sectors within equities performed well, even as the more concentrated, technology-heavy areas of the market pulled back. Bonds performed well during the month and may have provided a stabilizing counterweight to equity volatility within balanced portfolios. This environment provided a clear reminder of the importance of portfolio diversification.
Source: YCharts
Supreme Court Ruling Puts Trade Policy In The Spotlight
On February 20th, the Supreme Court ruled against the administration’s use of the International Emergency Economic Powers Act to impose tariffs. The ruling carries broad implications, including potential refunds for businesses and consumers. In response, the administration shifted its tariff authority to Section 122 of the Trade Act of 1974, which permits temporary tariffs of up to 15% for 150 days. Additional trade measures that fall under other statutes may come into play over time.2
For investors, it’s important to distinguish between the legal framework governing tariffs and the policy direction guiding them. While the Supreme Court ruling impacted the framework, the policy direction appears intact. As the administration adjusts and responds to the ruling, trade policy uncertainty will likely continue, generating headlines and periodic market volatility.
The Artificial Intelligence Narrative Continues to Evolve
Artificial intelligence remained a central investment theme in February, but the tone shifted as the market’s enthusiasm for AI’s growth potential gave way to concerns about the pace of adoption, the return on massive infrastructure investments, and the degree to which AI could disrupt existing business models. This contributed to underperformance among mega-cap technology stocks, with investors rotating toward sectors such as energy, materials, and industrials, which appear more resilient to technological disruption.
Source: MarketDesk
With nearly 30% of the S&P 500 closely tied to AI through the five key mega-cap players in this space, even diversified portfolios already carry meaningful exposure to this theme.3 As the market begins to more closely scrutinize AI stock valuations and long-term fundamentals, volatility is likely and reflects a natural evolution of the investment theme.
Growth Is Moderating, but Remains Healthy
Economic data released in February showed that growth is slowing but still positive. Real GDP grew 1.4% in the fourth quarter of 2025, down from 4.4% in the prior quarter, partly due to the effects of the government shutdown and a deceleration in consumer spending. Business investment, particularly in AI infrastructure, remained strong, and for the full year, the U.S. economy expanded by 2.2%. The overall picture supports the view that the economy is cooling rather than contracting.
Source: Bureau of Economic Analysis. Seasonally adjusted.
Meanwhile, the labor market is sending mixed signals. The unemployment rate stood at 4.3% in February, and January payrolls showed 130,000 jobs added. However, benchmark revisions revealed the economy created only 181,000 jobs in all of 2025, or roughly 15,000 per month. Some economists describe this as an environment of “jobless growth,” in which economic output expands, but employment growth slows. The key question for markets is whether slower hiring will eventually weigh on consumer spending, a critical driver of the economy.4
Geopolitical Tensions Rise
Late February brought a significant escalation in geopolitical risk, as the United States and Israel launched military strikes against Iran on February 28th. Energy markets remain sensitive to developments in the region, and safe-haven assets, including gold, have seen increased investor interest. The situation remains fluid and short-term volatility spikes are likely. While geopolitical events can move markets in the short term, long-term investment outcomes are generally driven more by economic fundamentals and corporate earnings trends.
Staying Focused on the Long Term Objectives
February demonstrated how quickly sentiment can shift when multiple headlines arrive at once. Yet stepping back, the picture remains constructive. The economy continues to grow, corporate earnings remain resilient, and diversified portfolios navigated the month’s volatility with more stability than narrowly positioned ones.
For long-term investors, the most effective response is to stay diversified across asset classes, geographies, and styles and remain disciplined in the face of short-term noise.
Sources
1Morningstar
2Wallstreet Journal
3CNBC
4Bureau of Labor Statistics
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