U.S. Economy Remains Strong Despite Equity Volatility
Economic data released last week revealed strength in some key areas of the U.S. economy. For example, GDP growth during the third quarter was slightly stronger than expected, while both manufacturing and services PMIs exceeded expectations. However, the news wasn’t entirely positive: Core durable goods orders and new home sales fell short of expectations, while consumer sentiment (as measured by the University of Michigan’s monthly survey) was slightly lower than forecasted.
In Europe, German manufacturing and services PMIs missed estimates—but the consumer climate index in the country was better than anticipated. Meanwhile, French services PMI topped estimates. In Asia, Japanese core CPI was in-line with expectations in what was a quiet week for economic news in the region.
U.S. equity markets had a rocky week. Once again, defensive-oriented sectors such as consumer staples and real estate outperformed due to their perceived relative safety. Cyclical sectors like energy and industrials lagged due to global trade tensions, concerns about global economic growth prospects and lower oil prices.
European equity markets were weighed down by global macro risks and by warnings from European companies about their future earnings growth. Many companies reduced guidance as the continent continues to wrestle with the lack of a Brexit conclusion, Brussel’s rejection of Italy’s proposed budget, and the possibility of slower growth. Japanese markets were impacted by similar factors and ended the week down significantly.
Emerging markets began the week in relatively strong shape, boosted by economic stimulus efforts from China. That strength was short lived, however, and emerging markets’ positive performance faded by week’s end. That said, Brazil continues to be a notable outperformer as election-related concerns in that country subside.
In the fixed-income markets, falling rates helped long-duration issues outperform shorter-duration securities. High-yield bond performance was weaker given global risk-aversion, and emerging markets debt fared only slightly better than high-yield. The Brazilian real and Turkish lira appreciated while other major emerging markets currencies (like the South African rand and Mexican peso) remained under pressure.
GAIN: Active Asset Allocation
Equity markets have now been in risk-off mode for the second time this year. Back in February, volatility-related trading drove the markets lower. During this latest round in October, selling among higher beta assets—stocks with more volatility than the overall market—has led the downturn. These include small-caps, growth stocks and international stocks.
Although the re-valuation of stocks may lead to more selling pressure, it is important to acknowledge the current strong economic backdrop and stable fundamentals that could help support the markets. Signs of positive news regarding trade and tariffs, as well as a softening stance on monetary policy by the Federal Reserve Board, could potentially spark a rebound.
Bonds rallied last week as stocks slid and as rates fell. Corporate credits have underperformed in the wake of rising equity market volatility, however. We are evaluating the portfolios’ exposure to credit securities. The Fed and its policy decisions and statements will play a major role in the fixed-income market between now and year-end. The Fed continues to reiterate that it is independent and that its decisions will be driven by data. If so, it is reasonable to expect more rate hikes if the U.S. economy remains strong and fewer rate increases if there are signs of a softening economy.
PROTECT: Risk Assist
Global stocks continued to struggle last week while stock market volatility expectations remained stubbornly high, with the CBOE Volatility Index (VIX) in the mid- to high-20s all week. We recently updated our volatility forecasts, an exercise that contributes to our allocation decisions.
SPEND: Real Spend
Inflation data released last week showed that the Fed’s preferred inflation metric—the PCE index—rose at a slightly slower rate than expected during the third quarter, coming in at 1.6% on an annualized basis versus expectations of 1.8%. This suggests that inflation overall is contained.
The one-year spread between stock and bond market returns remains in stocks’ favor, even in the wake of one of the worst months in years for equities. And although global stocks and bonds are down a little over 1% during the past 12 months, U.S. equities are up nearly 6% over that period.
A look at the medium term serves as a reminder that the type of short-term volatility and losses seen in October does not mean there is not the potential for longer-term gains. Example: While U.S. equities have generated a 10.7% annualized return over the past three years, bonds are up only 1% on an annualized basis during that period.
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Watch our special report on last week’s volatility to get our perspective.