- U.S. equities move into the year-to-date lead. The S&P 500 Index has returned 1.5% year to date, moving ahead of the MSCI EAFE Index’s 0.9% return and the modest 0.7% loss for the MSCI Emerging Markets (EM) Index. Despite recent volatility (more on that below), we continue to recommend investors, where appropriate, focus on tactical equity allocations in EM (and the U.S.) and limit exposure to developed international markets.
- Recent U.S. dollar strength has been a drag on EM equities. Relative performance of EM equities versus U.S. has been well correlated with the U.S. dollar over the past couple of years, so recent weakness is not particularly surprising. Still, EM equity performance has been resilient, with the MSCI EM Index little changed for the year despite this and other headwinds (rising interest rates, global risk aversion, inflation fears, geopolitics, etc.). While currency translation impairs returns overseas when the dollar rallies, the potential inflationary impacts for developing countries, rising U.S. interest rates, and recent overall global risk aversion are of greater concern. While EM volatility may remain elevated in the near term amid these headwinds, we believe strong economic growth, much improved fiscal positions (with the exception of Argentina and Turkey), the potential currency-related export boost, and generally supportive monetary policies in these economies point to continued EM resilience.
- Political risk in Europe rising. A populist, euro-skeptic political alliance in Italy is becoming increasingly likely, which led Italian equities to sell off about 1% and credit spreads to widen overnight. The combination of increased political risk and the recent string of disappointing economic data in the Eurozone increases the chance of near-term underperformance in European equities relative to the rest of the world.
- U.S. consumer inflation data comes in below expectations. The Consumer Price Index (CPI) rebounded +0.2% month over month in April, slightly missing the +0.3% consensus estimate, following the inflation dip in March. The increase in the headline figure was driven largely by rising fuel and food costs; though removing those two more volatile components showed the more closely watched Core CPI up just 0.1%, shy of consensus estimates and the prior month’s +0.2% reading. Year over year, the key Core CPI measure rose 2.1%, below +2.2% consensus and in line with the prior month. Though Federal Reserve (Fed) members tend to focus more on Personal Consumption Expenditures (PCE) data to assess pricing pressures in the economy, this data points to continued gradually rising inflation, at or near the Fed’s 2% target, consistent with our expectation for three Fed rate hikes this year, though four remains a possibility.
- Jobless claims lower than expected again. New applications for unemployment benefits were reported this morning, coming in at 211,000 versus expectations of 218,000. Claims remain near multi-decade lows, and the less volatile four-week moving average of claims also fell to 216,000. This follows the April unemployment report, which declined to 3.9% and further supports our view of a strong and gradually tightening labor market.
Monitoring the Week Ahead
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- Import & Export Price Indices (Apr)
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