Economic news during the holiday-shortened week was mostly positive: We saw better-than-expected results from the Institute for Supply Management’s manufacturing and services PMIs, durables goods orders, factory orders and nonfarm payrolls. That said, other employment data—such as June’s ADP nonfarm employment figure, the U.S. unemployment rate and average hourly earnings growth—disappointed.

International economies also showed positive signs. Preliminary reports suggest that average wages in Japan are growing at a rate not seen since 2003—giving investors hope that healthy levels of inflation may return to the country. In Europe, Germany saw better-than-expected results in services PMI, factory orders and industrial production (while manufacturing PMI was in-line with expectations). However, France failed to meet forecasts in terms of manufacturing, services and market composite PMIs.

U.S. equities generally performed well, albeit on light volume due to the July 4th holiday. Health care was the top-performing sector for the week, thanks in part to positive company-specific news. Utilities also outperformed, remaining a defensive haven and benefiting from falling interest rates. In contrast, trade tariffs and fears of a trade war continued to weigh directly on cyclical sectors of the market such as industrials and materials—and weighed indirectly on other cyclical sectors such as financials and energy, given the risks tariffs pose to the global economy.

Overseas, European markets outperformed as we saw a relief rally among auto and mining sectors that had previously been battered by concerns about tariffs. Emerging markets performed roughly in-line with the U.S., but that performance was bifurcated—with Latin America significantly outperforming Asian emerging markets.

In the fixed-income markets, longer-duration U.S. government bonds outperformed comparable short-duration securities. European bonds rose slightly, but underperformed U.S. government-issued debt. Emerging markets bonds rallied strongly, driven by rising currencies (especially in Latin America).

GAIN: Active Asset Allocation
The third quarter of 2018 began with a nice bounce back for equities. Risk assets lead the markets higher, buoyed in part by a strong jobs report on Friday.

We maintained our equity positioning, despite some rotation in leadership as the second quarter ended. Small-caps and growth sectors performed well, and European holdings got a boost from economic data that may potentially motivate the European Central Bank to begin pulling back on its fiscal stimulus program. Emerging markets remain weak, but we are looking for the potential for a relief rally.

We made no changes to the portfolios’ equity allocations last week, maintaining maximum equity exposure with an overweight allocation to U.S. stocks and a preference for growth stocks.

Bond prices also were up last week. Returns in fixed income have been very muted for the last five years, with an annualized total return of 2.5% for the Bloomberg Barclays Aggregate Bond Index.

The yield curve continues to flatten, with the spread between the 2-year Treasury yield and the 10-year Treasury yield at its narrowest in approximately a decade. Historically, flat yield curves often occur before economic and market slowdowns. As of now, we do not see immediate signs of weakness. But investment-grade securities and other credit assets are providing less return for their additional risk. We continue to hold equity-like risk with a barbell of longer-duration Treasuries.

PROTECT: Risk Assist
Expected future stock market volatility fell during the holiday-shortened week, with the CBOE Volatility Index (VIX) declining from around 17 to nearly 13. Overall market hedging activity through options, as well as general options volumes, were low. One gauge of volatility known as volatility skew remained slightly elevated due to concerns about the impact of trade tariffs on global growth.

The Risk Assist portfolios remain fully invested (i.e., they are not currently de-risked), with limited exposure to foreign markets.

SPEND: Real Spend
Global stocks rose last week and outpaced bonds (which were up slightly). So far this year, broad-based bonds are down 1.3% while global stocks are up nearly 1%—led by the U.S. market, which is up more than 4% year-to-date.

All Real Spend portfolios were rebalanced back to their target spending reserve allocations last week. Due to small losses from the previous quarter, these target allocations contained one quarter of spend less than their maximum spending reserve levels—meaning all models have 11 quarters’ worth of spend allocation to the reserves. This rebalancing serves the purpose of replenishing the spending reserve against distributions taken during the second quarter. All models maintain one year of spend in a cash allocation.

This week, several important inflation numbers will be released—including the producer price index and consumer price index for June. Currently, analysts’ consensus estimate for headline CPI (which includes the volatile food and energy sectors) is 2.9%—the highest year-over-year estimate since early 2012.

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