Equities swung sharply again this week as investors continued their struggle to determine the strength of the U.S. economy and what it might mean for the future of the Federal Reserve’s monetary stimulus program.

Stronger-than-expected economic data have tended to spook investors fearful of a Fed “taper” of its $85 billion-per-month bond-buying program. Next week, the Federal Reserve Open Market Committee will hold a much-anticipated two-day meeting, but there is likely to be no change in policy. Also, in his post-meeting news conference, Fed Chairman Ben Bernanke will reportedly seek to calm investor fears about higher rates.

Interestingly, an increase in real interest rates — not fears of inflation — has driven the rise in rates. Real rates are those adjusted to remove the effects of inflation. When real rates rise, that’s typically associated with expectations of a strengthening economy. As rates have recently moved higher, inflation expectations — measured by the difference between yields on fixed-rate and inflation-linked Treasury securities — have actually declined. While the movement in real rates should be considered a positive development for the economy, the Fed may view it differently, given its objective of keeping long-term interest rates low.

The S&P 500 closed the week at 1,627, down 0.97%. The yield on the 10-year U.S. Treasury note slid to 2.13%, down 0.04 percentage points. Gold rose slightly during the week to close at $1,391 an ounce, up 0.56% from last Friday.

Unsurprisingly, U.S. economic data remain mixed. Retail sales for May rose a better-than-expected 0.6%. The increase was the largest in three months and followed a more modest 0.1% gain in April.

The producer price index, which measures inflation at the wholesale level, rose a worse-than-expected 0.5% in May, reflecting an increase in energy and food prices. Economists were looking for a more benign increase of 0.1%.

Industrial production for May was unchanged despite expectations of a 0.2% advance, while capacity utilization edged down slightly. This confirms the weak May Institute for Supply Management manufacturing survey last week that indicated contraction in the sector.

USAA Investments Managed Portfolio Outlook

The extremely low levels of implied volatility and signs of excessive bullishness in equity markets affirm our current view of caution on risk assets. We remain slightly overweight in bonds and cash in our diversified managed portfolios. We also have a small position in gold and precious-metals mining stocks, which we view as attractive as a long-term inflation hedge.

Economic Releases Scheduled for Next Week
• Consumer price index
• Housing starts
• Existing home sales

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.

This content is provided courtesy of USAA.

By Wasif Latif
Vice President, Equity Investments



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