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Economy, Stocks and Bonds
As we ended February, we have seen increased volatility in the equities, with the S&P 500 closing the month at 3811.15. This is an increase of 2.6% for the month, and yet is 3.5% off the highs put in just 10 days prior. The VIX volatility index has been periodically spiking to near 30, which indicates increased perception of risk in the market. Notably, the Technology, Industrials, and Consumer Discretionary sectors have shown more weakness than the general market. Utilities are performing poorly, possibly because of inflation concerns in the marketplace. Financials, Energy, and Healthcare indexes have been holding up. It is important to note that while the media is blaming the recent increase in volatility to the inflationary signals we are about to discuss, we see evidence that a potential pullback has been on the horizon for some time. The fact is, the S&P 500 is up approximately 76.5% from the March 2020 lows, and 19.4% from the most recent significant pullback last October. All indications are that if a correction occurs, it is likely to be brief, as underlying conditions continue to show unexpected strength.
There are increasingly clear signals of rising inflation on the horizon even as Congress is in the process of enacting another $1.9 trillion stimulus package. Recent reports of import prices show growth of 1.4% month over month in January, following a 1% rise in December. Commodities such as lumber, cotton, wheat, aluminum, and oil are all trading near highs and apparently in strong uptrends, and the US Dollar Index is trending down. The Federal Reserve has committed to keep rates low for the immediate future, but they can only really control the short end of the curve by keeping the overnight borrowing rate low. Notably, the 10-year Treasury yield has risen by approximately 44% from 1.036% at the end of January to the current 1.479%. While absolute yield is still low, this is a very sharp increase in rates that is worth paying attention to, especially in light of the above trends in commodities and the Dollar.
We maintain a short duration exposure in fixed income, which should buffer the impact of higher rates on bond holdings. We are expecting a rising rate environment for the foreseeable future despite lots of media commentary that the spike in yields is going to be short-lived. The evidence quoted above is saying something different.
The economy continues to improve, household incomes are up, new applications for unemployment benefits are declining, retail sales and consumer confidence are rising and economic growth forecasts are being revised up by analysts.
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