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ECONOMIC FLASH – Inflation Could Create Headwinds for Markets

February 2018

US Economy: Underlying strength continues.

GDP growth for 4th quarter 2017 (the initial estimate) disappointed at 2.6%, on a jump in imports. However, forward-looking indexes for US manufacturing and consumer confidence both indicate continued expansion. Wages in Jan. 2018 were up nearly 3% from the year-earlier period.

US Stocks: A very strong January.

Although early February brought a market drop, January stock market returns were the best since 2016 in anticipation of strong earnings, tax cuts and a stable economy. Two sectors up more than 7.5% each: tech and discretionary consumer spending.

Foreign Stocks: Emerging markets still lead.

A very strong January for EM stocks (followed by a drop in early Feb.), due to strong global growth and better EM valuations. Higher oil prices boosted Russia (+12.6%) and Brazil (+16.8%).

Fixed Income: US Treasury yields surge.

The yield on 10-year Treasury bonds has risen to nearly 2.9% (as of early Feb.), the highest level in more than 4 years on expectations for rising interest rates and inflation.

Non-Traditional: Bitcoin down 65% in 2018.

After hitting a high of nearly $19,000 in late 2017, the value of 1 bitcoin plummeted to below $6,700 as some governments threatened to regulate cryptocurrencies.

THE TAKEAWAY

As goes January, so goes the year? Current market and economic fundamentals support a positive finish for 2018. However, we think inflation is a rising risk for both equity and fixed-income valuations. The market drops in early Feb. seem to indicate that.

We are largely keeping our global equity allocations intact, and we are adding positions likely to benefit from inflation, such as commodities and infrastructure. In fixed income, our focus on strategies less vulnerable to rising interest rates is proving to be beneficial.
Glossary and Disclaimer for Economic Flash

Equities Total Return

JAN 3 MOS 1 YR
U.S. Large Cap 5.7% 10.2% 26.4%
U.S. Small Cap 2.6% 5.1% 17.2%
U.S. Growth 6.8% 10.9% 34.1%
U.S. Value 3.7% 8.2% 16.6%
Int’l Developed 5.0% 7.8% 27.6%
Emerging Markets 8.3% 12.4% 41.0%

Fixed Income Total Return

JAN 3 MOS 1 YR
Taxable
U.S. Agg. Bond (1.2%) (0.8%) 2.1%
TIPS (0.9%) 0.2% 1.3%
U.S. High Yield 0.6% 0.7% 6.7%
Int’l Developed 3.1% 5.3% 10.5%
Emerging Markets 2.8% 5.2% 11.4%
Tax-Exempt
Intermediate Munis (0.2%) (0.9%) 1.8%
Munis Broad Mkt (1.1%) (0.5%) 3.8%

Non-Traditional Assets Total Return

JAN 3 MOS 1 YR
Commodities 2.0% 4.5% 3.6%
REITs (2.9%) (0.7%) 5.3%
Hedge Funds
Absolute Return 0.8% 0.5% 3.9%
Overall HF Market 2.5% 3.3% 8.0%
Managed Futures 4.0% 5.0% 7.8%

Economic Indicators

JAN-18 OCT-17 JAN-17
Equity Volatility 13.5 10.2 12.0
Implied Inflation 2.1% 1.9% 2.1%
Gold Spot $/OZ $1345 $1271 $1211
Oil ($/BBL) $69 $61 $56
U.S. Dollar Index 88.2 87.1 95.4