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The Game Is Still On

We’re in late innings, but it’s still too early for investors to scale back on risk.

In the past few weeks, investors have seen an increase in geopolitical risk which rocked some markets and triggered fears of a global synchronized downturn. Despite those stresses—trade tensions, currency fluctuations and unpredictable elections—the latest economic data show the global economy is growing nicely.

That’s why, even though it is late in the economic cycle and volatility is higher lately, it may be too soon to dial back on risk in your portfolio. U.S. markets have mostly moved sideways this year, but there may be upside ahead.

Here’s what’s going surprisingly well for markets in terms of both data and events.

  • Italy’s stresses, rather than jeopardizing the European Union, could prove constructive for the region. I now expect the EU to consider shifting its policy focus to fiscal stimulus, banking unity and structural reform, which is healthy.
  • In the U.S., economic data is surprising to the upside. Gross domestic product (GDP) forecasts are being revised up. May payrolls showed strong job growth and lower unemployment. Manufacturing and services growth is robust.
  • The European Central Bank is signaling it may scale back on its bond-buying program, a form of fiscal stimulus known as quantitative easing. That suggests increased confidence in inflation targets.
  • Global trade data for May was much better than expected. This is despite ongoing hostilities over tariffs. In China, net trade is growing at double-digit rates.
  • China's growth is holding up. Economic growth has slowed, but at a glacial pace. Industrial production is up over 6% and retail sales more than 9%.
  • The U.S. dollar may weaken, which would be good for global trade and financial conditions. That should help stabilize emerging markets and strengthen the euro.

While the latest data is surprisingly positive, I recommend keeping an eye on the U.S. dollar, emerging markets and high yield bonds (also known as junk bonds) for signs of a shift. A rise in the dollar and declines in emerging markets and high yield bonds could signal that global financial conditions are worsening.

Barring that, I suggest keeping portfolios tilted towards equities in sectors that do well during late-cycle economic expansions. These include energy, financials, business-facing technology and industrials. Well-managed, diversified stock funds should hold up well.

I’m more concerned about bonds, which may struggle if continued economic growth leads to higher rates (bond prices move inversely to interest rates). The economic cycle is in later innings, but the game isn’t over yet.