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: Barclays 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: Barclays 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 Barclays U.S. Aggregate Bond Index • Investment grade bonds represented by Barclays U.S. Corporate Investment Grade Index • High yield represented by high yield sector of the Barclays 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 These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page. The information, analysis, and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual or entity. Investing involves risk and principal loss is possible. Bond investors should carefully consider risks such as interest rate, credit, default and duration risks. Greater risk, such as increased volatility, limited liquidity, prepayment, non-payment and increased default risk, is inherent in portfolios that invest in high yield ("junk") bonds or mortgage-backed securities, especially mortgage-backed securities with exposure to sub-prime mortgages. Generally, when interest rates rise, prices of fixed income securities fall. Interest rates in the United States are at, or near, historic lows, which may increase exposure to risks associated with rising rates. Investment in non-U.S. and emerging market securities is subject to the risk of currency fluctuations and to economic and political risks associated with such foreign countries. In general, alternative investments involve a high degree of risk, including potential loss of principal; can be highly illiquid and can charge higher fees than other investments. Hedge strategies and private equity investments are not subject to the same regulatory requirements as registered investment products. Hedge strategies often engage in leveraging and other speculative investment practices that may increase the risk of investment loss. Investments in emerging or developing markets involve exposure to economic structures that are generally less diverse and mature, and to political systems which can be expected to have less stability than those of more developed countries. Securities may be less liquid and more volatile than US and longer-established non-US markets. Indexes and/or benchmarks are unmanaged and cannot be invested in directly. Returns represent past performance, are not a guarantee of future performance, and are not indicative of any specific investment. The Russell 1000® Index measures the performance of the large-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index and includes approximately 1000 of the largest securities based on a combination of their market cap and current index membership. The Russell 1000 represents approximately 92% of the U.S. market. The Russell 2000® Index measures the performance of the small-cap segment of the U.S. equity universe. It is a subset of the Russell 3000® Index representing approximately 10% of the total market capitalization of that index. It includes approximately 2000 of the smallest securities based on a combination of their market cap and current index membership. The Russell Global Index measures the performance of the global equity market based on all investable equity securities. The index includes approximately 10,000 securities in 63 countries and covers 98% of the investable global market. All securities in the Russell Global Index are classified according to size, region, country, and sector, as a result the Index can be segmented into more than 300 distinct benchmarks. The Russell Global Large Cap Index measures the performance of the largest securities in the Russell Global Index, based on market capitalization. The index includes approximately 3,000 securities and covers 86% of the investable global market. Russell Developed Large Cap Index offers investors access to the large-cap segment of the developed equity universe. It is constructed to provide a comprehensive and unbiased barometer for the large-cap segment of this market, and is reconstituted annually to accurately reflect the changes in the market over time. The Russell Emerging Markets Index measures the performance of the largest investable securities in emerging countries globally, based on market capitalization. The index covers 21% of the investable global market. Barclays U.S. Corporate Investment Grade Index: an unmanaged index consisting of publicly issued US Corporate and specified foreign debentures and secured notes that are rated investment grade (Baa3/BBB- or higher) by at least two ratings agencies, have at least one year to final maturity and have at least $250 million par amount outstanding. Bloomberg Commodity Index Total Return: Composed of futures contracts on physical commodities. Unlike equities, which typically entitle the holder to a continuing stake in a corporation, commodity futures contracts normally specify a certain date for the delivery of the underlying physical commodity. In order to avoid the delivery process and maintain a long futures position, nearby contracts must be sold and contracts that have not yet reached the delivery period must be purchased. This process is known as “rolling” a futures position. Barclays U.S. Aggregate Bond Index is an index, with income reinvested, generally representative of intermediate-term government bonds, investment grade corporate debt securities, and mortgage-backed securities. FTSE EPRA/NAREIT Developed Real Estate Index is a global market capitalization weighted index composed of listed real estate securities in the North American, European and Asian real estate markets. The S&P Global Infrastructure Index provides liquid and tradable exposure to 75 companies from around the world that represent the listed infrastructure universe. To create diversified exposure across the global listed infrastructure market, the index has balanced weights across three distinct infrastructure clusters: Utilities, Transportation, and Energy. Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment. Past performance does not guarantee future performance. This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type. Russell Investments is the owner of the trademarks, service marks and copyrights related to its indexes. 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