Week of December 24, 2018
By: Horizon Investments, LLC
Another week of mixed economic results, as the Philadelphia Fed manufacturing index and durable goods orders (as well as core durable goods orders) all were lower than expected. However, there were signs of good news from the housing sector, as housing starts and building permits exceeded estimates and as existing home sales accelerated more than expected. One caveat: The positive starts data was driven by multi-family homes. Construction of new single-family homes actually fell for the third consecutive month and hit its lowest level since May 2017.
In Europe, the German business climate index and business expectations index disappointed. On the plus side, the German consumer climate gauge was better than anticipated--as was the French business survey. In the UK, retail and core retail sales topped estimates, while home prices grew at a slower-than-expected pace.
In Asia, Japan’s core inflation rate (CPI) was just slightly weaker than expected—suggesting domestic demand may not be as strong as hoped for. Meanwhile, Australia’s employment change and labor participation rate were better than expected, while New Zealand GDP growth disappointed.
The U.S. equity market (as measured by the S&P 500) suffered its worst weekly performance since 2011. The utilities and materials sectors were relatively strong while the weakest sectors were energy and consumer discretionary (despite robust holiday spending by consumers). Utilities benefited from a shift to more defensive areas of the market, while materials got a boost from a range of factors (such as activist news, analyst upgrades, strength in precious metals prices and relatively attractive valuations). Energy was hit by another week of falling oil prices—as concerns about global economic growth and elevated supplies of oil in the U.S. offset OPEC’s price stabilizing efforts.
European markets also slumped, but fared better than the U.S. market. Cyclical and technology stocks generally felt the most pressure—however, materials stocks (such as like diversified miners) outperformed. Japanese markets, while weaker than Europe, also outperformed the U.S. for the week. Emerging markets were down but bested developed markets, as cheaper valuations and (ironically) relatively low political risk compared to in the U.S. kept sellers in emerging markets at bay.
In the fixed-income markets, long-duration bonds outperformed shorter-duration securities. High-yield corporate credits were hurt worst as risk aversion increased and spreads widened on more risky debt. Emerging markets sovereign and corporate bonds were down, but stronger emerging markets currencies added some support.
GAIN: Active Asset Allocation
Domestic stocks led the markets lower last week, as investors worried about comments made by the Fed following its decision to raise a key short-term interest rate and about turmoil within the Trump administration. Selling was broad-based and market sentiment remained weak, with few buyers stepping in on market dips. Developed international equity markets and emerging markets held up relatively well last week, however.
Fixed-income markets were mixed: Treasuries performed well as investors preferred “safe haven” assets, while corporate bonds slumped due to their perceived riskiness. Credit exposure has been positive for the portfolios for the year, but negative during the fourth quarter as corporate bonds (like stocks) have seen a lack of buyers. We expect more liquidity and a better market environment in 2019.
PROTECT: Risk Assist
Volatility increased sharply last week as investors sold equities. The CBOE Volatility Index (VIX) soared nearly 40% as it approached its high for the year set back in February. Investors worried about the Fed’s decision to raise a key short-term interest rate and its outlook for future rate hikes, and expressed concerns about recent developments in the Trump administration and the government shutdown. While there are no signs of an imminent economic collapse or recession, the present environment of exceptionally thin market liquidity is potentially exacerbating downside moves.
SPEND: Real Spend
The return spread between global stocks and investment-grade bonds fell once again last week as equity markets continued to suffer. Global stocks are now down more 10% year-to-date while investment-grade bonds are essentially flat. In addition, global stocks have realized a maximum drawdown of 18.2% this year--with maximum drawdowns for U.S. and international stocks of 17.6% and 21.9%, respectively.
Meanwhile, inflation remains soft as measured by the Fed’s preferred inflation gauge, the PCE index. Last week, core PCE (which excludes food and energy prices) for November rose 1.9% on a year-over-year basis--in line with expectations. That was up 0.1% from October, and slightly below the Fed’s longer-term target inflation rate of 2.0%. In fact, although PCE has touched 2% at various points this year--most recently in September—it has failed to climb any higher. (The last time the PCE index topped 2% was in early 2012.) Longer-term market expectations for inflation are now hovering around 2.2%, down from 2.45% at the start of the current quarter.