Weekly initial jobless claims came in much lower than expected last week, while the Philadelphia Fed manufacturing index significantly exceeded forecasts for September (after slowing sharply in August). That said, the housing market remains wobbly: Last week saw lower-than-expected builder permits and disappointing existing home sales. One ray of sunshine in the sector: Housing starts beat estimates.

Overseas, the UK posted better-than-expected retail sales growth while the German services PMI topped forecasts. However, manufacturing PMIs in France and Germany failed to meet expectations. Another important economic gauge—French GDP growth—was in line with expectations for the second quarter.

Asian economic news was relatively sparse last week, overall. The biggest headline: Japan’s central bank, the Bank of Japan, bought fewer bonds than expected—sending local bond yields to their highest levels since early 2016. In addition, Japanese exports exceeded forecasts while inflation came in at the expected level. Meanwhile, New Zealand’s economy expanded faster than anticipated (although the country also reported a larger current account deficit than expected).

U.S. equity markets gained ground, with the majority of sectors ending the week in positive territory. One stand-out sector was materials, which benefited from a muted reaction from China to Trump’s protectionist initiatives and from investor sentiment that the economy may be resilient to the potential negative consequences of recent trade measures. Additionally, the financials sector outperformed (after tepid performance in prior weeks) as the yield on the 10-year Treasury note rose above 3% and remained there for most of the week. In contrast, rising interest rates hurt the real estate and utilities sectors—the two weakest performers last week.

In Europe, equities rebounded on stronger global economic sentiment after Trump’s import duties turned out to be 10% rather than the expected 25%. That development helped cyclical industries, such as base metals, outperform. Meanwhile, Japanese stocks had their best week in two years thanks also to better sentiment as well as a weaker yen that encouraged investors to allocate more capital to equities.

Emerging markets generally continued their recent outperformance. For example:

• South African shares advanced thanks to mining company stocks’ performance.
• Argentinian stocks extended their four-week winning streak as investors became more confident that the International Monetary Fund will expand the country’s credit line.

In contrast, however, the Philippines market continued to be pressured amid higher inflation expectations. And even though some NAFTA risks have subsided, uncertainty about a U.S.-Mexico trade deal continued to weigh on Mexican shares.

In the fixed-income markets, shorter-duration Treasuries outperformed comparable longer-duration securities as rates rose. High-yield corporate bonds also outperformed as investors became more optimistic about U.S.-China trade relations and because of a rally in commodity prices. Emerging markets debt outperformed after the majority of emerging markets currencies appreciated; however, the Turkish lira and Mexican peso lagged.

GAIN: Active Asset Allocation
The strong week for global equities included some rotation in leadership, as recent losers (such as foreign equity markets) became winners. The question remains, however, about whether this shift is simply end-of-quarter profit taking and rebalancing, or something bigger. It’s worth noting that even with foreign stocks’ recent strength, domestic equities have outpaced foreign equities by more than 12% year-to-date.

We have maintained our current equity portfolio positions—90% domestic stocks with an overweight to small-caps and growth stocks.

In contrast to equities, bonds overall have generated meager returns so far this year (as well as over the past one, three and five years). Bond prices fell last week, with shorter-duration issues holding up the best.

Later this week, the Federal Reserve Board will meet to decide whether to raise a key short-term interest rate. Its decision should shed light on the likely direction of the U.S. dollar and whether foreign stocks will face headwinds or tailwinds going forward.

PROTECT: Risk Assist
It was a strong week for global risk markets as we approach the final weeks of the third quarter. Volatility expectations are generally very low right now, although—based on our conversations—we may see an increase in volatility as the U.S. midterm elections in November get closer. Meanwhile, even volatility expectations for currencies—which had been quite elevated—are beginning to fall. That development could have implications for our international positioning within the portfolios.

SPEND: Real Spend
Stocks outperformed bonds, which continued to struggle as the 10-year U.S. Treasury note yield rose above the psychologically important 3% mark. For the week, global stocks were up 1.7% while the broad-based bond market was down nearly 20 basis points.

Year-to-date results also favor global equities—up 4.7% versus approximately -1.8% for bonds.

The international positioning in the Real Spend portfolios outperformed for the week; in contrast, however, small-caps in the Real Spend portfolios struggled and ended down for the week.

Throughout 2018 we have repeatedly noted that market expectations for longer-term inflation—gauged by assessing tradable securities that make bets directly on inflation—have barely budged, despite signs of rising inflation. But last week, expectations rose by nearly 10 basis points—one of the biggest weekly moves all year. Later this week, the latest data for a key inflation metric preferred by the Federal Reserve Board—the PCE—will be released, and we will be watching closely for the market’s reaction.

In the yield space, international assets did well—led by international dividend stocks and REITs—while long-duration bonds and small-cap dividend-paying stocks suffered as yields shot up.

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