February is a month to remember. 

Note: we said "is a month to remember," not "was a month to remember."  The verb tense is important here, because it conveys some confusion about what to make of the market action in February. 

One may be thinking, "What's not to understand? The S&P 500 increased 1.0% in February, continuing a rally that began in mid-November, and the Dow Jones Industrial Average came within a whisker of setting a new all-time high.  The bulls remained in control."

Those are encouraging things to be sure, yet there were some less talked about moves that didn't exactly fit with a no-holds-barred bull market.

Ben There, Done That

The stock market went up in February and it did so in the face of the sequester deadline, weak GDP reports the world over, and an election mess in Italy that got investors reacquainted with the eurozone debt crisis.

To be fair, there were some legitimate sources of support that included economic data in the US pointing to a pickup in consumer confidence, home sales, and business spending.  The caveat is that a good number of those reports were for the months of December and January, or before consumers got a better understanding of the income hit associated with the higher payroll tax.

There was no mistaking, though, that the biggest source of support was Fed Chairman Ben Bernanke and his continued defense of quantitative easing.  His views were made clear in his semi-annual testimony on the economy and monetary policy before the Senate Banking and House Financial Services Committees last week.

The Fed chairman said a lot in that testimony, but his continued belief that the benefits of the Fed's unconventional policy continue to outweigh its costs was all the market needed to hear.  It didn't hurt either that he said he didn't see much evidence of an equity bubble.

Those admissions, and a viewpoint that it will likely take three more years to get the unemployment rate down to 6.0%, extinguished the market's concerns about the Fed shifting to a tightening posture sooner rather than later that were piqued by the FOMC Minutes for the January meeting.

The S&P 500, which dropped 1.8% on February 25 as Italy's election mess came to light, recouped that loss and then some just two days later in the wake of Mr. Bernanke's testimony.

It's True

So, with the market advancing 1.0% in February, it must have been more of the same with respect to the growth message embedded in the market's performance, right?  Well, not exactly.

It is true that the Dow Jones Transportation Average and the Philadelphia Semiconductor Index -- two leading market indicators -- outperformed in February, increasing 3.3% and 3.4%, respectively.  However, it is also true that copper prices and oil prices -- two other leading market indicators -- underperformed the market, dropping 4.9% and 5.1%, respectively.

It is also true that the CBOE Volatility Index jumped 6.1% for the month -- and 34% on February 25 alone -- as investors sought downside protection.

It is true that the defensive-oriented telecom services, consumer staples, utilities, and health care sectors were the best sector performers in February while most of the previously hot cyclical sectors cooled noticeably, as seen in the table below.

It is true that the US Dollar Index increased 3.5% in February despite a report of paltry 0.1% growth in Q4 GDP and the Fed chairman's dovish outlook for monetary policy.  That move wasn't based on the idea that interest rates are headed higher, however, so much as it was on a flight to safety in the world's reserve currency.

It is true that the Treasury market also benefitted from a flight to safety. 

The 10-year note yield, which ended January at 1.99%, closed February at 1.88%.  Strikingly, it moved up two basis points to 1.88% after Mr. Bernanke made it clear the Fed wasn't about to abandon its policy of buying $85 bln of agency MBS and long-term Treasury securities.

What It All Means

The concise takeaway is that the market's 1.0% advance in February was a defensive rally.  No one, though, is raising any surrender flags.  Not yet anyway.

The key distinction is that money was reallocated within the equity market.  It didn't come out altogether.   Moreover, only two sectors -- consumer discretionary and basic materials -- declined for the month.

The defensive posturing caught our attention, however, because it is not what one would expect in a no-holds-barred bull market.  To that end, we still find it peculiar that the countercyclical health care (+9.3%) and consumer staples (+9.2%) sectors are the best-performing sectors on a year-to-date basis.

Is their outperformance and the weakness in copper and oil prices foreshadowing growth disappointment ahead?  Or is the outperformance of the Dow Jones Transportation Average and the Philadelphia Semiconductor Index presaging a recovery in growth momentum that seems to get top billing in the marketplace?

We have expressed our doubts about the second-half recovery story and continue to believe the market is not appreciating the adverse economic effects of fiscal austerity combined with higher taxes.  However, with the Fed continuing its undying support of the wealth effect, we can understand why the market has embraced that unreal policy over the lingering weakness in the real economy.  

It is possible that the defensive posturing in February is a reflection of a shift in attitude about the growth outlook.  Then again, it could quite simply be a pause in the growth-oriented action.  We're just not sure.

One thing we do know is that February is going to be a month to remember several months down the road as a month that provided an early-warning signal for the bulls or false hope for the bears.

--Patrick J. O'Hare, Briefing.com