March 07, 2016

Monthly Market Summary – February 2016

The trends seen in the financial markets during January continued into the first half of February.  These trends continued because the same issues such as falling oil prices, China’s slowdown, the likelihood of more interest rate hikes, and mixed corporate earnings fueled uncertainty and investor uneasiness.  Market participants do not like uncertainty so the numerous cross currents led to continued highly volatile markets.  Prices for global equities, high yield corporate bonds, and oil all trended lower while government bond and gold prices moved higher in the early part of the month.  The S&P 500 hit a low on February 11 and was down 6.7% for the month at that point.  This low and the oil prices low of $26 per barrel coincided.  During this period gold hit a 12 month high boosted by investors seeking the perceived safety of the precious metal.  Then conditions shifted and the negative sentiment eased.  Oil rallied on talk of Saudi Arabia and Russia agreeing to production caps and on a weaker U.S. dollar.  Oil rallied through the end of the month and closed at $34 per barrel.  Equity indices moved higher in the second half of February in line with oil prices, but also helped by better than expected economic data.  For example, in the U.S. retail sales advanced 0.2%, existing home sales rose 0.4%, and personal income and personal spending each rose 0.5%.  In other regions, purchasing manager index (PMI) reports improved in the euro area, the U.K., and China.  In the euro area unemployment declined to 10.4% which is the lowest level since September 2011.

Major Market Indices – February 2016

February 2016 Chart of Returns

The result of the ups and downs in financial markets, or the “risk-on/risk-off” periods, was that the major U.S. equity indices (shown above) rebounded to finish the month with returns in a tight range of -1% to +1%, international equity indices lagged the U.S. equity returns with small negative returns, the fixed income index had a small positive return, and the commodity index posted its eighth consecutive negative monthly return.

In U.S. equity markets, the mid-capitalization (cap) index had the best return for the month followed by the small-cap index, and then the large-cap index.  Growth stocks outperformed value stocks in the mid-cap index but the opposite occurred in the large and small-cap indices.  Interestingly the cyclical sectors of materials and industrial had among the best returns for the month in each of the three market cap ranges followed by defensive sectors of telecom and utilities. The strength in materials and industrials could be a rebound from oversold conditions as investors saw an attractive entry point after the sell-off in these sectors in 2015 that continued through January 2016.  The weaker U.S. dollar is also seen as a positive for these sectors and likely contributed to the gains.  Financials was the poorest performing sector in the large-cap S&P 500 index while energy was the weakest sector with large negative returns in the mid and small-cap indices.  Financials was also weak in the mid-cap index.  The financials sector was a laggard for two primary reasons.  First, bond yields declined which hurts bank and insurance company earnings.  Second, concerns intensified about the risk of defaults on loans to the energy industry.

The MSCI EAFE index of developed international country equities and the MSCI Emerging Markets (EM) index each had a negative return for the month.  However, for the second consecutive month EM outperformed developed international.  In the EM index, energy importing countries such as Poland and Thailand had the best returns.  China’s equity market continued to decline despite additional stimulus policies, such as lower bank reserve and home purchase down-payment requirements being enacted there.  India was one of the weakest equity markets in the EM index with a return of -7% due to concerns about increasing loan defaults and political stalemates on key policy issues.  In developed international markets, equities in Japan sold off in reaction to the negative interest rate policy announced at the end of January and weak economic news including a report that exports fell for the fourth consecutive month.  European markets were pressured by concerns over the health of banks in that region.  In line with the rebound in materials sector stocks, commodity heavy economies such as Canada, New Zealand, and Australia were among the best performing developed markets.

The Barclays U.S. Aggregate Bond index had a return of 0.7% for February.  Treasury bond yields moved lower and prices higher for much of the month especially the early part of the month.  The 10-year bond yield declined from 2.2% at the end of January to reach 1.6% in mid-month before rising again slightly to end February at 1.7%.  Higher demand for bonds pushed prices higher and yields lower.  The demand came from investors seeking less risky assets as equities sold off.  Investors also see U.S. Treasury bond yields as more attractive than near zero or negative yields on government bonds in Japan and Europe.  International bond yields declined during the month with the 10-year German Bund yield falling to 0.15% on lower than expected inflation and Japanese 10-year yields falling to record lows.  All sectors of the U.S. fixed income market posted positive returns for the month.  Longer maturity bonds outperformed shorter maturity bonds in the declining yield climate.  The Barclays Corporate High Yield index, which had a sizeable negative return in the first part of the month, rebounded along with the equity market in the second half and posted a positive return of 0.6% for February.

The Bloomberg Commodity index had a return of -1.6% for February.  The precious metals sub-index gained 9% for the month as both gold and silver prices rose.  Gold advanced over 11% for the month as investors focused on safe haven trading when equity markets were declining sharply.  The industrial metals sub-index also had a strong gain for the month of over 3%.  The agriculture sub-index declined again due to a steep drop in grain prices.  After moving lower then rebounding, oil ended the month about flat.  However, natural gas fell over 25% for the month.

Vogel Consulting, LLC (Vogel) Tactical Recommendations

As we commented last month, it is likely that the high level of market volatility will continue until there is more clarity about the resolution to the main issues worrying investors.  We expect economic growth in the U.S. to continue to be positive, but moderate, due to various cross currents.  Those cross currents include the level of growth in the consumer and services side of the economy helped by improving jobs and wage conditions but offset by continuing pressure on the industrial side of the economy from the strong dollar and weak energy sector.  Outside the U.S. our expectation is that growth in Europe and Japan will trend higher as stimulus measures and favorable currency rates provide support for consumer and industrial activity in those regions.  Many emerging market countries will likely continue to be negatively impacted by the slowdown in China.

No changes were made to the tactical asset allocation recommendations during the month.  We continue to recommend using periods of market strength to replenish or build cash reserves to levels adequate to meet at least 12 months of spending needs.  We also recommend an equal weight position in each equity market sector (U.S. large-cap, mid-cap, and small-cap stocks as well as developed and emerging market equities).  We continue to favor hedge fund strategies over fixed income for the lower expected volatility portion of portfolios since yields are near historically low levels.  Our fixed income recommendation is to underweight this sector and to maintain a focus on short to intermediate term bonds.  Non-Treasury bonds are favored for the yield advantage they provide compared to Treasury bonds.  Finally, as our expectation is for a moderate rate of inflation to continue, we recommend an equal weight to real assets.

The statistical information contained in this commentary has been compiled from publicly available sources and is presented to you for your review and for discussion purposes only. The information contained in this commentary represents the opinion of the author(s) as of its date and is subject to change at any time due to market or economic conditions.  These comments do not constitute a recommendation to purchase, sell or hold any security, and should not be construed as investment advice or to predict future performance.  Past performance does not guarantee future results.

The statistical information contained in this commentary was derived from sources that Vogel Consulting, LLC believes are reliable, and such information has not been independently verified by Vogel.  Russell Investment Group is the source and owner of the trademarks, service marks and copyrights related to the Russell Indexes. Russell® is a trademark of the Russell Investment Group. An index is not managed and is unavailable for direct investment.