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U.S. Markets Recover During Volatile Week

Christmas week offered a mixed bag, economically. Initial jobless claims were lower than expected, but continuing claims were slightly more elevated than forecast. Manufacturing activity in the Chicago-area exceeded expectations, but housing data for the U.S. remained lackluster. For example, pending home sales fell rather than rose, as had been expected.

In Europe, Italy’s parliament finally approved the country’s 2019 budget just before the year-end deadline—likely helping prevent additional financial market volatility. Meanwhile, gross mortgage approvals in the UK topped estimates, Swiss KOF leading indicators (which help gauge the overall economy) were below expectations and quarterly GDP growth for Spain was in line with predictions.

The U.S. equity markets recovered last week to post a positive return, despite significant volatility along the way. The materials and consumer discretionary sectors outperformed as investors took on a more risk-on stance, while the more defensive sectors such as utilities and real estate lagged. Retailers were the top performing sub-sector within consumer discretionary after strong holiday sales were reported by an industry bellwether. Shares of chemical-oriented companies, which are benefiting from a recent decline in input costs, helped drive the materials sector’s outperformance. Utilities and real estate slumped due to elevated valuations and as investors favored riskier and less defensive segments of the market.

European equities lagged the U.S. market last week due to Italian budget worries early in the week, the status of Brexit and other concerns. Japanese stocks also lagged the U.S., but slightly outperformed Europe. Japan’s performance continued to be weighed down by fears of a slowing global economy. Meanwhile, emerging markets once again outperformed developed markets as valuations continue to be attractive and as emerging markets’ geopolitical situations seem relatively less risky.

In the fixed-income markets, shorter-duration securities outperformed longer-duration bonds. Credits perceived as relatively risky—such as high-yield bonds and emerging market corporate issuances—fared well as investors adopted a slightly more risk-on attitude. Emerging markets sovereign credits also gained ground, as most emerging markets currencies appreciated for the week.

GAIN: Active Asset Allocation
Global equity markets rebounded somewhat last week after a bruising quarter. The sectors that have been beat up the worst during the quarter did the best last week—including consumer discretionary, technology and communication services. This suggests that the selling pressure on those sectors, particularly from institutional investors like hedge funds and banks, may be coming to an end.

We remain neutrally weighted between growth and value in the equity portion of the portfolios. We also continue to favor emerging markets over developed markets. Small-caps have been particularly weak, but we have a neutral weight to that asset class.

In the fixed-income market, longer-duration Treasuries have benefited from interest rates falling to the lower end of their recent range. Credit markets have been weak due to softness in the stock market. As with stocks, institutional investors play a large role and have been reluctant to buy this late in the year. We expect to see more liquidity and activity as we move into 2019.

PROTECT: Risk Assist
Volatility has risen sharply in recent weeks, with realized volatility for U.S. equities ending the year at levels not seen since 2008. That said, we see a major disconnect as today’s economic conditions are extremely dissimilar to conditions back then.

SPEND: Real Spend
Last week was one of the most volatile weeks for equity markets since August, 2015. A full seven of the last 10 trading days for the S&P 500 have seen moves of greater than 1%. That compares to only eight such days during all of 2017.

The return spread between global stocks and bonds widened last week in favor of stocks. For the year, bonds are flat at just below 0% while global stocks are down 9.5%. Meanwhile, U.S. stocks are down just 5.4%.

Throughout the fourth quarter of 2018 , defensive and higher-quality domestic equities have contributed the most to the performance of the equity allocations in the Real Spend portfolios, while large-cap growth and value domestic equity allocations have detracted the most. Within fixed – income , allocations to shorter-term investment – grade bonds have held up the best while higher – yield fixed – income instruments dragged on returns.

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U.S. Markets Recover During Volatile Week

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