February 2018 Commentary

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[1]The FIS Benchmarks represent allocations to the following indices as the specific FIS portfolio: Global Stocks (MSCI ACWI: 20%, 15%, 10%, 5%, 0% for Aggressive -> Conservative Portfolios), US Stocks (Russell 3000 Index: 65%, 65%, 40%, 25%, 10% for Aggressive à Conservative Portfolios), Dividend Stocks (Dow Jones Dividend Index: 0%, 0%, 5%, 10%, 10% for Aggressive -> Conservative Portfolios), Investment Grade Bonds (Barclays Aggregate Bond Index: 2.5%, 12.5%, 32.5%, 50%, 77.5% for Aggressive -> Conservative Portfolios), and High Yield Bonds (Barclays High Yield Index: 12.5%, 7.5%, 12.5%, 10%, 2.5% for Aggressive -> Conservative Portfolios)

by David Abuaf

Stock prices surged higher in January, but early February saw volatile price swings with markets trending lower. The new year got off to a powerful start, sending major indices to multiple record highs as the month unfolded. However, February saw jitters over rising interest rates push markets lower as the month ended, with stocks recouping the majority (but not all) of their losses from earlier in the month. While financial markets remain uneasy, and we believe the volatility that started in early February is not yet over. Bond yields remain in flux and prospects for sharp increases are keeping equity markets on edge. Investors are also anxious about a profound shift in the macro environment, as inflation pressures are on the rise. To make matters worse, Trump’s tariff announcement added fuel to the fire.

The pessimistic view of this transition is that a brewing trade war will cause a spike in inflation at the same time that deficits become a problem. Such an environment could result in central banks tightening more than anticipated while growth momentum slows. This would be a negative environment for equities.

The more optimistic view is that while inflation risks are rising, the macro backdrop is essentially unchanged: Real economic growth remains supportive of corporate earnings while inflation firms but remains at or slightly below central bank targets. Such an environment would allow central banks to keep policy accommodative while slowly normalizing rates. And while rising trade protectionism would represent a risk, it would be tempered by the fact that fiscal and debt ceiling battles appear to be over.

While we acknowledge the downside risks, we lean slightly more toward the optimistic camp, especially over a longer time horizon. We think volatility is likely to continue but see little that would suggest a major decline in equity markets. Until bond yield volatility calms down and the inflation picture becomes clearer, we think stock markets are likely to remain uneven and trade sideways. As such, it is possible that we have already seen the low and the higher for all of 2018, or at least for the next several months.

On balance we think it is important to acknowledge that a combination of rising rates, higher inflation, and growing trade protectionism makes for a tough environment for stocks. But we also think a decent economic backdrop combined with strong corporate earnings and reasonable valuations suggests that the long-term path of equity prices is to the upside.