Markets in perspective – February 2016 in review

Markets in perspective February 2015 Following is the Russell Investments Chief Investment Officers’ views of the key themes affecting market performance in February 2016. All data is as of February 29, 2016. Sources and indexes used to represent asset classes can be found in the disclosures at the end of this post. Capital Markets Returns - March 2016 Sources: U.S. Equity: Russell 3000® Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Emerging Markets: Russell Emerging Markets Index, U.S. Bonds: Bloomberg U.S. Aggregate Bond Index, Global REITs: FTSE EPRA/NAREIT Developed Real Estate Index, Commodities: Bloomberg Commodity Index, Balanced: 30% U.S. Equity, 20% Non-U.S. Equity, 5% EM, 35% Bonds, 5% REITs, 5% Commodities Economic factors 1.     Recessionary fears spike then recede Weak business surveys and a lackluster U.S. earnings season stoked concerns about the health of the global economy. While downside risks remain, recent numbers (e.g. stronger retail sales and capital goods orders in the U.S.) have been a bit more upbeat, allowing global equities to bounce off of oversold levels. 2.     Central banks keep talking Central bankers adopted a more cautious tone in February. Janet Yellen and the Federal Reserve (Fed) are in a wait-and-see mode as they continue to assess what, if any, lasting impact recent market volatility will have on the U.S. economy. Meanwhile, the European Central Bank (ECB) and Mario Draghi appear poised to announce a more aggressive stimulus program at their March meeting to counterbalance downside risks to their inflation outlook. 3.     Oil: A bumpy ride to nowhere Crude oil prices took a wild ride to nowhere in February, starting and ending the month at roughly $33 per barrel, but dipping as low as $26 on February 11. A reduction in production and capital expenditure plans from U.S. shale producers and ongoing talks among global oil ministers helped push end-of-month prices higher.

Equity markets

1.     Intra-month volatility February started with markets selling off on the back of increased recession risk in the U.S. As the month progressed, this risk aversion abated, and many of the losses in riskier parts of the market rebounded strongly. This was evidenced by U.S. small cap stocks, which started the month down and then rallied mid-month to end February flat. Dynamic stocks ended the month trailing the broader U.S. equity market slightly as the rebound was not sufficient to offset losses at the beginning of the month. 2.     Central banks keep talking Inaction across U.S. and European central banks affected various equity market sectors. Central bank “chatter” acutely impacted banks and diversified financials as anticipated rate increases seemed less likely. Traditionally interest rate sensitive sectors, such as utilities and Real Estate Investment Trusts (REITs), were less affected. The weaker U.S. dollar seemed to indicate that the U.S. economy was in a precarious state with the possibility that the Fed’s increase in rates may have been premature, given the increased possibility of recession. 3.     Canada and Japan surprise performance Japan’s surprising adoption of the Bank of Japan’s (BoJ) negative interest rate policy (NIRP) failed to produce the expected outcome. Japan ended February as the worst performer with weak equity markets, which were down 3% (in USD), as well as strong appreciation in the yen contrary to expectations. Canada was the best performing market in February (up 4% in USD). This was led by materials and gold-related stocks, which appear to have shaken off recent sluggishness.

Fixed income markets

1.     Central banks keep talking In February, bond yields were lower globally as central bankers adopted a more cautious tone. The 10-year U.S. Treasury yield was lower as the Fed continued to assess impacts of recent market volatility. Buying trends suggested a flight to safety as macro risks (e.g. China growth, low oil) continued to loom. 2.     Credit continued to struggle Over the month, there were mounting concerns over bank issuers as investors worried about loan losses in the energy sector and pressures on their margin given the lingering low interest rate environment. There were some downgrades in this sector. This came after Moody’s reviewed ratings of energy and mining sectors issuers following a reduction in their commodity price expectations. 3.     Mixed currency activity The USD depreciated in February while the Japanese yen saw strong appreciation following the Bank of Japan’s surprise negative interest rate decision at the end of January. In Europe, “Brexit” news drove depreciation in the British pound.

