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CLS: Inflation, Stock Market, Focus on the Right Variables

03/23/2016

Week in Review
Equity markets rose 1% last week, moving domestic markets back into positive territory for the rst time this year. Most asset classes moved higher. Developed international markets, commodities, and bonds rose about 1%; emerging markets rose more than 3%; and oil climbed 2%. The 10-year Treasury yield inched lower to 1.87%.

All eyes were glued to the Federal Open Market Committee (FOMC) meeting, which was held on Tuesday and Wednesday last week. Markets reacted positively after the FOMC released a more dovish statement than what was anticipated. The statement signaled the FOMC is likely to raise rates only twice this year as opposed to four times, which was the original guidance. Fed Chair Janet Yellen stated that inflation could rise faster, particularly in the near term. Higher inflation could push the Fed to raise rates faster. Consumer Price Index (CPI) numbers revealed that year-over-year inflation hit its highest level in four years.

Is Inflation on the Horizon?
Inflation has been a hot topic recently as the latest reading on core inflation was released for February, showing a spike to a four-year high of 2.3%. Inflation measures the change in price of a basket of goods over a given time period. When inflation increases, the prices of goods go up, and the purchasing power of the dollar goes down. Core inflation calculations exclude food and energy, which can be very volatile and create a lot of “noise.”

Headline inflation, which includes food and energy, increased 1% year-over-year. That’s lower than core inflation primarily because of plummeting energy prices (however, food prices have consistently gone up as you may have guessed if you’ve been to the grocery store lately).

What causes inflation? Long periods of loose monetary policy, supply and demand, and inflation expectations are all key drivers. However, as global growth has slowed, investors have worried more about deflationary pressures than inflationary. But, according to the data, inflation is on the horizon.

What does this mean for investors? Not only can inflation erode the value of the dollar, it can also put a damper on certain asset class returns. Investing in assets that do well during inflationary periods, such as real assets (real estate and commodities) and inflation- protected bonds, can enhance returns when inflation is rising.

What has CLS been doing? Just that: as we anticipate rising inflation, we’ve added commodities and increased inflation-linked bond exposure. For more, refer to my colleague Marc Pfeffer’s outlook on inflation here.

Success in the Markets – It’s all about Playing the Odds

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