A mostly positive week for the U.S. economy, as initial jobless claims fell to their lowest level since 1969 and as the manufacturing sector (as measured by IHS Markit’s flash PMI) continued to expand and exceed expectations. Both readings signal a thriving U.S. economy, despite a somewhat challenging global growth environment.
That said, the housing sector remains lackluster, with existing home sales in December falling more than expected (and hitting their lowest level in three years). Additionally, U.S. crude oil inventories unexpectedly rose, adding to already swollen U.S. fuel stockpiles.
Europe’s economy delivered largely negative news last week, with the Eurozone Markit Composite PMI—a measure of overall business activity—hitting a 66-month low in January. Meanwhile, Germany’s manufacturing PMI contracted unexpectedly—the second major German economic indicator to disappoint investors in the past two weeks. On the plus side, however, France’s manufacturing PMI beat estimates and now indicates expansion in the sector. In the UK, average earnings (including bonuses) exceeded expectations.
In Asia, China’s GDP results for 2018 showed that the economy grew at its slowest pace in decades. One positive note: Industrial production rose on a month-over-month basis and exceeded market expectations. Japanese exports fell more than anticipated, but core CPI in Tokyo topped forecasts.
The U.S. equity market was down very slightly, despite strong performance late in the week. The top-performing sectors were real estate and technology. Real estate benefited from falling interest rates, while technology was boosted by better-than-expected earnings results from some semiconductor companies. In contrast, the energy and consumer staples sectors lagged. Energy was hurt as crude oil prices fell sharply early in the week. Consumer staples suffered from several factors—such as weak earnings results, slumping revenues, rising input costs and a shift by investors into more cyclical stocks.
European stocks rose slightly for the week, with cyclical areas like technology and auto & auto parts leading the way. Telecom and oil & gas stocks lagged. While only about 5% of European companies have reported their 2018 earnings results so far, earnings growth expectations fell significantly last week as many companies reported lackluster business activity. Meanwhile, Brexit news is becoming more encouraging as the risk of no deal abates. A positive resolution is likely to help UK equities. Asian markets gained ground, with lower volatility, as investors were heartened by lower equity valuations and by China’s economic stimulus initiatives.
Emerging markets also fared well. One standout: Thailand’s major index saw its largest weekly gain since last fall, as it was announced that the country will hold its first general elections since a 2014 military coup. Emerging markets equity funds saw their 15th consecutive week of inflows.
In the fixed-income markets, longer-duration debt outperformed shorter-duration securities as yields fell. High-yield credits were down slightly, although (similar to equities) they rallied at week’s end. Both emerging markets sovereign and corporate credits continued their strong recent performance, as rising emerging markets currencies and falling geopolitical risks helped inflows into emerging markets bond funds hit a 52-week high.
GAIN: Active Asset Allocation
Stocks stumbled at the start of the holiday-shortened week, but later staged a rebound that left them essentially flat for the week. The Federal Reserve Board boosted markets on Friday when it suggested it might not shrink its balance sheet as aggressively as expected—a sign that the Fed is being flexible and focusing on incoming data to make its decisions.
We made an allocation change to the equity portion of the portfolios during the week by adding to Japan and emerging markets positions. We continue to prefer these international markets to Europe.
Bonds rose modestly for the week, but showed little movement relative to recent weeks. The portfolios remain overweight to shorter-duration credits, with a focus on high-yield securities and senior loans. The Fed appears to be on pause, which should help rates find their equilibrium. The yield on the 10-year Treasury is likely to remain around 2.75% to 3.25%. Meanwhile, liquidity in the fixed-income market has increased in January and should improve further going forward.
PROTECT: Risk Assist
A flat week for the financial markets, with volatility expectations continuing to fall. Dovish comments suggesting flexibility by global central banks, along with the growing consensus that trade negotiations between China and the U.S. will be modestly constructive, helped volatility drift lower and lifted equity markets toward the end of the week.
The Risk Assist models added to their international positions, specifically in emerging markets and Japan.
SPEND: Real Spend
Global stocks and bonds were flat for the week. So far this year, stocks have rebounded strongly—up 6.5%—while bonds are flat. Over the past 12 months, the spread between global stocks and investment-grade domestic bonds is 10% in bonds’ favor (bonds are up 1% while global stocks are down 9% during that period). Stocks have significantly outperformed bonds over the past three years, however—up 12.6% versus 1.8% for bonds.
Meanwhile, market expectations for longer-term inflation remain where they started the year, at around 2.15%.
In the equity yield space, REITs were the best performers for the week (up more than 1%) while master limited partnerships (down nearly 1%) were the worst. In the fixed-income yield arena, emerging markets bonds and preferred stock were up more than 80 basis points, while safer assets like short-term Treasuries and mortgage-backed securities were flat.
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