In February, we adjusted our twelve-month forward outlook to remove Inflation for the U.S. and reverted to Stagnation across all global economies. Last year, markets had to digest Britain’s vote to leave the European Union (EU) and the unexpected victory of Donald Trump in the U.S. presidential election. This year, markets will focus on three political events: first, the general election in Netherlands; second, the presidential election in France, and third, the federal election in Germany.

Investors are now coping with geopolitical and macroeconomic risks, from disintegration of the EU, a hard landing in China, to trade wars and military conflicts. The U.S. economy added 227,000 jobs in January and saw the strongest monthly employment gains since August 2016. The average number of jobless claims applications filed in January reached the lowest level since 1973, while the unemployment rate inched up to 4.8% in January (from 4.7%), as the participation rate recovered along with improving economic confidence.

Both headline and core CPI were stronger in January and producer prices have been trending up. This should not be viewed as the beginning of a new, more dangerous inflation problem, as core goods prices have been decoupling from finished goods producer prices (i.e. the last stage of production) since 2000. This speaks to the massive deflationary pressure at the end of the supply chain: a combination of deflation from imported goods, major technological advances in supply chain management, and logistics. Changing consumer behavior in an e-commerce age also means that consumers are not price takers. These factors imply that any budding inflation pressures are expected to stay trapped at the earlier stages of the supply chain and PPI will not be driving CPI prices higher.

U.S. equities kicked off the year on a positive note. In January, the S&P 500 TR gained 1.9%, the S&P Midcap 400 TR gained 1.7%, and S&P Smallcap 600 TR was down 0.4%. S&P 500 Energy TR was the worst performing sector, down by 3.6%, a reversal after last year’s rebound. It was a tough month for energy prices, with S&P GSCI Energy down 4.7% and Natural Gas Futures off 16%. While the initial OPEC agreement was announced 7 weeks ago, and Russia has been adhering to the production limits, prices are not materially increasing. Metals performed better, with copper spot and gold spot prices rising 8% and 5.5%, respectively. Safe-haven assets have been undergoing a recovery since mid-December as gold, the Japanese yen, and the Swiss franc have all appreciated.  January results for U.S. fixed income were generally positive, with investment grade corporates and high yield bonds continuing to perform better than Treasuries. The U.S. dollar index retreated by 2.7% on the back of a firmer euro (almost 60% of the DXY basket) and a stronger Canadian dollar (+3%).

Shifting back to a Stagnation outlook for the United States, we made some changes in the portfolios in February. While we maintained our exposures to U.S. mid and small caps across all models, we increased equity exposure to both Canada and Australia, and removed our neutral currency hedge to both. We lowered exposure to the 3-7 Year Treasury to fund this shift.  We also closed our position in Mortgage Backed Securities and moved that exposure into Municipal Bonds across all models.  Municipal bonds behave well in Stagnation and concern of changes to their tax advantaged status has greatly diminished.

Since November, markets have been adjusting to the surprise of a Trump Presidency and a Republican Congress.  We believe the President’s disruptive style will continue to persist in the future.

We will continue to monitor the data for growth signals from employment, consumer spending, business sentiment, Fed policy, the yield curve, inflation, and global economics. Our focus is on protecting portfolios from downside risk, and we believe that our investment process is working to achieve that goal.


Deborah Frame, President and CIO
Data Source: Bloomberg