Investors Thankful for Foreign Equities and Bonds
The state of the housing market was in focus during the Thanksgiving holiday-shortened week. Existing home sales in October improved on a month-over-month basis and were stronger than expected, while housing starts and building permits beat estimates slightly. That said, the small increase in residential starts was due mainly to the strong multifamily category offsetting a decline in single-family starts.
It’s important to note that some of these results were likely influenced by rebuilding initiatives related to recent hurricane-related damage. Subsequent monthly data may provide more clarity into the underlying health of the U.S. housing market.
Meanwhile, durable goods orders and core durable goods orders were weaker than expected. Consumer sentiment, as measured by the University of Michigan’s consumer sentiment gauge, also disappointed.
In Europe, German GDP growth was in line with expectations—but manufacturing and services PMIs were weaker than anticipated. France fared somewhat better, with a services PMI that topped estimates. Elsewhere, Japanese inflation (both CPI and core CPI) met expectations.
U.S. investors took a more defensive stance last week, with real estate and utilities sectors outperforming while technology and energy posted the worst sector returns. Real estate and utilities continued to perform well as rates declined. Additionally, investors view the future cash flows of companies in these sectors as more stable relative to many other areas of the market. Technology stocks sold off on weaker demand expectations and production cuts, while energy shares were pressured once again by materially weaker oil prices. The silver lining of a tough week for equities: The U.S. market’s valuation is now just below its 10-year average, with respectable earnings growth expectations for next year.
European markets significantly outperformed the U.S. However, commodity weakness weighed on share prices (with energy and mining-related shares showing particular weakness). In contrast, the travel & leisure and auto sectors outperformed. In Asia, U.S. tech worries continued to spill over into the Japanese market, where defensive sectors outperformed and cyclical areas underperformed. And while emerging markets were hurt by commodity price weakness, they outperformed developed markets overall. Emerging markets were helped by relatively low valuations combined with increased optimism about select emerging market countries.
In the fixed-income markets, longer-duration bonds outperformed shorter-duration issues once again as rates fell slightly. High-yield credit again came under pressure as oil prices fell and as investors shifted their portfolios to higher-quality credits. Emerging markets debt also slumped as Latin American currencies continued to weaken.
GAIN: Active Asset Allocation
Markets saw continued weakness last week, along with further rotation away from growth-oriented sectors (such as consumer discretionary and technology) into sectors seen as relatively safe—a shift that may remain in place for a while. The lack of a sizable bounce in stock prices during a holiday week was concerning.
Our overweights to value stocks and emerging markets have been beneficial, while exposure to growth and quality factor assets have dampened performance.
Fixed-income markets were relatively stable last week; although, there are signs that stock market volatility is bleeding over into credit markets. While that is generally not a positive sign, the amount of stress currently in the credit markets is modest compared to similar situations in the past. The Gain fixed-income portfolios still have credit exposure—including high-yield and senior loan positions—but that exposure is smaller now than it has been for most of 2018, and we are monitoring the situation closely to determine if a further reduction in credit positions is necessary. Interest rates are at the bottom end of their recent range; any stability in equities should push them higher.
PROTECT: Risk Assist
Equity prices fell last week. As the markets re-test recent lows, we continue to monitor the portfolios for potential de-risking activity. Meanwhile, volatility expectations remain elevated (and our volatility forecasts confirm this). For example, the CBOE Volatility Index ended the week slightly higher than its long-term average.
SPEND: Real Spend
Stocks slumped during the holiday-shortened week, with global stocks down approximately 3% and U.S. stocks falling nearly 4%. Bonds, in contrast, were flat for the week. As a result, the one-year spread between global stocks and domestic investment-grade bonds is now -1.2%—meaning bonds have outpaced global stocks over that time period.
That said, a look at the domestic markets reveals a very different picture. The spread between U.S. equities and the broad bond market over the past 12 months remains strongly in stocks’ favor, at 5.2%. Investment-grade domestic bonds are down -2% during that time and have gained just 1.3% on average during the past three years—not enough to outpace headline inflation, which has averaged nearly 2% over that same time period.
In the yield space, fixed-income yield investments outpaced equity yield assets due to the sharp decline in equity prices. Long-duration bond prices were up nearly 40 basis points while some U.S. stock dividend strategies were down as much as -2.75%.
It’s worth noting that, based on a long history dataset, stocks are expected to outpace bonds about two-thirds of the time during any given one-year period, three-fourths of the time during any given five-year period,four-fifths of the time during any given 10-year period, and nearly all 20-year periods.
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