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ECONOMIC FLASH – Volatility Returns and Rattles Investors

November 2018

US Economy: US GDP growth underscores economic health.

The 1st estimate for US 3Q GDP growth slowed from 4.1% in the second quarter but at 3.5% remained above the post-crisis average. Headline inflation also decelerated to a pace of 2.3%.

US Stocks: Pullback wipes away gains.

Both small cap and large cap stocks gave away the majority of their 2018 gains despite healthy earnings results likely based on investors’ increased worry over the impact of trade clashes on global growth.

Foreign Stocks: Growth, political drama weighs on markets.

Both China and Japan showed signs of deteriorating growth. In Europe, renewed anxieties over a Brexit deal, the Italian deficit and a court decision hindering Spanish bank profitability concerned investors.

Fixed Income: Rates tick higher.

Municipal bonds were slightly negative as interest rates crept higher. However, persistent retail demand has driven outperformance relative to taxable bonds.

Real Assets: Infrastructure, commodities hang tough.

Infrastructure and commodities investments fell less than equities. We expect both to continue to provide downside and inflation protection.

Alternatives: Long/short equity strategies fall.

Long/short equity strategies within hedge funds struggled. Higher beta and tech companies, which many of these funds own, were particularly hard hit.

Equities Total Return

U.S. Large Cap (6.8%) 3.0% 7.3%
U.S. Small Cap (10.9%) (0.6%) 1.8%
U.S. Growth (9.2%) 6.2% 10.2%
U.S. Value (5.5%) (1.5%) 2.8%
Int’l Developed (8.0%) (9.3%) (6.9%)
Emerging Markets (8.7%) (15.7%) (12.5%)

Fixed Income Total Return

U.S. Agg. Bond (0.8%) (2.4%) (2.1%)
TIPS (1.4%) (2.3%) (1.2%)
U.S. High Yield (1.6%) 0.9% 0.9%
Int’l Developed (0.9%) (3.7%) (1.7%)
Emerging Markets (0.9%) (5.4%) (3.1%)
Intermediate Munis (0.3%) (0.1%) (0.8%)
Munis Broad Mkt (0.7%) (1.2%) (0.7%)

Non-Traditional Assets Total Return

Commodities (2.2%) (4.1%) (1.7%)
REITs (2.6%) (0.9%) 1.4%
Hedge Funds
Absolute Return (0.1%) 0.9% 0.6%
Overall HF Market (3.1%) (4.3%) (3.5%)
Managed Futures (2.8%) (6.2%) (5.3%)

Economic Indicators

OCT-18 APR-18 OCT-17
Equity Volatility 21.2 15.9 10.2
Implied Inflation 2.1% 2.2% 1.9%
Gold Spot $/OZ $1215 $1315 $1271
Oil ($/BBL) $75 $75 $61
U.S. Dollar Index 90.6 86.4 88.7

Our Take

Clearly market volatility has returned and investors are more cautious. As mentioned in our most recent outlook, trade tensions, rising US interest rates, and a stronger-than-expected dollar are at the root of this repricing, particularly for growth-oriented stocks.

Looking forward, the Federal Reserve has telegraphed intentions to continue raising rates and we believe this will be the case. As rates move higher, we will be watching credit, mortgage, real estate markets for significant signs of deterioration which may be the best indicators for a downturn in the economy. That said, we don’t think a recession is a near-term possibility as we look at strong corporate earnings, above-trend GDP growth and low unemployment.

Financial market performance in the last month has provided investors few places to hide with nearly all major asset classes offering negative returns. Nevertheless, we identified real assets as an area to make a dedicated allocation to earlier this year and are pleased that these positions are behaving as expected in the current environment if not with the absolute level of returns.