After a stretch of mostly positive news, U.S. economic announcements were largely disappointing last week–with initial jobless claims, PPI Final Demand, wholesale inventories, retail sales and import prices all coming in worse than expected. However, top-line CPI inflation data was in-line with expectations. Meanwhile, international economic data was more mixed. German industrial production was stronger than expected, although German factory orders disappointed. Industrial production in France was weaker than anticipated, but retail sales in Italy came in better than expected.
In the U.S. equity market, financial services companies—banks, in particular—outperformed due to rising interest rates. Higher rates generally help boost banks’ profits. In contrast, REITs and utilities—which are highly sensitive to changes in interest rates—underperformed as rates rose.
Overseas, European stocks outperformed. They were driven largely by the financials sector, which is benefiting from a combination of accommodative central bank policy, accelerating European growth, improving capital ratios and higher interest rates. International underperformers included Mexico and Canada, due to new of a potential renegotiation of NAFTA.
In the fixed-income markets, equity-oriented securities like preferred stocks and convertible bonds outperformed. But long-duration bonds underperformed as rumors of China might curtail its buying of U.S. government debt roiled Treasury markets–pushing interest rates higher and bond prices lower.
Last week was another solid week for equities, with U.S. stocks bouncing back and outperforming foreign stocks. In particular, small-cap and mid-cap stocks are off to a strong start this year after a period of subpar returns. In contrast, emerging markets were soft and detracted from performance.
Bonds were down last week, with longer duration bonds getting hit hard (down close to 2%). The yield on the 10-year Treasury is closing in on 2.6%, up from 2.4% to start the year. We continue to emphasize corporate credits. We also prefer a modestly shorter duration profile, which helps limit some of the volatility of these rate moves.
The ETF universe continues to grow, and most of the new ETFs are copies of others already out there (possibly with a lower expense ratio). However, some of them offer unique exposures to various segments of the markets, which is helpful to us as portfolio managers. The more variety we have to choose from, the more ways we can express views.
The Risk Assist portfolios remained fully invested as stocks continued to climb last week and volatility remained near its historically low levels. In addition, drawdowns have been small and infrequent: The S&P 500 index is closing in on 400 sessions without a 5% drawdown.
Falling investor demand for bonds pushed bond prices lower, and bond yields higher, across all maturities last week. That, coupled with stock market gains, caused the trailing one-year spread between global equity returns and broad-based bond market returns to increase to around 23 percentage points.
In economic news, the December Producer Price Index (PPI) experienced its first month-over-month decline since August 2016—coming in 0.3% under the consensus estimate. The PPI measures the prices received by domestic producers and can be thought of as predictive of future consumer inflation (as high producer prices may imply high consumer prices down the road). The index’s decline puts further downward pressure on already lower-than-normal consumer price inflation. Meanwhile, the Consumer Price Index (CPI) that measures overall consumer prices rose by 2.1% over the past 12 months.
In the Real Spend portfolios, large-cap domestic growth stocks were the best performers as their recent momentum continues. Bonds and dividend-focused stocks were the worst performers in the wake of rising rates.
Yield-focused investors saw poor results from long-duration bonds and yield-centric equities such as REITS and infrastructure plays, as rising rates pushed down prices on these securities. Preferred stocks and master limited partnerships held up well, however, with preferreds benefiting from strong performance among financials and MLPs following oil price stability.