Stock Market Cyclicals Show Strength

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A mixed bag of economic news last week saw, on the plus side, U.S. industrial production and the Philly Fed manufacturing index coming in notably better than expected. In contrast, building permits and housing starts in June missed estimates. U.S. retail sales and core retail sales (which excludes automobiles, gasoline, building materials and food services) met estimates.

Overseas, Eurozone inflation (CPI) data was in-line with estimates, but some key UK economic data (CPI, retail sales and core retail sales) were lower than anticipated. Meanwhile, core inflation in Japan was in line with forecasts while Australian employment data was robust.

The U.S. equity market saw strength in cyclical sectors, with financials and industrials outperforming on a combination of strong second-quarter earnings and better-than-expected guidance for future financial results. However, the energy sector underperformed. The main culprit: lower oil prices, driven largely by fears that a U.S.-China trade war could hurt global economic growth and global oil demand. Signs of higher supplies of crude oil in several regions was another factor that weighed on the price of oil. Telecom stocks also underperformed.

Internationally, European markets were mostly higher for the week—with technology and cyclical sectors (chemicals, autos and industrials) leading the charge. Emerging markets fell slightly, due mainly to relative weakness in Asian emerging markets (China and India, in particular). However, Brazil performed well as investors cheered news that a presidential candidate there received backing from a key group of political factions.

In the fixed-income markets, shorter-duration U.S. government securities outperformed longer-duration issues in the wake of comments from the President expressing unhappiness about the prospect of further Fed tightening and the potential for a stronger U.S. dollar that could dampen economic growth. Emerging markets debt fell as more emerging markets currencies depreciated than appreciated.

GAIN: Active Asset Allocation
It was a quiet week for equities as markets digested both earnings reports and political developments. International equities outperformed domestic stocks—a rare occurrence for much of 2018. Investors are increasingly focusing on underlying economic and corporate fundamentals, while shrugging off many of the President’s inflammatory comments.

The portfolios’ allocations remain unchanged. We continue to maintain a maximum equity exposure with an overweight to U.S. equities and a preference for growth stocks. Small-cap stocks remain at a benchmark weighting.

Bond market returns were generally flat. That said, there were some interesting developments with interest rates after the President labeled several foreign countries as currency manipulators and later stated he didn’t like the Federal Reserve Board raising interest rates. In response, the yield curve steepened, and there was increased speculation that the Fed could be even more determined to raise rates. Our fixed income portfolio positioning continues to favor preferred stocks, real estate and high-yield bonds with a barbell of long-term Treasuries in an endeavor to reduce volatility if the market gets choppy.

PROTECT: Risk Assist
Another reasonably solid week for global equity markets shows the third quarter of 2018 to be off to a good start. The market’s volatility expectations across all asset classes except currencies remain subdued. For example, the CBOE Volatility Index (VIX) hovered under 14 all week—well below its historical average. Even currency market volatility expectations are at historically normal levels—nothing extreme.

SPEND: Real Spend
Global equities and bonds were fairly flat last week, with the return spread between equities and bonds currently at nearly 4% year-to-date and more than 11% over the past 12 months. So far in 2018, broad-based bonds are down more than 1.5%—and have declined by nearly 1% during the past year. We continue to caution on the overuse of fixed-income in retirement spending portfolios, as bonds are expected to face headwinds if rates continue to rise as anticipated.

There was no major inflation news last week, but all recent data suggests that inflation is at (or is approaching) the Fed’s target of 2%. In fact, the Fed’s preferred inflation gauge—the personal consumption expenditures (PCE) price index—is at 2% while core CPI is at 2.3%. Longer-term measures of inflation expectations have been little changed this year—hovering at around 2.4%, which is below the median historical realized inflation rate.

In the yield-focused space, longer-duration bonds took a hit (down 1.5% for the week) as rates spiked on Friday. REITs also struggled, down more than 1%. Master limited partnerships were up, despite falling oil prices, while preferred stocks were flat.

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