Economic data out of the U.S. was mixed last week. While industrial production beat expectations, initial jobless claims and housing starts both disappointed. Internationally, GDP and CPI data came in mostly as expected and industrial production in Russia was better than anticipated.

In the U.S. equity market, small-cap stocks outperformed. Investors see small-caps, which typically generate less revenue from overseas customers than do larger companies, as purer plays on the strength of the U.S. economy. Meanwhile, interest-rate-sensitive sectors (such as utilities and REITS) underperformed as bond yields rose.

Overseas, European stocks were the top performers due to better-than-expected economic reports. But emerging markets continued to struggle as the rising U.S. dollar put pressure on emerging markets currencies.

In the fixed-income markets, convertible bonds outperformed. Their equity exposure overpowered the negative effects of rising interest-rates. Emerging markets bonds underperformed, however, as emerging markets currencies weakened.

GAIN: Active Asset Allocation
Although stock markets were generally flat for the week, there were pockets of strength. U.S. small-cap stocks, in particular, did well. Their dependence on the domestic market has helped shield them somewhat from global trade tensions, the strength of the U.S. dollar and other concerns about multinational companies. Indeed, the U.S. dollar has created a headwind for many foreign companies of late, and we have begun to favor U.S. equities (including small-caps) in recent weeks.

PROTECT: Risk Assist
Expectations for market volatility remain somewhat muted, despite a down week for equities. For example, the CBOE Volatility Index (or VIX, which measures expected future stock market volatility) ended the week roughly where it began.

As with the Gain portfolios, the Risk Assist portfolios reduced emerging markets exposure in favor of factor-based ETFs with the characteristics noted above. The Risk Assist portfolios continue to be modestly de-risked (approximately 10% to 20%). Broadly speaking, global equities would have to rally 4% to 5% to trigger re-risking in the portfolios (and would have to fall 5% to 6% to de-risk further).

SPEND: Real Spend
Global stocks and broad-based bonds gave up ground last week. Long-term bond yields rose nearly 10 basis points, causing the yield curve to steepen. The return spread between global stocks and bonds over the past 12 months is near 17% in stocks’ favor, as bonds are down nearly 1.5% during that time (and down more than 3% year-to-date).

We continue to caution against an overuse of fixed-income in portfolios. Rising rates have been a huge headwind for bonds in 2018—the 10-year U.S. Treasury note is up 65 basis points so far this year—and we expect that trend to continue.

Market expectations for inflation were flat week-over-week, but have risen nearly 15 basis points since the start of the second quarter. The most recent inflation data has shown an uptick in prices in several areas of the economy.

Yield-focused investors experienced a challenging week. Longer duration securities were hit hard due to rising rates, with longer duration Treasuries and corporates down between 0.85% and 1.70% respectively. Equity yield plays also suffered, with REITs down nearly down 2.75% on the week and global infrastructure down 2.5%. The lone bright spot: master limited partnerships, up more than 3% for the week thanks to rising oil prices.

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