Shuffling Into Spring
February 5, 2025
Historically, bond markets have been used as a productive hedge to equities as the two tend to perform inversely. That is, as bond yields rise money tends to flow out of equities and vice-versa. Over the course of the last fifteen years, however, empirical evidence has suggested that bonds may be an inappropriate hedge to equities because the two have begun to have a more direct relationship. While this may indeed have been the reality, market returns throughout the last month propose that the traditional, indirect relationship that bonds had with equities prior to the Great Financial Crisis has its chance at a comeback.
US equities, tracked by the Nasdaq Composite Index and the S&P 500 Index returned -3.91 and -1.30% respectively. Bond markets returned +2.20 as tracked by Bloomberg's Global Aggregate Unhedged Total Return index. Moreover, daily returns tended to exhibit relevant negative correlation to both the Nasdaq and the S&P 500. International markets were far from producing strong returns, but both handily outperformed the Nasdaq and the S&P 500. Emerging markets returned +.50% as tracked by the MSCI Emerging Market Index and developed markets returned +1.96% as tracked by the MSCI Europe, Australia, and Far East Index (EAFE) Index. The collective anemia of the aforementioned returns gave commodities, specifically gold, a chance to shine. As tracked by the LBMA Gold Price AM index the price of gold improved by +2.50% this month and commodities returned +.45% as tracked by the Bloomberg Commodity Index.
Broadly speaking, these weak returns as well as the recent months volatility is likely attributable to doubt in policy, as well as fragile economic data. The January Consumer Price Index (CPI)1 report reflected ongoing, unremitting, sticky inflation. New policies have introduced labor changes2 and tariff hikes3 that will both put pressure on this already persistent inflation. The Fed has previously come out to say their monetary policy decisions will be data driven4. Moreover, Bloomberg's World Interest Rate Probability (WIRP) function is predicting the next cut to take place in late summer. Based on the Fed’s statement and Bloomberg’s WIRP, market participants seem to conclude that the impact of Fed decisions could be continued high borrowing rates.
The term “stagflation” was coined in the 1970’s to describe the effect of the US simultaneously experiencing a weak labor force, high inflation, and a low economic output. This was preceded by policy uncertainty as President Richard Nixon ended the convertibility of the US dollar to its equivalent in gold, an output gap between the potential economic productivity and the actual economic productivity, years of consecutively low5 interest rates, trade embargoes that further pressured inflation, and many other factors.
While its duration was, to put it mildly, dissatisfactory, its aftermath was quite transformative for many central banks.6 All said, stagflation has once again crept into the national economic conversation as fears of a new period of sustained stagflation loom as a result of recent events.7 Moreover, some of the fear-based effects of this may already be priced into the market as more money has flowed into speculative out-of-the-money put options.8
February represented cheap returns, second-rate economic data, and weakening investor sentiment. The volatility experienced in January appeared to be a hard act to follow, but February had no trouble keeping the same pace. Perhaps one day market conditions won’t lead commentators to default to the use of the general term “volatility” but, until then, more granular vocabulary such as strife, friction, turbulence, dissension, turmoil, and unrest will serve as necessary descriptors.
Hazel Allen
Portfolio Management Analyst
1https://www.bls.gov/news.release/pdf/cpi.pdf
Published February 12, 2025; AccessedFebruary 28, 2025.
2https://www.whitehouse.gov/fact-sheets/2025/02/fact-sheet-president-donald-j-trump-works-to-remake-americas-federal- workforce/
Published February 11, 2025; Accessed February 28, 2025
3https://www.whitehouse.gov/fact-sheets/2025/02/fact-sheet-president-donald-j-trump-imposes-tariffs-on-imports-from-canada-mexico-and-china/
Published February 1, 2025; Accessed February 28, 2025
4https://www.federalreserve.gov/newsevents/speech/powell20241114a.htm
Published November 14, 2024; Accessed February 28, 2025
5https://www.federalreservehistory.org/essays/great-inflation
Published November 22, 2013; Accessed February 28 2025
6https://www.federalreservehistory.org/essays/great-inflation
Published November 22, 2013; Accessed February 28, 2025
7https://www.reuters.com/markets/us/stagflation-fears-haunt-us-markets-despite-trumps-pro-growth-agenda-2025-02-20/
Published February 20, 2025; Accessed February 28, 2025
8https://www.nasdaq.com/market-activity/etf/spy/option-most-active
Published continually; Accessed February 28, 2025
A hedge is an investment that is selected to reduce the potential for loss in other investments because its price tends to move in the opposite direction.
The S&P 500 Index is the Standard & Poor’s Composite Index of 500 stocks and is a widely recognized, unmanaged index of common stock prices.
The NASDAQ Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market, and itis highly followed in the U.S. as an indicator of the performance of stocks of technology companies and growth companies.
The Bloomberg Global Aggregate Unhedged Total Return Index is a benchmark that measures the value of global investment grade debt. It includes fixed-rate bonds from developed and emerging markets and is reported in US dollars.
The MSCI Emerging Markets Index consists of 23 economies including Brazil, Chile, China, Colombia, Czech Republic, Egypt, Greece, Hungary, India, Indonesia, Korea, Malaysia, Mexico, Peru, Philippines, Poland, Qatar, Russia, South Africa, Taiwan, Thailand, Turkey and the United Arab Emirates. The MSCI is afloat-adjusted market capitalization index.
The MSCI EAFE Index (Europe, Australasia, Far East) is an unmanaged free float-adjusted market capitalization index that is designed to measure the equity market performance of developed markets, excluding the US & Canada.
The MSCI All Country World Index (ACWI) captures large and mid cap representation across Developed Markets (DM) and Emerging Markets (EM) countries. The index covers approximately 85% of the global investable equity opportunity set.
LBMA Gold Price is a key benchmark for pricing gold widely used by producers, consumers, investors and central banks across the world. Prices are in GBP per troy ounce. Prices are set at 10:30 London UK time.
The Bloomberg Commodity Index (BCOM) is a financial benchmark that tracks the price of physical commodities using futures contracts. It's made up of 24exchange-traded futures contracts on 22 commodities.
A consumer price index (CPI) measures changes in the price level of a market basket of consumer goods and services purchased by households.
Bloomberg's World Interest Rate Probability (WIRP) function is a chart that shows the probability of different interest rates for the US benchmark rate. The chart is based on interest rate caps and floors, as well as options on Treasury futures.
A "stock option" is a contract that gives the buyer the right, but not the obligation, to buy or sell a certain number of shares of a stock at a predetermined price within a specific timeframe.
An out-of-the-money (OTM) option is an options contract that has no intrinsic value. It is neither “in the money”(past its strike price) or “at the money” (at its strike price). This means that if the option is exercised, the holder would lose money.
A Put is an options contract that gives the owner the right, but not the obligation, to sell a certain amount of the underlying asset, at a set price within a specific time.
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