HI_Market Notes_1012018

Fed Raises Rates as Third Quarter Comes to a Close

The Fed, as expected, raised a key short-term interest rate last week as the U.S. economy exhibited a mix of strength and weakness. The bright spots included:

  • Consumer confidence in September exceeded expectations, hitting an 18-year high.
  • Durable goods orders in August exceeded expectations (and increased at their fastest pace since February).

That said, a deeper dive reveals some areas of concern. The housing market continues to look shaky, for example. Although new home sales for August were in line with expectations, there were downward revisions made to past months’ figures—indicating that housing has been even weaker than previously reported. What’s more, pending home sales for August missed estimates. And a closer look at the durable goods results shows that, excluding transportation-related goods, the pace of orders was the worst in six months.

In Europe, economic news was also mixed. The UK’s GDP was weaker than expected—making the first half of 2018 the most lackluster economic growth seen in the UK since 2011. That said, German economic indicators (such as the business climate index) topped estimates, while French consumer spending was stronger than anticipated. For the eurozone as a whole, core inflation missed forecasts and remains stubbornly low.

In Asia, Japanese retail sales were stronger than expected—as was consumer inflation in Japan’s biggest city, Tokyo—but industrial production disappointed. Meanwhile, New Zealand’s trade balance missed estimates.

U.S. equity market performance for the week was lackluster, with more sectors falling in value than rising. However, the week also marked the end of the third quarter—which saw U.S. equities posting their best quarterly returns in nearly five years. A new sector—communication services—outperformed, as did health care, as investors favored sustainable growth and defensive-oriented investments. Commodity-oriented areas of the market, such as materials and financials, came under pressure.

European stocks also came under pressure as investors focused on the drama and uncertainty around the Italian government’s 2019 budget. A profit warning from a large automobile-industry manufacturer—citing trade disputes as a key headwind—also hurt European shares. Meanwhile, Japanese equities cooled after a strong run, as investors weighed risks related to global trade tensions. Emerging markets were mixed, with Turkey outperforming but Argentina lagging.

In the fixed-income markets, longer-duration securities and high-yield bonds outperformed shorter-duration issues. Emerging markets debt outperformed as well, in the wake of many emerging markets currencies appreciating. Two exceptions: The Argentine peso and the Brazilian real lagged.

GAIN: Active Asset Allocation
Stocks hit a speed bump last week to close out a very strong quarter. Large-cap growth and other areas of equity market leadership during much of the quarter re-established that leadership last week after some recent weakness. We will be monitoring various returns to watch for potential shifts in leadership as the new quarter begins.

The portfolios’ equity allocations remain 90% domestic with an overweight to small-caps and growth stocks. For the quarter, the S&P 500 was up more than 7.5% while foreign equities as a whole gained less than 1%. Given that dispersion, we will be looking for any signs that international markets are starting to improve and are potentially ready to play catch-up after their poor relative performance.

In the bond market, rates were stable following the Fed’s widely anticipated decision to raise a key short-term interest rate. Fed Chairman Powell’s comments were more interesting than the rate hike itself. He stated that he doesn’t care what happens in Washington, but he does care what happens in emerging markets. He continues to be a pragmatic and independent figure even in the face of the President’s comments expressing frustration about rising rates. We expect there is a likelihood of more Fed hikes and we expect to maintain the portfolios’ recent barbell positioning—a preference for credit along with a long Treasury position to help mitigate volatility.

PROTECT: Risk Assist
A flat week for global equity markets, even in the wake of the Federal Reserve Board’s decision on Wednesday to raise a key short-term interest rate for the third time this year. There was no activity in the Risk Assist models.

We are updating our volatility forecasts for October this week, and expect the forecasts will likely remain subdued as they have been of late. Yet, quantitative forecasts cannot predict an event such as the upcoming November midterm elections in the U.S. Therefore, our qualitative analysis suggests there could be more equity market volatility as October progresses—despite what our econometric modeling might indicate.

SPEND: Real Spend
Global stock and broad-based bond market returns were fairly similar last week, with stocks down slightly and bonds flat. The Fed raised a key short-term interest rate, as expected, while the Fed’s preferred inflation gauge—the core PCE index—came in at 2% on a year-over-year basis in August for the second consecutive month. That result was in line with expectations.

In the yield space, equity yield investments—such as REITs and dividend-paying stocks—had a tough week as yields pulled back from their year-to-date highs. Meanwhile, most fixed-income yield plays were up modestly.

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Fed Raises Rates as Third Quarter Comes to a Close

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