The second quarter of 2018 ended with economic signals both strong—new home sales in May were well ahead of forecasted estimates—and tepid: GDP for the first quarter was revised lower for the second time, to just 2.0%, on downward revisions to spending on services and decreases to inventory investment.
International economies saw mostly good news:
- + French consumer spending was higher than anticipated.
- + Great Britain’s GDP for the first quarter beat expectations on a quarter-over-quarter basis and was in line with predictions on a year-over-year basis.
- + German unemployment was better than expected. (However, CPI and retail sales were lower than forecast.)
U.S. equity investors generally maintained their preference for defensive sectors last week, with the utilities and consumer staples sectors outperforming. Among cyclical sectors, energy was the bright spot. However, most sectors were negative—with the once red-hot tech sector suffering the worst on reports that the Trump administration might restrict U.S. technology companies’ exports to China. Talk from the White House about possibly banning Chinese companies from acquiring U.S.-domiciled tech firms further hurt the sector.
Overseas, European stocks were weak—especially in Germany, where concerns about Trump’s tariffs hitting the auto industry weighed on the market. In contrast, larger emerging markets in Latin America such as Mexico outperformed as political fears subsided.
In the fixed-income markets, longer-duration U.S. government bonds underperformed comparable European bonds—although, on the plus side, both were up for the week. Emerging markets debt underperformed as currencies in these markets continued to weaken.
GAIN: Active Asset Allocation
Stocks struggled for a second consecutive week as markets worried about various “headline risks” coming from the White House. A risk-off tone prompted many investors to take profits and rotate assets into areas of the markets that had been performing relatively poorly.
We have seen this type of rotation in the past, and it tends to be short-lived. Indeed, the final days of the week showed signs of the rotation coming to an end, as previous market-leading sectors once again asserted themselves. Given the large dispersion between asset class returns, we would assume that various risk-based strategies (such as risk-parity and risk-target strategies) had to rebalance near quarter-end.
Domestic stocks have been more stable than foreign equities for the past few months, and we continue to evaluate our overall exposure to international markets—Europe, in particular. We made maintained out current equity allocation, however, and ended the quarter with maximum equity exposure and an overweight to U.S. stocks and preference for growth stocks. Small-caps remain at a benchmark weight.
Bonds rallied on the week as stocks sold off. We adjusted the income portfolios by reducing investment-grade corporate debt and adding a barbell of real estate and longer-term Treasurys. Together, the new holdings continue to provide the equity-income exposure that we prefer while helping to buffer volatility when equity markets get choppy.
PROTECT: Risk Assist
Suffering emerging markets once again weighed on global equity markets last week, due largely to falling currencies in these markets that hurt their growth prospects. The Risk Assist portfolios have very limited exposure to this asset class.
Expected stock market volatility rose during the week due to concerns about emerging markets and the potential for a trade war between the U.S. and various countries and regions. That said, volatility remains below its long-term historical average.
As the second quarter of 2018 ended, we maintained the portfolios’ positioning.
SPEND: Real Spend
Global stocks ended the week down more than 1%, while bond prices rose slightly. Last Friday marked the end of the second quarter of 2018, which saw global stocks and bonds post similar returns.
The Federal Reserve Board’s preferred measure of inflation—the PCE index—showed that core inflation (which strips out the food and energy sectors) in May rose by 2% year-over-year, which was slightly higher than expectations. This was the first time that the core rate hit 2%—which is the Fed’s long-run target level for inflation—since 2012. However, the Fed has stated recently that it is comfortable with inflation running at a slightly higher-than-target rate for now.
Yield-focused investors had a mild week. Master limited partnerships, high-yield bonds and emerging markets debt were down. But longer-duration bonds posted gains as interest rates fell slightly. For the quarter, yield-focused investment such as MLPs and REITs performed well.
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