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U.S. Economic Strength Helps Domestic Equities Outperform

Key inflation data for the month of July was released last week. Core inflation (as measured by the consumer price index) was mostly in line with expectations, while wholesale inflation in July (as measured by the producer price index) came in lower than anticipated. Meanwhile, initial jobless claims for the previous week were lower than expected.

Overseas, German industrial production was weaker than forecast while UK GDP data for the second quarter was mostly in line with expectations (although second quarter business investment in the UK exceeded expectations.)

In Asia, Japan’s GDP for the second quarter was better than predicted, as was month-over-month household spending. Meanwhile, inflation in China was mostly in line with expectations and the pace of home loans in Australia slowed.

Many U.S. equity market sectors were down for the week, with real estate and consumer staples hit particularly hard. Real estate suffered losses after rumors of tenant bankruptcies reminded investors of the potential risks in the sector. Some of the weakness in consumer staples was due to Wall Street downgrades of companies in the sector and the potential for sector consolidation being questioned by the market.

On the plus side, the consumer discretionary sector outperformed as retailers reported strong earnings and as investor sentiment toward the industry continues to improve. The telecommunication sector also outperformed as second-quarter earnings results and future guidance beat expectations.

European financial markets came under pressure, particularly shares of financial companies with ties to Turkey—where economic conditions are becoming increasingly concerning to investors.  Emerging markets continued to underperform as the pressures of Turkey and the Turkish lira spooked investors—resulting in weakness in many other emerging markets. One exception was the Chinese equity market, which outperformed for the week.

In the fixed-income markets, longer-duration issues outperformed high-yield and shorter-duration securities.  Emerging markets debt underperformed as emerging markets currencies continued to weaken (particularly the Turkish lira). That said, parts of Asia (such as Thailand) were relatively resilient.

GAIN: Active Asset Allocation
Global equity markets began the week looking promising, but experienced volatility and losses on Friday as the Trump administration directed new tariffs at Turkey. The last two weeks have seen outperformance from U.S. equities after some international equity strength during the previous weeks.

We remain overweight to U.S. equities due to the relative strength of the U.S. economy, which remains the largest driver of global growth. That is part of the reason why international equity markets have suffered on a relative basis when tariffs and trade-related developments have occurred in recent weeks. Whenever there has been talk of a new tariff, international markets have led the downturn. That said, if the domestic economy sputters at all, we could see more market volatility.

We maintain our current allocations, though we continue to evaluate and monitor our international positioning and our exposure to momentum-based areas of the market.

The equity sell-off late in the week led to relative weakness among investment-grade corporate bonds and high-yield bonds, but helped modestly boost demand for bonds overall. Intermediate- and long-term Treasuries performed well as investors sought safety in high-quality assets. Fixed-income returns remain very low across the board: As of Friday, the Bloomberg Barclays US Aggregate Bond Index had returned just 2.32% (annualized) over the last five years, 1.74% over the last three years, and -0.62% over the last year. We continue to look for alternative income sources, such as preferred stock and real estate, and we maintain an allocation to longer-duration Treasuries that have historically held up well during periods of equity market stress.

PROTECT: Risk Assist
It was largely a quiet week for global financial markets, as evidenced in part by the CBOE Volatility Index (VIX) hovering under 12—significantly lower than its long-term average. That said, concerns late in the week about Turkish financial instability and how it could potentially impact other markets did cause the VIX to rise above 13 on Friday.

The Risk Assist portfolios maintain current allocations, but we continue to monitor market conditions. Trading volumes have been quite low so far this month, even by historical standards for the month of August. Consequently, even small market moves could potentially be exacerbated.

SPEND: Real Spend
Global equity markets fell around 1% for the week. Meanwhile, the broad-based bond market was up as the 10-year U.S. Treasury yield was unable to break through the psychologically important 3% level. Over the past 12 months, bonds remain down about 1% (and down by nearly 4% in real terms, accounting for inflation). In stark contrast, global equities have gained approximately 12% during the past year—with U.S. equities doing even better, up 18%.

Consumer price index data for July released last week showed headline inflation rising by 2.9% on a year-over-year basis, which was in line with economists’ expectations. But core CPI (which strips out the index’s volatile food and energy components) rose by 2.4%—slightly higher than anticipated.

In general, inflation is now running ahead of the Federal Reserve Board’s long-term target level—which likely provides support for future Fed rate hikes. That said, inflation remains below its long-term median of approximately 3.1%. And tradeable market securities that price in longer-term inflation expectations have barely budged all year, hovering around 2.3% to 2.4%.

In the yield space, longer-duration Treasury securities led the way (up more than 1%) as interest rates pulled back. Emerging markets debt suffered last week, down 1.8%, due largely to new U.S. tariffs aimed at Turkey. REITS also performed poorly, following equity markets lower despite falling rates (which have often provided a boost to this asset class in the past.)

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U.S. Economy Stays Strong as the Fed Holds Steady - download Horizon's Market Notes

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