Last week, the domestic market equity was fractionally positive, and while not completely immune to global events, it was, for the most part, relatively insulated. The mounting political tensions between the U.S. and Turkey took a heavy toll on the value of the Turkish lira, boosting borrowing rates for the country and further threatening its economic stability. These concerns radiated to the European banking sector, a larger holder of lira-denominated debt. Beyond the financial implications, concerns about Turkey’s relationship with the West over issues of immigration, as well as economic and military cooperation, darkened the mood among investors. These concerns were evident in currency and interest rate moves last week, as the U.S. dollar gained between 1% and 2% against the G10 currencies, while demand for U.S. Treasuries pushed yields back down to 2.873% for the ten-year and 3.03% for the 30-year. Falling interest rates brought the growth/momentum leadership back into the spotlight with consumer discretion up 0.77% and technology up 0.43%. While the gains were fractional, the declines were not, as consumer staples fell 1.93%, whereas materials and industrials tied for second with losses of 1.03%. By Friday’s closing bell, the S&P 500® Index clung to a gain of 0.18%, eclipsed once more by the small cap segment, as both the S&P 600 Index and Russell 2000® Index posted gains of 0.80%. The potential threat to European markets was evident in international equity returns where emerging markets, as measured by the MSCI Emerging Markets Index, fell 1.02%, versus the larger 1.57% drop registered by the MSCI EAFE® Index. The spike in the value of the U.S. dollar was felt in commodity prices, where U.S. grain reversed recent strength, falling roughly 3%, followed by metals, which were off generally less than 1%.
Earlier this year, we implemented some weighting changes in our model portfolios. Those changes involved increasing the allocation to smaller stocks, value stocks and emerging markets. So far, the shift to smaller stocks has been a good one, as value stocks remain prisoners to an unyielding interest rate environment, while emerging markets have fallen victim to trade tariffs, a rising dollar and something of a global risk-off trade. It is critical to limit investment losses and review the rationale behind the initial decision, looking at what might have been missed or what has changed. In the research leading up to those changes, a review of relative valuation and growth potential was done. Some of that involved assessing the price paid for current economic results with the balance being a valuation of future results. On the former, whatever we are paying for past results, the rationale has not changed: the large-cap core of the U.S. equity market is expensive. The case for future value rests on how long the U.S. economy can continue to expand. It currently looks as if 2019 should be okay, but there is no denying we are late in the cycle. The bias to value over growth hangs on the long end of the yield curve, which, given the size of the upcoming Treasury auctions and corporate refinancing, is going to encounter upward pressure, so it is more of a ‘when’ than ‘if’. The remaining question is that of international versus domestic, and as recent events have borne out that entails additional layers of risk. But to better appreciate this context, Exhibit 1 tracks the relative performance of the S&P 500® Index and MSCI Emerging Markets Index. You will note that except for the financial crisis (where everyone’s ox was gored), these two have a habit of trading off leadership with one another. The U.S. market suffered for over a decade before it could finally overcome the bursting of the Tech Bubble, while the emerging markets were climbing to new highs. Since the financial crisis, it has been the emerging markets struggling to regain altitude. Looking at the current performance gap between the two and how that gap has played out in the past, the bigger risk in emerging markets is likely not being invested. It does not require a great deal of study to see the parallel between now and the post currency collapse of the late 90s. It also highlights the near parabolic rise of the U.S. equity market since the crisis. Very little in human experience gets that good that fast. All this is to say, we will stay the course with international at present, but we should always be mindful of our surroundings.
Exhibit 1 (Source: Bloomberg)
For a PDF version of this publication, click here: 08.13.2018_WeeklyMarketOverview
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Source: Unless otherwise noted, all statistics herein obtained from Bloomberg.
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