Central Banks Weigh In on Global Economy

All eyes were on global central banks and their monetary policy decisions last week. In the U.S., the Federal Reserve Board opted to raise a key short-term interest rate for the second time this year. Fed Chairman Powell’s comments after the decision were more hawkish than expected—prompting some investors to predict that, going forward, the Fed might raise rates more aggressively than was expected prior to the Fed’s meeting.

Overseas, the European Central Bank diverged from the Fed by taking a more dovish posture with its monetary policy. Although the ECB said it would end its quantitative easing bond-buying program, it also stated that it planned to maintain interest rates at their current levels though at least the summer of 2019. (These divergent actions caused the dollar to strengthen relative to the Euro.) Finally, the Bank of Japan chose to keep its quantitative easing program in place, while also lowering its inflation expectation range.

Meanwhile, economic data in the U.S. was generally positive. Month-over-month results for both the Producer Price Index and the core Consumer Price Index, along with retail sales figures, came in better than expected.

Utilities outperformed in the U.S. equity market as activist investors became more involved in the sector and as interest rates declined slightly for the week. In contrast, energy stocks suffered due to falling oil prices brought on by talk from OPEC about potentially increasing oil production.

European equity markets benefited from the ECB’s decision to keep rates low. Stocks higher on the risk spectrum outperformed (e.g. Italy), while blue-chip names across Europe generally lagged.

In emerging markets, China opted to keep some of its key interest rates steady—causing global investors to wonder if China’s economy is slowing. Weaker-than-expected retail sales and industrial output also weighed on China last week. Meanwhile Latin America continues to be under pressure, with currencies such as the Mexican peso hitting a low not seen since early 2017. One reason: The leading presidential populist candidate is viewed as a risk to Mexico’s fiscal status. That said, in Argentina there is some hope that MSCI will upgrade the country’s emerging markets status. That would bode well for their equity market and potentially quell at least some of the fear in the region.

In the fixed-income markets, U.S. Treasuries fared well relative to international bonds after the ECB indicated that interest rates would remain at low levels for an extended period. But emerging markets debt experienced downside pressure as investors remain nervous about the state of Latin American markets.

GAIN: Active Asset Allocation
U.S. stocks generally were flat for the week, while foreign equities were down. Most market trends of late remained in place last week—with growth stocks and small-caps outperforming the broader market. One reason is that the risk in the markets is coming from global sovereign leadership (such as presidents) and central banks’ policies. Small-caps and growth stocks (tech, especially) have historically been largely immune from these types of headline risks. Although the strong run from small-caps is cause for some concern, research reveals that they remain attractive at current levels when using a slightly longer return window.

We continue to favor equities, with an overweight allocation to U.S. stocks and a preference for growth shares. Small-cap allocations are at a benchmark weight.

The portfolios’ positions in emerging markets and Europe have been drags on returns. Our remaining international exposures, in the Pacific region, have held up relatively well due to low volatility in that region relative to Latin America and Europe.

The fixed-income markets were fairly calm despite all the central bank activity. We remain shorter duration with exposure to high-yield credits, which have benefited the portfolio, and preferred stocks. Our longer-duration credit positions dragged on the fixed-income portions of the portfolios.

PROTECT: Risk Assist
The overall fairly quiet week was flat to modestly positive for global equity markets. Volatility, as measured by the VIX, remained low—generally around 12—throughout the week. As it turned out, the VIX at 12 was on the high side: That level implies a daily move in the S&P 500 of about 0.65%, but the index never saw a move of more than 0.40% last week. We are currently monitoring international equities.

SPEND: Real Spend
Global stocks ended the week fairly flat, while bond posted gains—credit spread performed well and the yield on the 10-year U.S. Treasury note moved lower to 2.93%.

Investors were most focused on monetary policies decisions by global central banks. In the U.S., the Federal Reserve Board raised a key short-term interest rate by 25 basis points to a range of 1.75% to 2.00%. Since this decision was widely expected, it didn’t move markets significantly. The Fed also lowered its forecast for the unemployment for 2018 from 3.8% to 3.6%—a decision seen as slightly hawkish by investors.

Meanwhile, the European Central Bank announced it will end its bond-buying program by the end of this year and that it doesn’t expect to raise interest rates until the Fall of 2019 at the earliest. These announcements were also as investors expected.

Two key pieces of inflation data were released last week. Both the CPI (which gauges consumer prices) and the PPI (which measures wholesale costs) were in-line with investors’ estimates. The rise in core inflation (a metric that excludes the volatility food and energy sectors) for the CPI and PPI were 2.2% and 2.6%, respectively, during the 12 months through May. High-yield bonds were the top performers in the fixed-income market for the week, followed by long-duration Treasury bonds. Investment-grade bonds, REITs and preferred stocks were mostly flat.

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