Markets Rise Outweighing Geopolitical Fears

Economic data in the U.S. last week was largely positive, showing strength in several key areas:

  • GDP growth for the second quarter was revised upward, to 3%, driven largely by strong consumer spending.
  • Consumer confidence rose in August to its second highest level since 2000.
  • The average of initial jobless claims over the past month fell to its second lowest level since 2009.

One negative: The U.S. created far fewer jobs in August than expected. Despite that recent development, the U.S. labor market remains healthy overall–with the jobless rate still near a 16-year low.

Meanwhile, international economic data was mixed. In Italy, consumer and manufacturing confidence as well as inflation data were much better than expected—some much-needed good news from one of Europe’s most troubled economies. In contrast, home prices in the UK as well as money supply growth in the eurozone were worse than expected.

The biotechnology sector led the pack in the U.S. equity market. Shares of gold mining companies also outperformed, as gold (often a safe haven investment) rose after North Korea fired a missile over Japan’s airspace. U.S. financial services stocks underperformed due to a combination of low interest rates and concerns about Hurricane Harvey’s potential impact on the insurance industry.

Overseas, rising commodity prices helped commodity-focused countries such as Russia outperform. Emerging markets underperformed for the week, as geopolitical tensions largely curtailed investors’ appetite for investment risk.

In the fixed-income markets, investors nervous about North Korea and other issues favored the relative safety of bonds—pushing bond yields lower and prices higher. Long-duration government and agency bonds, which are most sensitive to changes in interest rates, outperformed in that environment, while short-duration securities underperformed.

GAIN: Active Asset Allocation

Stocks posted gains last week, despite a brief sell-off following news that North Korea launched a missile that flew over Japan. Those gains were driven largely by positive economic news throughout the week, such as strong consumer spending and GDP growth. Through August, the S&P 500 in 2017 is up 10.4%.

In our equity portfolios, we eliminated our exposure to small-company stocks and reallocated those assets to the aerospace and defense sector. Small-caps have underperformed for some time due in part to their relative lack of liquidity. In a low-interest-rate environment, their prospects for sustainable gains is low.

In contrast, the aerospace and defense sector has a history of handling market volatility well. It’s also possible that there will be a big push from the current administration for greater defense spending by the government, which would benefit the sector. The ongoing conflicts in Afghanistan, coupled with North Korean aggression, further strengthen this possibility.

Government bond yields fell early in the week as investors sought safe-haven investments in the wake of the North Korean missile launch. Signs of continued low inflation also kept a lid on bond yields for the week. In the fixed-income portion of the portfolios, we recently reduced exposure to corporate securities. While things are currently quiet for the most part in fixed income markets (e.g., Treasury yields are at around 9-month lows), many are paying attention to the current administration’s choice of nominee to head the Federal Reserve and how that could affect markets.

PROTECT: Risk Assist

Market volatility spiked briefly last week in the wake of a missile launched by North Korea that flew over Japan. However, the surge was short lived, and the CBOE Volatility Index (VIX) ended the week lower than it began.

Historically, September often has seen increased levels of volatility. Although our volatility forecast remains low, we will (as always) carefully watch for signs that could indicate a change in the overall volatility landscape.

SPEND: Real Spend

In the month of August, of global stocks and broad-based fixed-income market returns were mostly flat. For the year so far, however, global stocks are outpacing fixed-income by more than 11 percentage points. The best-performing holdings in the Real Spend portfolios last week were high-quality U.S. large-cap growth stocks. International positions suffered some of the worst returns.

Meanwhile, market expectations for inflation remained stable—once again hovering in a tight range between 2.2% and 2.3%.

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