Economic Flash: Difficulty Can Present Opportunity

This article is brought to you in collaboration with our colleagues at Laird Norton Wealth Management from their post, Economic Flash: Opportunity in Difficulty.

U.S. Economy: Inflation Persists

After an uptick in January, U.S. inflation is running at 6.4% annualized based on the Consumer Price Index and 5.4% based on the Personal Consumption Expenditures index. While consumer confidence and spending (+1.8% in January) remain strong, wages are not keeping up with inflation, and debt is on the rise. Consumers in their 30s have already increased their debt levels by 27% since the onset of the COVID-19 pandemic, the fastest pace since the 2008 recession.

U.S. Stocks: Widespread Volatility

Although tech stocks (+0.5%) generally held up well in February, equity markets gave back a good portion of 2023 gains on disappointing inflation data and the potential for the Fed to continue raising interest rates. Volatility in the U.S. Treasury bond market (MOVE Index) jumped 24% to more than 123 (the historical average is 91). Stock market volatility rose past 20 (VIX Index) after hitting a 12-month low.

Foreign Stocks: Mixed Results

The U.S. dollar, which had been weakening since October, spiked in February on expectations that U.S. interest rates would stay elevated for longer. A stronger dollar detracted from foreign market results, but slightly better inflation data and corporate earnings in the Eurozone boosted returns relative to the U.S. Germany (-1.8%) outperformed somewhat despite economic activity declining to pre-COVID-19 levels.

Fixed Income: Safe and Short

Given the ongoing rise in U.S. interest rates, savings accounts and short-term debt instruments were the leaders in February, with the three-month U.S. Treasury bill up 2.7%. Municipal bonds lost ground (-2.4%), even though they are typically less sensitive to rising Treasury rates, as did high-yield bonds (-1.3%) despite their attractive relative payouts. Non-U.S. debt issued in foreign currencies was hurt by dollar strength.

Real Assets: Surprise Downshift

Commodity prices typically benefit from higher-than-expected inflation, but that was not the case across the board in February. Gold was the key commodity that managed to eke out a gain, but a warmer than usual winter drove down demand for oil (-2.3%) and natural gas (-6.6%). Meanwhile, the potential for an economic slump hurt both infrastructure equities and Real Estate Investment Trusts (REITs).

Alternatives: Limiting Downside

Hedge fund strategies continued the modest or flat performance that made them relative winners in 2022 again in February. In the private market arena, which tends to be less liquid and slower to adjust valuations, 2022’s downturn has started to be reflected in lower asset pricing and has created new opportunities. This is especially the case in the “secondary” market for private equity, as equity owners needing to raise cash are willing to sell at a discount.

Source of data: Bloomberg


Equities Total Returns

Fixed Income Total Returns

Economic Indicators

Our Take

For the last several months, the “rock stars” of economic data points have been those that describe inflation, and this month was no different. Year-over-year trends still seem to suggest that inflation is turning over, but the most recent reading, taken in January, indicates the path forward is unlikely to be a straightforward decline. After decelerating since last October, prices in January rose 0.5% after just a 0.1% increase in December. Understandably, the uptick jolted financial markets, which have begun to price in a higher probability that the Fed will keep raising interest rates.

Currently, derivatives markets are pricing in that the Fed’s key interest rate, the Fed funds rate, will be 5.4% by September (up from 4.6% now). Meanwhile, consumer expectations for long-term inflation (over the next five years or more) have been anchored in the 2.5%-3.0% range. This is far below the 6.4% inflation experienced in the past 12 months, and it indicates consumers are not likely to accelerate purchases in anticipation of rising prices, further fueling inflation.

Other key economic indicators point to a potential recession or, at best, a slowdown in growth as higher interest rates take their toll on key economic drivers, including the real estate market and S&P 500 earnings, which were down 4.8% for the fourth quarter of 2022, the first drop since 2020. The Conference Board’s Leading Indicators Index has fallen for ten straight months, something that has never happened without a recession following soon after.

On the positive side, the labor market continues to be the torch bearer of U.S. economic resilience, even if job cuts have risen in the last few months. Assuming the data leans negative and a recession is in the offing, that is not necessarily a bad thing since recessions tend to wash away excesses, create new opportunities for investors, and usher in robust equity and bond market performance not long thereafter.

Aside from economic fundamentals, increased geopolitical risk remains top-of-mind. Essentially, the global economy has benefited from a peace dividend since the fall of the Berlin Wall in the form of a massive tailwind from cooperative trade, reprioritized military spending and globally integrated supply chains. In the past three years, we’ve seen a global pandemic, the war in Ukraine, and rising U.S.-China tensions, marking a shift toward regionalism and nationalism/populism with great implications for economies and markets.

Looking Forward

“In the middle of difficulty lies opportunity” is a phrase ascribed to Albert Einstein. It is relevant to investors today because we are in an uncomfortable environment where volatility is a constant companion instead of an occasional visitor. When fear and risk dominate, it is incumbent upon us as advisors to identify what may be being overlooked by other investors and use that to drive longer-term portfolio results. Currently, opportunities related to the restructuring of global supply chains and the building/renovation of infrastructure are among those we are exploring via the public and private markets.

