Please find the next blog in our monthly series that provides timely market data as well as perspectives on the current state of the economy and the global financial markets.
The ongoing growth and inflation story took center stage in February, as markets re-priced the potential for overheating. Concerns over rising wages fueled the fire early in the month, with the January data showing average hourly wages increasing by 2.9% year-over-year.
Despite the latest reading on 4Q-17 GDP being revised down slightly to 2.5%, reports on the US economy and corporate fundamentals continue to display signs of strength. The unemployment rate remained at 4.1% for the fifth consecutive month, primarily because the participation rate edged up to 63.0%. Core PCE, the Federal Reserve’s preferred measure of inflation, held steady at 1.5% over the past 12-months.
The Federal Open Market Committee (FOMC) did not meet in February, but Jerome Powell took over as the new Chair. His public comments thus far have been slightly hawkish, leading to increased expectations for at least three and perhaps four (>35% probability by month end) rate hikes by the end of 2018. The markets reacted to positive comments about the economy by pricing in a more rapid rise in inflation, with both the equity and bond markets declining.
The European Central Bank (ECB) adjusted its growth estimate for 2018, which has now inched up to 2.4%. Inflation expectations remain anchored, with expectations of just 1.4% year-over-year price increases for both 2018 and 2019. Fear of trade wars and protectionism rose in February as the US prepared to impose import tariffs on steel and aluminum.
China’s official Purchasing Managers’ Index (PMI) dropped to 50.3 in February, below forecasts, but still remained in expansion territory. Perhaps more notable was the Communist Party’s announced repeal of the constitutional provision relating to presidential term limits, which could allow Xi Jinping to stay in power beyond 2023 and perhaps indefinitely.
Market volatility returned with a vengeance in February, with the impact felt across all asset classes. Although large domestic stocks, as represented by the S&P 500, are still up for the year. This key benchmark fell into correction territory (decline of at least 10% from the prior high) as of February 8th. A subsequent recovery ensued, but the index finished down -3.7% for the month, breaking the streak of 15 consecutive months of positive returns. All major sectors were down for the month, with Energy (-11.3%), Consumer Staples (-7.8%), Telecom (-7.1%), and Real Estate (-7.0%) the hardest hit.
Small cap returns were also negative for the month and consequently, down year-to-date. The Russell 2000 gave back -3.9% for the month, erasing the gains of January and then some. Somewhat surprisingly in the risk-off atmosphere, small cap value (-5.0%) trailed small cap growth (-2.9%).
In the broad international developed markets, the MSCI EAFE index was down -4.5% in February, but was able to hold onto year-to-date gains (+0.3%). Among the various regions, Japan outperformed on a relative basis, down just -1.5%, while MSCI Europe suffered a loss of -5.9%. Currency played a material role in this spread, with the US dollar (USD) continuing to decline against the Yen, but appreciating versus the Euro. Developing economies were also down significantly in February (-4.6%), but the MSCI Emerging Markets index is still solidly up for the year at +3.4%. Within the index, Latin America (+9.1%) and Eastern Europe (+8.4%) have been the regions of strength.
Real estate was weak again in February, with the FTSE EPRA/NAREIT Developed index down -6.6%, and the FTSE NAREIT US Real Estate index down -7.0%. Rising interest rates and late cycle characteristics hampered returns.
The Alerian MLP index (-9.7%) declined in February, with higher interest rates and softer energy prices among the suspected reasons. The Bloomberg Commodity index was down -1.7%, similar to the decline in the USD.
The US Treasury (UST) market suffered its second consecutive monthly loss. As the yield curve steepened, longer-term issues were hit particularly hard (20+ year index down -3.1%). While rates finished off their intra-month peaks and showed traditional diversification benefits on days when stocks suffered their worst losses, there are a number of ongoing headwinds contributing to UST weakness. The Federal Reserve will next meet on March 20-21, and markets are pricing a 100% chance for an upward rate hike. The group’s updated economic and policy projections will be closely watched.
The Bloombar US Aggregate index lost -0.9% in February, bringing year-to-date losses to -2.1%. Given universal spread widening, government issues actually outperformed the primary market’s other key sectors on a duration-matched basis. IG corporate credit spreads were 10 bps wider, and overall yields for IG corporates now exceed 3.7%.
The Bloombar 1-15-Year Municipal index returned -0.3%, as tax-exempt issues outperformed at virtually all points along the maturity spectrum. Notable retail mutual fund outflows, along with weaker corporate demand softened the technical environment. While valuations are not cheap, the tax benefit of municipals grows as yields continue to rise.
The Bloombar US Corporate High Yield index produced a loss of -0.9% in February. While spreads appeared resilient amid equity market volatility, the benchmark’s overall spread level widened by 17 bps. Local currency emerging market bonds lost -1.0%, but dramatically outperformed sovereign and corporate issues, which are more sensitive to US rates.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is a Registered Investment Adviser.