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ECONOMIC FLASH – Feb. 2018: Worst Month for Equities in Two Years

March 2018

US Economy: Inflation starts to percolate.

Key measures of inflation accelerated in Feb. (core inflation +0.2%; headline inflation +0.4%). Other economic data generally underscored a healthy US economy, including manufacturing expectations (60.8), which hit the highest level since 2004.

US Stocks: Volatility makes a comeback.

Concern about higher inflation and interest rates caused US stock markets to vacillate. The CBOE VIX measure of volatility spent nearly the entire month over 20, well above the five-year average of 15.

Foreign Stocks: Non-US equities trail.

Non-US equities sank and stayed down on concern over monetary policy, as the European Central Bank indicated rising interest rates in Europe.

Fixed Income: Treasury yields surge.

The yield on 2-year US Treasuries hit 2.1% — the highest level in more than a decade. The “hawkish” tone of new Fed Chair Jerome Powell’s first congressional testimony was a contributing factor.

Non-Traditional: Managed futures struggle.

Managed futures saw their equity holdings suffer alongside global stock markets, and the increase in volatility whipsawed strategies.

THE TAKEAWAY

Recent stock market volatility is likely to become the norm as uncertainty about the pace of interest rate increases around the globe remains at the forefront of investors’ minds. Additionally, a risk we identified earlier this year – the potential for protectionist US trade policies, such as high tariffs that disrupt markets – has increased. Volatility aside, the outlook for solid economic growth and investment opportunities remains positive in our view.

Consequently, we recommend maintaining portfolio positions in equities but diversifying to include assets likely to benefit from an inflationary environment, such as commodities and infrastructure. Within fixed income, three to four hikes in the Fed target rate seem likely in 2018. We continue to recommend fixed-income strategies that are less vulnerable to rising interest rates.
Glossary and Disclaimer for Economic Flash

Equities Total Return

FEB 3 MOS 1 YR
U.S. Large Cap (3.7%) 3.0% 17.1%
U.S. Small Cap (3.9%) (1.8%) 10.5%
U.S. Growth (2.6%) 4.8% 25.5%
U.S. Value (4.8%) (0.0%) 7.4%
Int’l Developed (4.5%) 1.9% 20.1%
Emerging Markets (4.6%) 7.0% 30.5%

Fixed Income Total Return

FEB 3 MOS 1 YR
Taxable
U.S. Agg. Bond (0.9%) (1.6%) 0.5%
TIPS (1.0%) (0.9%) (0.2%)
U.S. High Yield (0.9%) (0.0%) 4.1%
Int’l Developed (0.2%) 2.9% 9.9%
Emerging Markets (1.1%) 3.0% 9.0%
Tax-Exempt
Intermediate Munis (0.3%) (0.1%) 0.7%
Munis Broad Mkt (0.4%) (0.5%) 2.7%

Non-Traditional Assets Total Return

FEB 3 MOS 1 YR
Commodities (1.7%) 3.2% 1.6%
REITs (7.3%) (10.3%) (6.1%)
Hedge Funds
Absolute Return (0.4%) 0.7% 3.4%
Overall HF Market (2.4%) 0.7% 4.3%
Managed Futures (6.0%) (1.7%) (1.0%)

Economic Indicators

FEB-18 NOV-17 FEB-17
Equity Volatility 19.9 11.3 12.9
Implied Inflation 2.1% 1.9% 2.0%
Gold Spot $/OZ $1318 $1275 $1248
Oil ($/BBL) $66 $64 $56
U.S. Dollar Index 85.6 89.2 93.9

Our Take