Other positive considerations:

Higher interest rates are a double-edged sword. They pose a risk to the economy but also mean low-risk, short-term debt can offer a decent yield, which hasn’t happened for at least a decade. Equity valuations have become more attractive in the U.S. and even more so in foreign markets. And U.S. bonds and stocks have performed well historically in different types of inflationary environments, as long as inflation does not rise beyond 6% and stay there.

Glossary of Indices


U.S. Large Capitalization = S&P 500 Index

Tracks the performance of a representative sample of 500 leading companies in the major industries of the U.S. economy.

U.S. Small Capitalization = Russell 2000 Index

Tracks performance of the 2,000 smallest companies in the Russell 3000 Index, representative of the U.S. small capitalization equity market.

U.S. Growth Equities = Russell 3000 Growth Index

Tracks the performance of those Russell 3000 companies that have higher price-to-book ratios and higher forecasted growth values.

U.S. Value Equities = Russell 3000 Value Index

Tracks performance of those Russell 3000 companies that have lower price-to-book ratios and lower forecasted growth values.


International Equities (Developed Countries) = MSCI EAFE Index

A float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. Consists of the stock market indices of these 20 developed countries: Australia, Austria, Belgium, Denmark, Finland, France, Germany, Hong Kong, Ireland, Italy, Japan, the Netherlands, New Zealand, Norway, Portugal, Singapore, Spain, Sweden, Switzerland, and the United Kingdom.

Emerging Market Equities = MSCI Emerging Markets Index

A float-adjusted market capitalization index designed to measure equity performance in the major emerging markets. Consists of the following 25 emerging-market -country indices: Argentina, Brazil, Chile, China, Colombia, Czech Republic, Egypt, Hungary, India, Indonesia, Israel, Jordan, Korea, Malaysia, Mexico, Morocco, Pakistan, Peru, Philippines, Poland, Russia, South Africa, Taiwan, Thailand, and Turkey.


U.S. Aggregate Bond = Barclays Capital U.S. Aggregate Bond Index

Covers U.S. dollar-denominated, investment-grade, fixed-rate, taxable bond market consisting of SEC-registered securities. Includes U.S. Treasuries, U.S. agency bonds, U.S. corporates, mortgage-based securities (MBS, CMBS) and asset-backed securities (ABS).

TIPS (Treasury Inflation-Protected Securities) = Barclays U.S. Treasury Tips Index

Measures the performance of TIPS of various maturities issued by U.S. Treasury.


International Developed Bonds = BofA Merrill Lynch Global Government Bond II ex U.S.

Measures the performance of non-U.S. developed-market government bonds on an unhedged currency basis.

Emerging Market Bonds = BofA Merrill Lynch Emerging Markets Sovereign

Bond Index Measures the performance of emerging markets government bonds on an unhedged currency basis.


Intermediate Municipal Bonds = Merrill Lynch Municipals, 3-7 Yrs Index

A subset of The Merrill Lynch U.S. Municipal Securities Index, including all securities with a remaining term to final maturity of between 3 and 7 years.

Municipals, Broad Market = Merrill Lynch Municipal Master Index

Tracks the performance of U.S. dollar denominated investment-grade tax-exempt debt publicly issued by U.S. states and territories, and their political subdivisions.


Absolute Return Funds = HFRX Absolute Return Index

Tracks the performance of hedge funds aiming to provide stable performance regardless of market conditions. Such funds tend to be less volatile and less correlated to market benchmarks. Data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month and is subject to revision.

Market Directional Funds = HFRX Market Directional Index

Tracks the performance of hedge funds that add value by participating in the direction of various financial markets. Such funds characteristically have higher expected volatility than Absolute Return strategies (see above). Performance data is based on estimates for the most recent months, may not include performance for the last business day of the indicated month, and is subject to revision.


Equity Volatility = CBOE VIX Index

Aims to measure investor expectations for near-term stock-market volatility as conveyed by the pricing of stock options on the S&P 500 index that mature within 30 days.

Implied Inflation = 10-Yr TIPS Implied Inflation

Gauges investor expectations for future U.S. inflation based on the difference between the yield on a 10-year TIPS (Treasury Inflation Protected Security) and the yield on a nominal 10-year Treasury.

Gold Spot $/oz.

An index intended to measure the current price of gold, based on futures contracts deliverable in the following month priced in U.S. dollars per Troy ounce.

Oil = Brent Crude Oil Spot Price $/bbl

Brent Crude Oil refers to a particular grade of crude oil often quoted in financial reports as the global benchmark for the price of oil. It typically trades at a premium to the West Texas Intermediate price.

U.S. Dollar = Trade-Weighted U.S. Dollar Index

Value of the U.S. dollar relative to a composite of 26 currencies of major U.S. trade partners, weighted based on trade data.


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