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The Weekly Review April 30, 2018

The Weekly Review May 7, 2018

Guest Post - Monday, May 07, 2018


Economic data for the week was highlighted by a FOMC meeting in which policy was left unchanged, some mixed to lower results for a variety of manufacturing and services indexes; the April employment situation report was mixed as well but continued to point to a strong underlying labor market.

U.S. equity markets were mixed due to a waxing and waning of trade fears, while foreign stocks lost ground due to a stronger dollar. Bonds were flat in the U.S. with little changes in rates, while foreign issues had similar dollar effects. Commodities gained with higher prices in crude oil and metals.

Economic Notes

(0) As described earlier in the week, the FOMC left the fed funds policy rate unchanged at 1.50-1.75% at the conclusion of their May meeting. Their formal statement language was similarly little changed, although they did acknowledge that inflation had bumped up from a level of underwhelming to close to target. Overall, it appears member consensus has tightened, with fewer members seeking continued accommodation, in an acknowledgement of economic strength. Debate continues about the pace of rate movement, with 3-4 hikes both this year and next looking like the base case. If the high end of these estimates were achieved, that would bring the nominal fed funds range up to 3.50-3.75%, which, assuming inflation was consistently at its 2% policy target or even a bit higher, would imply a real rate of 1.00-1.75%—far closer in line with historical norms over the years for real rates.

(-) The ISM Manufacturing Index for April fell by -2.0 points to 57.3, deeper than the forecasted decline to 58.5, and representing a 9-month low. Under the hood, production, new orders and employment all declined by up to several points in line with the overall measure, as did inventories. Prices paid rose a point, with continued increases in commodity prices. Backlogs rose, pointing to potential capacity constraints, which would not be unusual later cycle. Despite the drop and concerns over ‘peaking ISM’, readings in the upper 50’s continue to signify strong growth.

(+) TheChicago PMI index for April rose 0.2 points to 57.6 to snap a three-month losing streak. Activity continued to rise as seen by the overall index, although only production and supplier deliveries grew for the period; production and new orders continued on their downward trend, with the latter down -10% from levels a year ago. Backlogs that were in effect earlier in the year have similarly fallen in recent months, and prices paid have continued to rise, to their highest levels in about 7 years. The special question of the month was in regard to the impact of tariffs, with half of respondents deeming these insignificant in ongoing operations, although a third saw potentially major impacts. This is to no surprise considering the industrial nature of this survey group.

(-) The ISM non-manufacturing index for April similarly fell by -2.0 points to 56.8, a bit further than the more moderate decline to 58.0 expected by consensus. Business activity, employment and supplier deliveries all fell by several points, while new orders rose by a half-point to a strong 60 level. Prices paid also ticked higher. Anecdotally, respondents appeared to show some concern over tariffs and a resulting increase on cost of goods, which is a bit interesting in that this services survey is less directly impacted than manufacturing is, where respondents appear less concerned.

(+)The trade balance improved by -$8.8 bil. to a deficit of -$49.0 bil. in March, tighter than forecasts calling for -$50.0 bil. Goods/service imports fell by just under -$5 bil., while exports for the same rose by over +$4 bil. The deficit with China fell during the month, which was assumed to be due to the timing of Chinese New Year.

(0) Personal income for March rose +0.3%, while personal spending gained +0.4%—both of which were similar to but just a tick under expectations. On a year-over-year basis, income rose +3.6%, which is a positive, while spending decelerated in pace to +2.4%. Thus, the personal savings rate fell two-tenths of a percent to 3.1%. The PCE price index was flat on a headline basis, but rose +0.2% on the core side. On a year-over-year trailing basis the Fed-watched PCE figure rose +2.0% and +1.9% on a headline and core basis, respectively, which are both right in line with the FOMC’s target level.

(0) Pending home sales for March rose +0.4%, coming in under expectations calling for a +0.7% gain for the month; additionally, the prior month’s gain was revised down by a fraction of a percent. Regionally, the South and Midwest gained over +2%, while the West declined slightly but Northeast fell by over -5%—seemingly affected by weather.

(-) Construction spending for March fell -1.7%, in contrast to the +0.5% gain expected; on the positive side, levels for the prior two months were revised higher by several percent. In March private residential declined by the largest magnitude, while public construction was little changed on net.

(+) The ADP employment report for April came in showing an increase of +204k, beating the +198k rise in private sector jobs expected, while the March figure was revised down by -13k. Services led, as usual, with +160k jobs added, highlighted by professional/business services with +58k, followed by education/healthcare and leisure. Goods-producing jobs rose +44k, with gains in construction contributing to nearly two-thirds of that total, followed by manufacturing. The magnitude of final numbers vs. consensus seems to be the primary usefulness of the ADP report, but results weren’t far out of consensus.

(+) Initial jobless claims for the Apr. 28 ending week ticked back up by +2k to 211k, but still under consensus estimates calling for 225k. Continuing claims for the Apr. 21 week declined dramatically by -77k to 1,756k, which was far below expectations calling for 1,835k. There is little new news here, but the overall level of claims, hovering near multi-decade lows, continues to point to exceptionally strong labor activity and lack of layoffs.

