Economic Update 10-15-2018

• Economic data for the week featured more tempered inflation results than expected as seen in last month’s PPI and CPI, lowering the trailing year’s results.  Consumer sentiment declined and jobless claims ticked upward a bit due to hurricane-related effects.
• Global equity markets suffered a volatile week, with the worst down day stretch seen in over six months.  Bonds fared positively, due to cash flows moving to less risky assets.  Commodities were mixed to down, as the price of crude oil declined sharply.

In keeping with October’s reputation for enhanced market volatility, markets did not disappoint last week.  Equities broke out of a fairly tempered streak by declining by the largest two-day amount since February, by a cumulative -5% loss, before recovering a bit by Friday.  Regardless, the declined wiped out half of 2018’s gains thus far, and put small caps into -10% correction territory.  Every stock sector was in the red, with defensive segments utilities and consumer staples faring the best with losses under -2%, while heavily cyclical materials and industrials declined well over -6% on the week.  Decent early earnings reports in the financial sector seemed to help restore a positive tone by Friday.

While no one cause seemed solely to blame, a combination of higher interest rates and continued U.S.-China tariff concerns seemed to remain an issue as much as any other catalyst, although (ETF-driven) systematic selling activity may have also exacerbated the issue once the price of the S&P fell below its 100-day, then 200-day, moving average.  The President described recent interest rate hikes by the Federal Reserve as ‘loco’ and ‘going wild’, which were not taken overly seriously by markets but didn’t help overall sentiment.  The overriding concern, however, seems to be the fear that the U.S. (and global) economy is easing from a mid- into a late-cycle environment, which would indicate slowing growth and an eventual recession.  The IMF has also updated their world forecast of GDP growth downward, for the first time in over two years, from 3.9% to 3.7%—largely due to fears over escalating trade tensions and stress in emerging markets from rising interest rates.

Foreign stock returns were negative as well for the week, albeit not to the same degree as U.S. equities, helped a bit by a weaker dollar.  Interestingly, in contrast to many ‘risk-off’ weeks in the past, emerging markets fared best with the smallest equity losses by segment.  Italian stocks fared worse than other developed markets, with continued worries about the nation’s upcoming budget deficit and potential conflict with the EU.  In emerging markets, Chinese stocks fared poorly again due to the ongoing trade dispute with the U.S.  In response to the controversy and potential negative economic growth effects, the PBOC cut the banking reserve requirement (for the fourth time this year) by 1%, which is effectively a rate cut, injecting the equivalent of about $175 bil. into the economy.  Brazil, on the other hand, saw gains as the right-wing protectionist candidate commanded the largest number of votes in the initial presidential election and will proceed to a runoff.

U.S. bonds fared well, ironically, compared to the poor returns of the week prior, due to widespread worries of interest rates rising too far and too fast.  Treasuries fared best, outperforming corporate credit as spreads moved wider on the week, which explained the negative performance of high yield.  The concept of ‘spread duration’ accounts for the sometimes divergent impacts of one element of duration (term spread of government bonds, in the case of last week—moving lower and pushing bond prices higher) and the offsetting effect of another (credit spread, which is tied a bit more closely to equity risk, which moved higher and pulled down prices).  Foreign developed market government bonds fared positively as well, benefitting from flows to lower-risk assets and helped by a weaker dollar.  Emerging market local debt performed surprisingly well on the week.

Real estate fared negatively, in keeping with broader equity markets.  Asian and European REITs came in slightly better, with a beneficial dollar effect.  As expected, more cyclically sensitive REIT groups, such as lodging/hotels lost the most ground, while residential/apartments and malls held up better.  While real estate fundamentals remain sound, valuations have been depressed to due such interest rate worries, with a continued wide bifurcation between more popular index components and those with perceived greater structural headwinds, such as retail and regional malls.

Broader commodity indexes lost ground on net, despite a weaker dollar, led by losses in energy—while agriculture and precious metals gained ground during the week.  Precious metals, per their historical tendency, served as a profitable crisis asset.  Crude oil ended the week -4% lower at over $71/barrel.

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.                                                                              

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.