While January was a good month overall for the financial markets, February was more of a mixed bag. Although the stock market finished the month with losses, the pullback was fairly minor considering the fact that long-term interest rates took a big jump. What did it all mean for your portfolios, and what can we expect for the months ahead?

Before I get to those questions, let’s take a closer look at what happened in February. Again, after a strong January, Wall Street slipped in February, and all three major indexes finished the month in the red. The Dow ended February down 4.2%, while the S&P 500 fell by 2.6% and the Nasdaq by 1.1%.* Meanwhile, even though the Federal Reserve made good on their promise to only raise short-term interest rates by a quarter-percent at their February meeting, long-term rates nevertheless spiked during the month. The interest rate on the 10-year government bond rose from 3.42% on Feb. 1 to 3.99% by March 1.**

All of this occurred after a January in which the stock market rose by some 6.5% and long-term interest rates fell by about 0.3%. Why the reversal of fortune, and why the disconnect between the big spike in interest rates and the fairly minor pullback for the stock market?

Let’s start with the first question because the answer is easy: the Fed. As I’ve discussed many times, whenever the Federal Reserve is actively raising short-term interest rates, the markets tend to be volatile. They’re up one month then down the next. We saw this pattern throughout 2022, from the beginning of the year when the Fed first announced they intended to raise rates to fight inflation, all the way to the end of December.

Although the Fed has slowed its pace and is nearing the end of its rate-hiking schedule, they are still actively raising rates, so it’s no surprise that this up-down pattern for the stock market is still going. The Fed has slowed down mainly because inflation also slowed down consistently for the last six months of 2022 before edging back up just slightly in January of this year.

Strong Data

Ironically, the reason the stock market didn’t see a bigger pullback in February probably has a lot to do with the fact that inflation is, as of now, still higher than normal. Remember, inflation comes from too much demand chasing too few goods and services. The whole idea behind raising shortterm rates is to try to decrease demand by raising borrowing costs. Although we’re seeing some signs that the strategy is working, the bottom line is that demand remains high, which is a sign the economy is fairly strong. And it’s not the only sign.

In January, the U.S. unemployment rate fell to 3.4%, beating estimates and hitting a 53-year low.*** The strong job data came on the heels of news that GDP growth for the fourth quarter of 2022 was a healthy 2.9%. Add all this to the fact that the Fed is slowing down and nearing the end of their rate hike schedule, and it probably explains why the stock market ended February with only a minor pullback even though long-term interest rates spiked by over half a percent.

Still, it was a pullback which means that, despite all the positive data, investors remain somewhat concerned about the potential of a recession hitting sometime this year. Although recession fears have ebbed since last year, many analysts believe a sharp economic downturn could still happen in 2023. I also still believe a recession is likely, given that the Fed’s historic record for achieving a “soft landing” when raising rates is not great. But, as I’ve also said before, I think that if a recession does occur it will be relatively minor and brief.

Your Portfolios

And speaking of minor, just as the impact of February’s interest rate spike was fairly minor in terms of the stock market, it was also minor in terms of your portfolios. At the end of January, most of you saw your values up by 7-8% on average, depending on your holdings, and—as you might recall — I noted in last month’s newsletter there was a good chance we’d give some of that back, given that the Fed was still raising rates. And in February we did give some of it back, but only about 2-2.5% on average, which means most of you are still up by about 5% for the year.

Psychologically that’s good, but, of course, as I always point out, regardless of whether the values of the bonds and bond-like instruments in your portfolios go up or down (as they likely will continue to do for a while yet), it’s largely irrelevant when you’re investing for income. The most important point is that your interest-and-dividend return has remained consistent and that you can continue to count on that consistency no matter what the markets do from one month to the next.

As always, be sure to contact our office if you have any questions about your statements or any other questions or concerns at all. In the meantime, Think Spring!

*“Dow Erases 2023 Gains as Stocks Finish February in the Red,” MarketWatch, Feb. 28, 2023

**MarketWatch.com

***“Jobs Report Shows Increase of 517,000 in January as Unemployment Rate Hits 53-Year Low,” CNBC, Feb. 3, 2023

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