Key Points:
- Higher than expected inflation data for January disappointed investors causing yields to rise.
- Stocks dropped in February after surging in January. The S&P500 lost 2.44% in February but is up 3.69% for the year.
- High quality bonds sold off during the month with rising Treasury yields hurting existing bond prices.
After a strong January in the markets investors hope for lower inflation (and less rate hikes) dwindled as inflation slowed less than expected. Higher inflation raises the odds of recession as the Fed’s tightening cycle may be higher for longer. Inflation should eventually come down but according to Invesco’s Global Market Strategist Brian Levitt, “..it takes roughly 12-18 months for tighter policy to be felt in the economy – and one year ago the Fed Funds Rate was 0.00%.” The economy appears relatively strong with consumers still spending and unemployment at just 3.4%, the lowest in 54 years. The layoffs in big tech have been offset by strong employment gains in leisure and hospitality industries. Volatility will likely remain elevated for the next few quarters as investors monitor the economy and the likelihood of a recession. The stock market is evaluating if it was accurately priced into last year’s market selloff.
The S&P 500 dropped 2.44% in February. The tech-heavy NASDAQ Composite held up the best losing just 1.01% while the Dow Jones Industrial Average fell -3.94%. Technology (+0.45%) was the only positive sector of the market while small caps performed better than large caps. Growth outperformed value during the month as energy stocks were hit the hardest (-7.12%): weaker economies usually require less energy. Developed international stocks dropped 2.09% while emerging markets fell 6.48%. The tensions with China (balloons, Russian relations, etc.) saw the MSCI China index fall 10.37%. The European equity markets were relatively flat as they enjoy dramatically lower natural gas prices amid a mild winter.
Bonds sold off in February as yields moved higher. The entire Treasury yield curve shifted up with inflation not falling at the pace that investors had hoped for. As a result of the move in yields, the Barclays Aggregate Bond Index dropped 2.59%. Inflation seems to have stabilized but remains far away from the Fed’s 2% target as personal spending remains strong. This may be temporary as consumers spend down the last of their pandemic savings, but the Fed is intent on slowing the economy to stabilize prices. The strong labor market has afforded them to be aggressive in raising interest rates. If they can thread the needle and slow the economy just enough to avoid a recession, risk assets should rise in the coming quarters.
Sources: Morningstar Direct, Wall Street Journal, First Trust, Merrill Lynch