Optimism Amid Volatility

Summary

• The major stock indexes posted modest gains in February, despite heightened volatility at the end of the month.
• International stocks were just behind US large caps.
• Overall, the fixed income market had a negative month as yields spiked higher (remember, bond prices and yields move inversely).

Heading into March, the economic recovery is showing signs of momentum, COVID infections and hospitalizations are decreasing, and vaccine distribution is improving.

At the same time, the recent rise in interest rates and inflation expectations have become a hot topic, roiling the market. While investors may be feeling uneasy about the latest bout of volatility, the good news is that these market conditions coexist with prospects for robust economic growth-and a path forward that may look more normal than the events of the past year.

Here's a quick recap of what happened in the markets last month, and what's ahead.

US equities

The major stock indexes posted modest gains in February, despite heightened volatility at the end of the month. The Dow and S&P 500®, both of which started the month in negative territory, finished in the green year-to-date. Small caps maintained their strength, with the Russell 2000 adding 6.2% to its 5.0% run in January. The Nasdaq Composite eked out a 1% gain, despite experiencing its biggest pullback since October amid the uptick in long-term interest rates. Rising rates can spook stock investors since they increase borrowing costs and cut into corporate earnings. They also make bonds look more attractive.

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The best performing sectors were energy and financials, which benefited from higher oil prices and interest rates, respectively. Defensive sectors like utilities, health care, and consumer staples were the worst performers.

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International equities

International stocks were just behind US large caps. Developed markets finished ahead of emerging markets amid strong gains in the UK. Within emerging markets, which lost a lot of their earlier gains at the end of the month, Asia was one of the top-performing regions. Indian equities were a bright spot, gaining 5.2%.

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Fixed income

Overall, the fixed income market had a negative month as yields spiked higher (remember, bond prices and yields move inversely). The yield on the benchmark 10-year Treasury note surged to its highest level since last February, at one point reaching 1.6%-up from 1.09% at the start of the month.¹ Longer-term Treasuries were the month's worst performer. Meanwhile, short-term rates were little changed, anchored by Fed policy.

The sole positive price performer among fixed income assets were high-yield corporate bonds.

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Looking ahead

The past year has been punctuated by a continuous stream of robust monetary and fiscal stimulus intended to help the markets and economy through the COVID crisis. This is, obviously, not the norm. As vaccine distribution and the economic recovery progress, new market catalysts-and challenges-will likely materialize. A few points to keep in mind:

• Rising rates aren't necessarily cause for doom and gloom. Although interest rates have risen markedly since the start of the year, it's important to remember they're still relatively close to historical lows. Nonetheless, the recent weakness in high-flying tech shares illustrates the headwinds this can create for stocks. But fear not, as Morgan Stanley's Chief Cross-Asset Strategist Andrew Sheets noted in a recent Thoughts on the Market podcast, "there's a lot of historical evidence that markets can do just fine if yields are rising because the economy is getting better."
• The Fed doesn't appear to be ready to take its foot off the gas. Some investors are worried that a pick-up in inflation is on the horizon, which could cause the Fed to reign in its support. But Chairman Powell has repeatedly assured market watchers that the Fed's ultra-accommodative stance isn't changing anytime soon. In his Congressional testimony last month, Powell downplayed inflation fears, saying, "We do expect that inflation will move up. But we don't expect the effects on inflation will be particularly large or persistent."
• Diversification is a tried-and-true strategy. For investors concerned about the risks of rising rates and potential inflation, portfolio diversification is key. Over the long term, equities have tended to keep pace with, or stay a little ahead of, inflation-but stock selection is important in this environment. Investors may be considering high-quality, dividend-paying stocks, and on the fixed income side, Treasury inflation-protected securities (TIPS).

Analyst’s Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Comments

[Buyandhold 2012]

I'm always optimistic.

Volatility or no volatility.

Take today as an example.

I made the mistake of putting a carton filled with a dozen eggs into the refrigerator after I had been kept on hold by an infernal talking robot on the telephone.

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So when I was putting the carton of eggs into the refrigerator I was so agitated by the infernal talking robot that my hands were shaking and I dropped the eggs.

But being an eternal optimist, I looked on the bright side.

Only 4 eggs broke and I didn't get any broken eggs on my feet.

And if I can deal with that infernal talking robot, equities are a piece of cake.

[tom117]

Thank you for your article, very level headed and a great read. +1 follower!!