The number of Americans filing for jobless benefits fell more than expected during the week ending January 5th—another sign of labor market strength. However, the ISM non-manufacturing index (which gauges activity in the services sectors of the economy) came in lower than expected.
Meanwhile, inflation—as measured by the CPI and core CPI—for December was in line with estimates and remains contained. Those results align with recent relatively dovish comments about the economy from Fed officials. That said, it’s important to note that the retail, leisure and hospitality sectors saw acceleration in compensation growth—which could signal higher wage inflation as the year progresses.
European economic data was mixed, even within certain countries. For example, German factory orders and industrial production disappointed but German retail sales beat forecasts. In the UK, home prices rose faster than expected while manufacturing production slumped. The manufacturing data surprised investors, who had predicted positive growth.
In Asia, Japanese household confidence came in slightly lower than expected; however, household spending topped estimates. Meanwhile, inflation (CPI) in China was below expectations due to lackluster demand. The Chinese government provided additional liquidity to banks to help stimulate more small business lending and counter economic weakness. Other potentially supportive actions to improve automobile and home appliance consumption in China were being evaluated.
The U.S. equity market saw another week of positive returns, with the industrials and real estate sectors leading the way. Industrials benefited from better performance in the transportation industry, particularly railroads, while real estate stocks benefited from multiple upgrades by Wall Street analysts. In contrast, two defensive sectors—utilities and consumer staples—lagged given the more risk-on market mentality during the week.
European markets benefited from reports that the U.S. and China were making progress in their trade talks. Technology and retail stocks outperformed, while telecoms and energy lagged. Asian markets also gained ground, with oversold cyclical stocks in Japan enjoying a bounce after investor sentiment toward the global economy improved. Defensive areas of the market, like household product stocks, lagged. Emerging markets stocks built on their recent gains, rising for the third consecutive week as investors became increasingly willing to take on risk.
In the fixed-income markets, shorter-duration credits tended to outperform longer-duration debt. The top market sector was high-yield bonds, which benefited from another week of rising oil prices. Both emerging markets sovereign and corporate bonds appreciated during another week where the dollar weakened and investors sought riskier credits.
GAIN: Active Asset Allocation
The equity market rally so far this year has been driven by the assets that investors sold off during the fourth quarter of 2018. For example, small-company stocks have rebounded while growth stocks have performed on par with value shares. Institutional investor such as banks and hedge funds are finding opportunities to take risks they couldn’t take in December. Additionally, emerging markets have continued to perform well, building on their relative outperformance last quarter. We continue to favor emerging markets, as domestic equities are still looking for consistent leadership among investment styles and sectors.
The broad-based fixed-income markets were flat to down last week, but high-yield and other corporate bonds were positive. The stability seen in stocks along with improved liquidity helped push these assets higher. We had anticipated the return of this buying early in the new year, following a sharp decline in interest and activity in December.
Corporate earnings announcements for the fourth quarter will start next week, and investors will be looking for warning signs of slowing global economic growth. As long as the comments from corporations are measured in tone, we would expect stocks to hold up. Meanwhile, the Fed seems to have improved its messaging and investors now expect a pause in rate hikes. We expect that rates may move a bit higher, but not reach their highs from last year.
PROTECT: Risk Assist
Volatility has declined sharply, with the CBOE Volatility Index (VIX) finishing the week below 20 for the first time since early December. At one point in December, the VIX exceeded 30–close to its highs reached back in February 2018.
But despite elevated volatility very recently, it’s important to note that the one-year moving average of the VIX is around 17—lower than the index’s long-term average of 20 dating back to 1990.
We are watching volatility levels and equity market performance carefully, as both play important roles in our systematic process of de-risking and re-risking portfolios.
SPEND: Real Spend
Global stocks rallied last week, up 2.4%, while broad bonds fell slightly. So far this year, global equities have outpaced bonds by 3.75%. However, the one-year return spread has stocks trailing bonds by nearly 9.5%, due largely to the difficult fourth quarter for stocks.
All Real Spend models have 11 quarters of spend in the spending reserve rather than the usual 12 quarters’ worth. That effectively tilts allocations slightly more toward the non-spending reserve portions of the models—positioning that may be beneficial if markets continue to rise.
Regarding current allocations in the Real Spend portfolios, most domestic equity allocations had a positive week, as did higher-yielding fixed-income allocations (such as preferred stock and high-yield bonds). Investment-grade bonds such as Treasuries and mortgages were some of the week’s worst performers.
Inflation data last week showed that core CPI (which excludes the volatile food and energy sectors) sits at 2.2%—in line with estimates and higher than headline CPI, which has been weighed down by falling energy prices. Many economists see continued signs of wage inflation propping up prices, which could support further rates hikes by the Fed this year.
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