Alternative markets

1.     Intra-month volatility Sharp reversals across asset classes (e.g. equities, high yield corporate spreads, energy, rates and currencies) negatively affected many hedge funds. This is not quite a “risk-on” market for REITs as total return performance flattened out, and defensives staged a partial reversal of trends seen earlier in the year. The listed infrastructure sector continued to outperform global equities, continuing to display defensive equity characteristics in a shaky global growth environment with negative to lukewarm equity market sentiment. 2.     Central banks keep talking Central bank activity remained highly influential in REITs. For example, Japanese REITs posted exceptionally strong performance with support from negative interest rates, direct security purchases, and yen appreciation. In listed infrastructure, higher-yield, rate-sensitive sectors tended to outperform, as rates on the 10-year U.S. Treasury continued their decline. 3.     Commodities supply/demand imbalance remains The Bloomberg Commodity Index was down -1.6% with energy as the worst performing sector (down over -9% for the month). This is due to low seasonal demand and ample inventories. The agriculture sector also fell (-2.8%) during the month as supplies for grains commodities remained high. Precious metals and industrial metals rose amid continued turbulence in equity markets. However, there are signs of improved fundamentals in the base metal markets.

Asset Class Dashboard – February 2016

With every single asset class except Emerging Markets Debt and U.S. Bonds in negative territory for the 12 months ending February 2016 and half of them falling below their historical typical range, investors could be forgiven for feeling nostalgic for better times - like when the Asset Class Dashboard was heavily weighted toward positive side of the ledger in December 2013. In those cases, it may help to remind clients that prices and returns historically move back toward the average in the long-term, so the current state is not necessarily a new normal. ACD - March 2016 Large cap U.S. equity: Russell 1000® Index, Large cap Defensive U.S. equity: Russell 1000 Defensive Index, Large cap dynamic U.S. equity: Russell 1000 Dynamic Index, Small cap U.S. equity: Russell 2000 Index, Non-U.S. Equity: Russell Developed ex-U.S. Large Cap Index, Global equity: Russell Developed Large Cap Index, Emerging markets: Russell Emerging Markets Index, Commodities: Bloomberg Commodity Index, Global infrastructure: S&P Global Infrastructure Index, Global real estate: FTSE EPRA/NAREIT Developed Index, Cash: Citigroup 3-Month U.S. Treasury Bill Index, Global high yield bonds: Bank of America Merrill Lynch (BofAML) Global High Yield Index, Emerging markets debt: JP Morgan Emerging Markets Bond Index Plus, U.S. bonds: Bloomberg U.S. Aggregate Bond Index. How do I read this chart? This dashboard is intended as a tool to set context and perspective when evaluating the current state of a sample of asset classes. The ranges of 12 month returns for each asset class are calculated from its underlying monthly index returns. The stated inception date is the first full month of an index's history available for the dashboard calculation. Here is how to read the graphic on this page: FOR EACH INDICATOR, THE HORIZONTAL BAR SHOWS FOUR THINGS A GRAY BAR shows the full range of historical rolling 12-month returns for a sample of asset classes. A BLUE COLOR BAND represents the typical range (one standard deviation away from the mean, i.e. 68% of historical observations) of rolling 12-month returns for these asset classes. AN ORANGE MARKER represents the most recent 12-month return of the asset classes.

All data is as of February 29, 2016.

Corresponding indexes/sources by section:

Equities

• Small cap equities represented by Russell 2000® Index • Dynamic equities represented by Russell 1000 Dynamic Index • Sectors represented by Russell 1000® Index sectors: Financials, Utilities. • Japan represented by the Russell Japan Index • Canada represented by the Russell Canada Index • Value represented by Russell Global Value Index • Growth represented by Russell Global Growth Index • Emerging markets represented by the Russell Emerging Markets Index

Fixed Income

• Broad fixed income represented by the Bloomberg U.S. Aggregate Bond Index • Investment grade bonds represented by Bloomberg U.S. Corporate Investment Grade Index • High yield represented by high yield sector of the Bloomberg U.S. Aggregate Bond Index

Alternatives

• Hedge fund strategies data as observed across third party managers by Russell Investments • REITs represented by FTSE EPRA/NAREIT Developed Real Estate Index • Infrastructure represented by S&P Global Listed Infrastructure Index • Global equities represented by Russell Developed Large Cap Index • Commodities represented by Bloomberg Commodities Index Total Return • Oil represented by WTI crude prices