Fears of Trade War Put Pressure on Equities

HI - Market Note - 3262018

It was an tough week for global stocks, and the worst weekly performance for U.S equities since January, 2016. For the week, the S&P 500 fell nearly 6% while international equities were down nearly 4%.

Stocks sank after President Trump announced new tariffs on Chinese imports—fueling fears of an impending trade war that investors worry could hurt global economic growth. It’s possible that such fears may be overblown, however, as there are reports that the U.S. and China are already beginning the process of negotiating the situation.

Still, the news entirely overshadowed positive economic news last week, including a large monthly gain in durable goods orders that exceeded expectations. In addition, the number of people collecting unemployment benefits hit a 45-year low. Overseas, however, a measure of business sentiment in Germany fell to its lowest level in nearly a year.

The other major development last week was the decision by the Federal Reserve Board to raise a key short-term interest rate, noting that “the economic outlook has strengthened in recent months.” Statements from new Fed Chairman Powell following the rate hike suggest that, with him at the helm, the Fed is unlikely to raise rates continuously without signs that inflation is rising.

In the fixed-income markets, bonds were essentially flat for the week. The Fed rate hike likely somewhat capped the increase in bond prices that would normally would occur when risk assets such as stocks fall sharply.

GAIN: Active Asset Allocation

As the markets tumbled last week, the technology sector performed the worst—down 7.9%, due largely to concerns that Facebook user data may have been used to influence political outcomes. Financials also underperformed, down 7.2%. In contrast, energy and utilities performed best (although both sectors were negative for the week).

Despite the negative news, the market sold off in a mostly orderly manner—without signs of tremendous stress or panic selling.

Bonds were flat, with Treasuries holding up better than corporate credits as investors favored the relative safety of government-back fixed-income securities. At this time, we continue to prefer a shorter overall duration and higher yield profile in the portfolios, but we will continue to monitor.

PROTECT: Risk Assist

Volatility as measured by the CBOE Volatility Index (VIX) rose significantly during the week as markets sold off due to fears of a potential trade war between the U.S. and China. The VIX ended the week at around 24—higher than its long-term average.

Risk Assist uses volatility forecasting to help guide de-risking and re-risking decisions, with the goal of helping portfolios avoid the worst of the “whipsaw” effects that could have occurred in the past few weeks (i.e., re-entering the market at a top and then having to de-risk again shortly thereafter due to declines).

SPEND: Real Spend

Stocks sold off heavily last week, while bonds finished essentially flat. Typically, bond prices rise when stocks are under pressure as investors seek relatively safe assets. However, investors’ interpretations of the Fed’s comments following the decision to raise interest rates may have offset the additional demand for bonds, and kept a lid on prices.

The new Fed Chairman reiterated last week that the economic outlook has strengthened. Inflation volatility has been largely non-existent, as the Fed has been effective at helping expectations stay in line with actual results. While inflation remains low, the market outlook for inflation is realistic and healthy.

Yield-focused investors were hit hard last week, especially in the equity space as both dividend-paying stocks and REITs plummeted more than 4%. Meanwhile, master limited partnerships were down nearly 6%. Fixed-income-based yield-focused investments also suffered losses, with high-yield bonds and emerging markets bonds down more than 1%. Only Treasury bonds finished up, albeit modestly, for the week.

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