It was a tale of two economies last week. On one hand, consumers are showing strength—as evidenced by retail and core retail sales results for July that exceeded expectations and by lower-than-expected initial jobless claims in early August. On the other hand, some manufacturers may be struggling somewhat: July industrial production fell short of expectations and the Philadelphia Fed manufacturing index missed consensus forecasts.

Overseas, German GDP growth in the second quarter beat estimates—which helped broader eurozone GDP growth accelerate at a faster-than-expected pace during the quarter. That said, industrial production across the continent fell short of expectations. In the UK, the unemployment rate during the quarter fell to a 43-year low—but the pace of wage growth ebbed, suggesting that inflationary pressures may not be as pronounced as economic leaders think.

In Asia, China’s spending on fixed assets during the first seven months of 2018 cooled to its lowest point in nearly 20 years while industrial output was worse than expected. On the plus side, industrial production in Japan in June topped expectations (and was an improvement from the previous month). Meanwhile, business confidence in Australia was stronger than anticipated.

Many U.S. equity market sectors rose for the week. Overall, investors shifted to a more defensive posture. That helped telecom and consumer staples outperform, but dampened the performance of many cyclical sectors. Energy and materials were the weakest performers. Oil prices retreated after a larger-than-expected increase in crude inventories. A stronger U.S. dollar also put downward pressure on energy stocks. Shares of companies in the materials sector with significant exposure to the Chinese economy, such as industrial metals and mining firms, lagged significantly as investors worried about China’s potential economic woes.

In what should have been a sleepy summer week, European markets underperformed as Turkey’s woes continued to weigh on the region (particularly European banks with sizable Turkish ties). Emerging markets were pressured from Turkey’s issues as well as from renewed concerns about a possible deceleration of the Chinese economy.  One bright spot: Mexico, which recovered after reports that the U.S. and Mexico were making progress with their NAFTA discussions.

In the fixed-income markets, longer-duration issues once again outperformed both high-yield and shorter-duration securities. Emerging markets debt recovered as currencies like the Turkish lira and Mexican peso strengthened. That said, the Brazilian real and South African rand depreciated relative to other currencies.

GAIN: Active Asset Allocation

The Gain portfolios held up well during a week in which foreign equities came under pressure. In contrast, domestic stocks added to their year-to-date gains and opened up a significant lead over international equities. Global markets today are being led by the U.S. economy (unlike in the early 2000s, when foreign markets were disconnected from domestic markets). While the U.S. economy is strong at the moment, other economies are lagging on a relative basis.

In the U.S. market, defensive sectors have held up better during the past few months—a sign that investors are more nervous then they were a few years ago. We added to our domestic overweight last week by selling our European and emerging markets exposures. The portfolios now have the most domestic small-cap exposure they have had since mid-2016.

PROTECT: Risk Assist

It was a mostly flat week, overall, for financial markets—although we saw some volatility mid-week due to continued uncertainty about emerging markets and tariff-related issues. We implemented one trade during the week—reducing our international exposure to its lowest level since 2016, while increasing our small-cap allocation to its highest level since 2016. It’s likely that emerging markets will continue to face headwinds for the foreseeable future.

SPEND: Real Spend

For the week, global stocks were flat while broad-based bonds were up slightly. So far this year, global stocks are up 1.8%—and domestic stocks have risen 7.8%—while broad bonds are down 1.1% The return spread between global stocks and bonds over the past 12 months now sits at more than 12%.

Small-caps and high-quality dividend growers were some of the top performers in the Real Spend portfolios last week, while international positions fared the worst.

There was no major inflation news last week. Headline CPI is currently 2.9%, below its long-term historical median of 3.1%. Meanwhile, market expectations for longer-term inflation remain low at just 2.4%.

Yield-focused asset classes once again saw some divergence. REITs did well (up 3% for the week) but global infrastructure and master limited partnerships lost ground. In the fixed-income space, the returns were fairly muted: Preferred stock led the way, while Treasuries managed only a small positive return.

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