February Market Insights
Concerns about stubborn inflation weigh on markets in February
What happened
After a strong start to 2023, markets retreated in February. Both domestic and international stocks finished down. Large-cap U.S. stocks fell by 2.44% for the month and small caps by 1.23% (S&P 500 and 600 indexes). Developed-market international stocks were down by 2.09% and emerging-market stocks by 6.48% (MSCI EAFE and Emerging Markets indexes). As interest rates rose again, bonds fell (bond prices fall when interest rates rise). The Bloomberg U.S. Aggregate Bond Index was down by 2.59%. It was another volatile month, with the S&P 500 moving by more than plus or minus 1% on nine of the February’s 19 trading days.
Why it happened
Fresh economic data, including new insights on inflation and interest rates, continued to drive market action this month. In January, there were signs that inflation was falling consistently, which would mean the Federal Reserve could ease up in its interest-rate increases, which in turn would help companies. There was optimism that we might be swiftly returning to the ideal of economic growth with low inflation.
February was another story. Early in the month, the Consumer Price Index fell from 6.5% to 6.4% on a year-on-year basis, but this was a smaller decline than expected. This reignited concerns that inflation may be tougher to tame than previously thought and, if inflation turns out to be sticky, the Fed may need to increase rates more, and keep them high for longer than expected. This, in turn, could lead to or worsen a recession – harming companies’ profits and share prices. The Fed did indeed raise rates by 0.25 percentage points, as widely anticipated, but Fed officials emphasized that the fight against inflation was not over yet.
Economic data continued to be mixed, making prediction difficult. The labor market seemed to be holding up well: More jobs were created than expected, and the unemployment rate was 3.4%, a 53-year low. Many employers still face a challenging labor market and find it difficult to fill open positions. Retail sales and orders for durable goods were stronger than expected, but consumer confidence fell more than expected, a possible warning sign.
This narrative about the relationship between economic growth, inflation and interest rates has been playing out for a year – and looks set to continue. The Fed’s goal is to bring down inflation without tipping the economy into recession, but the ability to raise short-term rates is its primary tool, and it’s an indirect one. The Fed simply cannot precisely target a 1% slowdown in corporate investment, for example, in an effort to slow inflation. Every time the Fed announces an interest rate change, or even when it makes statements that cause market observers to change expectations about future rate changes, financial markets are updating their estimates of how much the Fed’s policy will affect economic activity. Given how much is out of the Fed’s control, however, these predictions are subject to a lot of error.
What it means for you
It is anyone’s guess as to whether and when the Fed will be able to bring inflation under control without causing a recession. That means continued uncertainty in bond and stock markets, so you should stick to a long-term strategy rather than make portfolio changes based on short-term market movements.
In the end, although past performance is no guarantee of future results, history suggests that a well-diversified portfolio will grow over the span of several years, even if there are large economic and market dips along the way.
This material was prepared for educational purposes only. Although the information has been gathered from sources believed to be reliable, we do not guarantee its accuracy or completeness.
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Diversification cannot eliminate the risk of investment losses and does not assure or guarantee better performance. There are no guarantees that a diversified portfolio will outperform a nondiversified portfolio.
Past performance does not guarantee future results.