February market activity witnessed converging correlations to the downside across nearly every corner of the global investment landscape, as global equities, fixed income (both high quality and below investment grade), and real assets generally produced negative returns. Weak performance across both risk and high-quality sectors
Trade War Fears Permeate Global Investment Markets
President Donald Trump announced trade tariffs on imports of steel and aluminum on March 1, following through on presidential campaign promises aimed at cracking down on "unfair" trade practices. The White House announced a 25% tariff will be levied on steel imports and a 10% tariff placed on aluminum imports. The newly-announced tariffs have the potential to lead to tit-for-tat trade wars, particularly with counties with economic sensitivities to U.S.-related trade, such as China, Canada, Mexico, as well as European countries.
The import tariffs are likely to serve as a tailwind behind import price inflation, which tends to have a fairly high correlation with broader consumer price inflation, as the U.S. perennially runs large trade deficits (i.e., importing more than exporting). However, higher import prices may lead to incrementally slowing growth in the pace of aggregate import volume, in turn narrowing the trade deficit and supporting the net-export component of
As global trade is a zero-sum dynamic, the potential for narrower trade deficits in the U.S. comes at the expense of the U.S.’s trading partners, who are likely to witness headwinds to current trade surplus levels. For instance, China has already witnessed substantial downward pressure on their current account balance, which has declined from more than 10% of GDP in
The micro implications of higher steel and aluminum import prices are more
In summary, President Trump announced trade tariffs on imports of steel and aluminum on March 1, sparking renewed concerns for global "trade wars." Higher import costs may lead to a narrowing of the U.S. trade deficit, likely at the expense of certain U.S. trading partners. Higher import costs for the U.S. have the likelihood of supporting broader consumer price inflation, which could drive nominal interest rates higher.
February served as a reminder to investors that what goes up must come down. The VIX, which measures the market’s expectations for future 30-day volatility, increased to its highest levels since 2015. Of the 12 major stock exchanges around the world, 10 ended the month in negative territory following a global sell-off
inthe beginning of February. For example, the Japanese stock market fell 4.7% on February 6, its biggest one-day fall since 1990. The S&P 500 Index declined 10.1% during the first week of February; the last correction was February 2016, when the S&P 500 declined 10.5%.
The U.S. markets were spooked in early February by signs of inflationary pressure given drastic corporate tax cuts, which some corporations passed onto employees via higher wages or one-time bonuses. Fears of higher inflation caused investors to worry that the Federal Reserve would take a more hawkish stance and raise rates at a pace higher than previously expected.
Many investors expressed that the recent market volatility was a return to normality rather than a deterioration of an economic variable causing a deeper market sell-off.
The rally that directly followed the sell-off and mitigated some of the early-February declines served as evidence that investor sentiment had not turned to fear.
During the Bank of England’s February inflation report press conference, officials sent a hawkish signal to the market by mentioning that interest rates would need to rise "somewhat earlier and by a somewhat greater extent." This statement indicated that the Fed’s British counterpart may not want to fall too far behind the Fed’s rate hikes and weighed on international equity markets.
Emerging market equities were not immune to the U.S. equity market declines during the first half of February. The MSCI Emerging Markets Index was down nearly 3.3%, with Asian stocks leading the fall and declining around 4% amid increasing trade tensions between China and the U.S. In India, concerns over the quality of loans and a $2 billion fraud revelation sent financial stocks downward.
Market volatility early in the month that stemmed from concerns of more aggressive actions by the Fed affected most
sectors, leading to negative returns throughout fixed income markets. fixed income
The minutes of the Federal Open Market Committee, released in the middle of the month, suggested an optimistic outlook and supported gradual normalization of monetary policy.
Internationally, the impact of U.S. tax reform continued to affect the market, as short maturity government securities and corporate fixed income experienced selling pressures as cash has begun to be repatriated to the U.S.
Credit spread levels remained relatively stable over the month in spite of the increase in Treasury yields at the start of the month.
Early in the month, fixed income strategies in the U.S. saw inflows into both "risk-on" and higher quality assets, while European high yield saw fund outflows accelerate over the month.
U.S. REIT returns declined in February, amid expectations for rising short-term interest rates that have the potential to reduce the attractiveness of REITs as fixed income substitutes. Additionally, negative fund flows and an emphasis on sentiment regarding the maturity of the real estate cycle affected the market.
Commodity prices declined slightly due in part to the similarly slight gain in the U.S. dollar, in which commodities are priced.
February saw gains in agriculture, which has notably been the major sector left behind in the commodity recovery. The shift in U.S. grain production that favored soybeans and corn ethanol production over animal feed has helped stabilize prices.
The energy complex struggled during the month due to abnormally warm weather that pressured natural gas and heating oil prices following a frigid January.
The metals sector was essentially unchanged through February, but turmoil is expected in March following the March 1 tariff announcement.
Global macro managers generated disparate performance for the month, with discretionary strategies tending to outperform systematic strategies. Discretionary managers broadly benefited from higher global rates, while systematic trend followers were whipsawed by the early February reversals across asset classes.
Event-driven managers benefited from exposures to two merger arbitrage deals. The takeover target of a media merger received a competing bid that represented a significant increase over the initial suitor’s offer. Additionally, exposure to a semiconductor company that received an increased takeover bid profited as the deal became more likely.
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