International Stocks Outperform During Choppy Week
A mixed week economically in the U.S., as better-than-expected retail sales growth in October was countered somewhat by soft industrial production. And while the NY Empire State Manufacturing Index exceeded expectations, the Philadelphia Fed Manufacturing Index missed estimates.
In Europe, ZEW economic sentiment for the EU overall was worse than expected but German month-over-month GDP growth slightly exceeded estimates. Monthly wage growth in the UK improved, in line with expectations.
In Asia, Japanese GDP met estimates but was weak due to natural disasters earlier this year that weighed on consumer spending. It is likely that Japanese economic growth will recover going forward. Tertiary industry activity in Japan was weaker than expected, while Chinese industrial production topped forecasts.
In the U.S. equity market, the real estate and materials sectors outperformed for the week. Real estate benefited from falling interest rates while metals and mining stocks helped support the materials sector. In contrast, technology and consumer discretionary stocks lagged. Companies in both of those sectors reported disappointing earnings results and/or future earnings guidance that fell short of expectations.
European markets fared better than the U.S., although concerns about Brexit weighed on stock prices. Weakness among technology stocks in the U.S. negatively impacted much of the European tech sector as well. That said, telecom stocks rose on positive financial results. In Asia, Japan was hurt by negative results in the tech sector; although, shares of consumer goods companies helped offset that weakness. Emerging markets outperformed for the week, as global trade tensions eased and because earnings results from companies in emerging markets were generally positive.
In the fixed-income markets, longer-duration bonds once again outperformed shorter-duration issues after rates continued to fall. High-yield credit fared the worst after oil prices tumbled. (A large portion of high-yield issuances are in the energy sector.) Emerging markets debt fell due to currency weakness in Latin America.
GAIN: Active Asset Allocation
International equities outperformed U.S. stocks significantly during a choppy week. Emerging markets also performed well for the week, even as oil prices fell. Value stocks were beneficial to the portfolios last week, as investors sold off previously high-flying technology and growth stocks. However, our small-cap position dampened returns.
The event- and news-driven market environment of late is likely to persist into the end of 2018, and we will continue to monitor for signs of improvements in trade relations between the U.S. and other countries. Emerging markets may be volatile going forward, but we believe they appear attractive on a risk-return basis.
Bonds rallied last week, led by long-duration U.S. Treasuries, as comments from Fed officials put downward pressure on interest rates. That said, it’s worth noting that fixed-income markets have become more volatile in recent months. The portfolios remain positioned with a relatively short duration profile and with an overweight to high-yield credits. We are monitoring credit spreads to see if equity market softness further impacts the high-yield sector.
PROTECT: Risk Assist
Expectations for stock market volatility remain elevated, with the CBOE Volatility Index at around 18 (putting it in the 95th percentile over the past two years). However, investors are more sanguine about other asset classes: Both the MOVE index (which measures expected volatility in the U.S. Treasury securities market) and the FXVIX index (which measures expected volatility in the currency markets) remain at significantly lower levels.
SPEND: Real Spend
Global stocks fell nearly 1% last week, while broad-based U.S. bonds were up slightly (0.5%) as the yield on the 10-year U.S. Treasury note fell by 12 basis points.
At the end of last week, the one-year return spread between global equities and broad-based bonds was approximately 3.5% in favor of stocks—this despite the elevated volatility seen in the equity market this year. A look at domestic-only markets shows an even greater disparity, with the spread between U.S. stocks and U.S. bonds at more than 10% over the past 12 months.
Inflation data released last week showed headline inflation (CPI) at 2.5% year-over-year—in line with expectations. Core CPI (which strips out the volatile food and energy components of the index) was slightly lower than expected, at 2.1% year-over-year. Market expectations for longer-term inflation have fallen throughout the fourth quarter and now stand at 2.3%, based on financial instruments that track inflation expectations.
In the equity yield space, master limited partnerships were down as oil prices fell. Domestic and international REITs were up more than 1%, however. In the fixed-income yield space, high-yield bonds were down but longer-duration bonds benefited as interest rates fell.
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