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ECONOMIC FLASH – Volatility Surges Amid Fears of a Slowdown

January 2019

US Economy: Signs of weakness.

Robust job creation (312,000 jobs added in December) and strong consumer confidence must be weighed against weakness in the manufacturing sector, and indications that the trade war with China is deteriorating the earnings outlook for US corporations, including technology companies.

US Stocks: Uncertainty rules.

Concerns over the pace of global economic growth, high equity valuations, and tightening in US monetary policy combined to pull down major stock indices amid high levels of volatility. Energy companies were especially hard-hit in December (-12.6%) due to falling oil prices.

Foreign Stocks: Less trade pressure.

Non-US equities have been relative outperformers in the last few months. Much of the uncertainty about trade has already been priced into foreign stock prices, and they held up better as investors reconsidered US equity valuations in context of trade.

Fixed Income: Corporate debt jitters.

Corporate bond issuance fell roughly 25% in 2018 — to its lowest levels since 2011 — as investors demanded higher yields. The yield spread between lower-quality corporate bonds and US Treasuries is now 5.4%, higher than the historical average.

Real Assets: Gold climbs higher.

The price of gold hit its highest level since the summer, as a weakening US dollar and concerns over global growth made the metal attractive for its perceived safety. Real Estate Investment Trusts (REITs) continued to struggle with interest rate uncertainty.

Alternatives: Managed futures shine.

Managed futures have struggled with having either too little or too much equity exposure during the past decade. In December, however, less exposure was the right answer and many managed futures strategies added value as US stocks fell.

Equities Total Return

U.S. Large Cap (9.0%) (13.5%) (4.4%)
U.S. Small Cap (11.9%) (20.2%) (11.0%)
U.S. Growth (8.8%) (16.3%) (2.1%)
U.S. Value (9.8%) (12.2%) (8.6%)
Int’l Developed (4.9%) (12.5%) (13.8%)
Emerging Markets (2.7%) (7.5%) (14.6%)

Fixed Income Total Return

U.S. Agg. Bond 1.8% 1.6% 0.0%
TIPS 0.5% (0.4%) (1.3%)
U.S. High Yield (2.2%) (4.6%) (2.3%)
Int’l Developed 2.9% 2.1% (0.9%)
Emerging Markets 1.7% 3.6% (1.0%)
Intermediate Munis 1.0% 1.6% 1.8%
Munis Broad Mkt 1.2% 1.6% 1.1%

Non-Traditional Assets Total Return

Commodities (6.9%) (9.4%) (11.2%)
REITs (7.9%) (6.1%) (4.0%)
Hedge Funds
Absolute Return (1.2%) (1.7%) (0.7%)
Overall HF Market (2.2%) (5.9%) (7.0%)
Managed Futures 1.5% (2.4%) (5.8%)

Economic Indicators

DEC-18 SEPT-18 DEC-17
Equity Volatility 25.4 12.1 11.0
Implied Inflation 1.7% 2.1% 2.0%
Gold Spot $/OZ $1282 $1193 $1303
Oil ($/BBL) $54 $83 $67
U.S. Dollar Index 92.1 90.0 88.7

Our Take

Equity market volatility has risen to levels seen only twice in the last seven years, indicating lower investor confidence as we enter 2019. Economic data remain positive in balance, but trade war-driven weakness in leading indicators, such as manufacturing expectations, may forecast a slowdown ahead.

Generally, strong consumer and wage data indicate stable (if not robust) growth, and the risk of recession remains low even as the drama of the trade war continues to play out. In our view, while trade remains front and center in the headlines, the greater risk to the US economy in 2019 is that the Federal Reserve will raise target interest rates too quickly (although this is still unlikely).

LNWM portfolios are positioned for economic expansion but with the goal of improved downside protection. Consequently, we will be emphasizing asset classes that tend to perform well during the latter parts of economic cycles and downturns, such as infrastructure. Given what appears to be political quagmire in Europe, we are reducing some of our exposure to developed international stocks. In fixed income, we are increasing exposure to shorter-maturity bonds, which now offer similar return with less risk than longer-term issues.