(0) The big government employment situation report for April showed a mixed result, but labor conditions remained quite strong overall, which has kept expectations for a June Fed rate hike on course for happening.

Nonfarm payrolls rose by +164k, underwhelming the +193k the level expected. Professional/business services jobs led the way, gaining +54k, followed by +31k in education/health services, +24k in manufacturing, +18k in leisure/hospitality and +17k in construction. The March report was revised up by +32k, which is significant, while February results were revised down marginally by just a few thousand. While severe late winter weather could have played a role in early month results, it’s important to remember that the room for error on these preliminary payroll reports is quite high and subject to large revisions, although markets tend to react to them immediately as a finished product.

The unemployment rate fell by two-tenths of a percent down to 3.9%, the lowest level since 2000, following six months holding steady at 4.1%. The U-6 underemployment rate also fell by the same amount, to 7.8%. The labor force participation rate was generally steady at 62.8%. Looking deeper into the data, those ‘marginally attached to the labor force’ have significantly declined over the past year, implying that their job situations have improved, as would be expected when unemployment rates turn this low. However, the number of ‘discouraged’ workers (those not looking for a job as they believe no jobs are available for them) hasn’t changed much in the past year.

The average workweek length was unchanged at 34.5 hours. Average hourly earnings rose by +0.15%, offsetting some downward revisions for the prior month, and representing a less-than-expected +2.6% gain on a year-over-year basis. This is in keeping with recent trends, and is running at a slightly higher rate than broader CPI/PCE inflation but not dramatically so at this point.

Unit labor costs rose at a pace of +2.7% for the first quarter, below the +3.0% level expected, bringing the year-over-year gain to +1.1%, as growth in Q4 was revised down substantially to an annualized level of +2.1%. Nonfarm productivity in the first quarter gained +0.7%, yet still fell below expectations calling for +0.9%; however, prior quarter revisions were a positive +0.4%. Market Notes

Market Notes

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U.S. stocks were mixed, with large caps falling slightly after bouncing back later in the week, while small caps gained more ground to enlarge their lead for the year. A key sentiment factor appeared to be the upcoming deadline for waivers on certain tariffs—fears were calmed later in the week. Technology led with gains over +3%, led by Apple’s results, followed by flat results for energy and materials; health care and telecom brought in the rear. Health care results were hampered by more talk about drug price regulation.

Foreign stocks achieved positive results in local terms in Europe and the U.K., due to positive earnings growth reports, although the pace of economic growth in the Eurozone weakened, which could keep hopes alive for extended stimulus—however, a stronger dollar pulled returns into the negative. Japanese stocks lost ground slightly on a holiday-shortened week. Emerging market equities were negative in both local and USD terms, led by declines in Brazil, Mexico and Turkey—some of which was centered on U.S.-China trade uncertainty.

U.S. bonds were flattish on the week, as the yield curve flattened slightly, with short rates rising a bit in keeping with continued expectations for a June Fed move, while long rates ticked downward. Governments slightly outperformed investment-grade and high yield corporates, as spreads widened. Foreign bonds were similarly flattish in local terms, but the stronger dollar turned results into sharp losses; emerging market debt lost ground in both local and USD terms as spreads widened.

There is trouble in Argentina again. The equity market (now in ‘frontier’ status, a level below that of emerging markets), lost -10% on the week due to additional monetary problems, and the peso currency continuing to lose ground to the dollar. This has been an evolving issue, starting with the rollout of a new tax on central bank debt held by non-residents that went into effect in April. This, coupled with a +3% rise in the U.S. dollar, has created a sell-off in pesos to the degree that the Argentinian central bank has needed to drain a substantial amount of their foreign reserve stock to sustain the currency’s value. Last week, policymakers also hiked short-term rates to 40% in an attempt to bring inflation back toward the eventual central bank target of sub-15% (right now it’s at 25%). While hopes for change continue with the new presidential regime, old problems, such as high inflation and pockets of inefficiency, continue to make for a challenging environment for investors. This becomes relevant more directly, as many active emerging market debt managers have bought into the story that conditions have changed, so hold fairly sizable chunks of Argentinian bonds.

Real estate gained over a percent in the U.S., beating out Asia and Europe, which suffered under the weight of a stronger dollar.

Commodities indexes gained, led by strength in energy and industrial metals, despite the usual headwind of a stronger dollar. Crude oil prices initially declined but ended the week over +2% higher, to $69.72/barrel. Interestingly, speculation has surrounded Saudi Arabia’s desire to push prices higher in order to fund domestic economic reforms; however, other research has shown that higher oil prices are more likely due to the less-dramatic reason of a seasonal drawdown in inventories.

Sources: FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, PIMCO, Standard & Poor’s,, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends. Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness. All information and opinions expressed are subject to change without notice. Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product. FocusPoint Solutions, Inc. is a registered investment advisor.

Notes key: (+) positive/encouraging development, (0) neutral/inconclusive/no net effect, (-) negative/discouraging development.

Additional Reading

Read the previous The Weekly Review for April 30, 2018.

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