ECONOMIC FLASH – Inflation Could Create Headwinds for Markets

february 8th, 2018

US Economy: Underlying strength continues.

GDP growth in the fourth quarter of 2017 (the original estimate) was 2.6 percent, due to an increase in imports. Forward-looking indicators for US manufacturing and consumer confidence, on the other hand, both suggest ongoing increase. Wages increased by roughly 3% in January 2018 compared to the previous year.

US Stocks: A very strong January.

Despite a market collapse in early February, January stock market gains were the strongest since 2016 in anticipation of robust profits, tax cuts, and a steady economy. Tech and discretionary consumer expenditure are both up more than 7.5 percent.

Foreign Stocks: Emerging markets still lead.

Due to robust global growth and stronger EM values, EM equities had a very good January (followed by a decline in early February). Higher oil prices benefited Russia (+12.6%) and Brazil (+16.8%).

Fixed Income: US Treasury yields surge.

The yield on 10-year Treasury bonds has risen to nearly 2.9% (as of early Feb.), the highest level in more than 4 years on expectations for rising interest rates and inflation.

Non-Traditional: Bitcoin down 65% in 2018.

Following a peak of roughly $19,000 in late 2017, the value of one bitcoin fell to around $6,700 as various countries moved to regulate cryptocurrencies.

The Takeaway

What happens in January, what happens throughout the rest of the year? Current market and economic factors point to a good 2018 end. However, we think inflation is a rising risk for both equity and fixed-income valuations. The market dips in early February appear to imply this.

We are essentially maintaining our global stock allocations while adding positions that are projected to profit from inflation, such as commodities and infrastructure. In fixed income, our concentration on methods that are less exposed to increasing interest rates is paying off.

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