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Weekly Review - April 10, 2017

Weekly Review - April 10, 2017

Guest Post - Monday, April 10, 2017


Economic reports for the week came in mixed, with slightly weaker ISM manufacturing and non-manufacturing data, although both remained strongly expansionary. While the ADP employment report was quite strong, the government nonfarm payrolls report was far less so, while the unemployment rate declined.

Equity markets were mixed with flat to lower results in the U.S., with large-caps holding up much better than small, and better results from emerging markets than developed. Bonds gained a bit with interest rates ticking downward a bit, but foreign assets of all kinds held back by a stronger dollar. Commodities edged upward along with higher prices for crude oil.

Economic Notes

(0) The ISM manufacturing index fell a half-point for March to 57.2, generally in line with expectations. However, several underlying components fared better, with employment and new export orders both rising. New orders and production declined, but remained at levels in the upper 50's to mid-60's, which is considered quite strong. This index continues to point to expansion, with the good news being its historical correlation to economic and equity market growth, despite manufacturing being a much smaller component of the economy than it once was.

(-) The ISM non-manufacturing index for March fell -2.4 points to 55.2, which underperformed the 57.0 level expected. New orders, overall business activity and employment all lost ground, as did prices paid, but all remained in expansionary territory. New export orders, on the other hand, rose several points to above 60. Despite the decline, the over-50 level still points to overall expansion in the segment.

(+) The final February trade deficit narrowed by -$4.6 bil. to -$43.6 bil., which was tighter than the -$44.6 bil. level expected. Real goods exports ticked up by a few tenths of a percent, due to a +12% rise in exported petroleum; real goods imports declined by -3%. A weaker dollar in the early part of the year likely helped these statistics, since this can boost exports. There also could have been some effect from the timing of the Chinese New Year.

(0) Factory orders for February rose by +1.0%, which was on target with forecast; in addition, January orders were revised up by several tenths of a percent. Durable goods orders were revised higher to +1.8% for the month; manufactured goods inventories were also revised higher.

(0/-) Construction spending for February rose +0.8%, which was below the anticipated +1.0% increase, although prior months were also revised higher. Private residential construction rose +2% while non-residential declined by several tenths of a percent. On the public side, investment gained over a half-percent, led by residential housing construction.

(+) The ADP employment report for March came in strong at +263k, compared to a forecasted +185k. On the negative side, however, the February results were revised downward by over -50k. This is the drawback in less precise employment measures with a high degree of possible statistical error. For March, service employment, as usual, led the way with job gains in professional and business services, leisure/hospitality and healthcare; education jobs declined, however. Good-producing jobs also grew, in both construction and manufacturing.

(+) Initial jobless claims for the Apr. 1 ending week fell by -25k to 234k, which was far below the 250k expected. Continuing claims for the Mar. 25 week fell by a similar -24k to 2,028k, which was a touch below the 2,030k expected. It appears that states in the Midwest and Mid-Atlantic areas affected by recent winter storms were those that bounced back most quickly. All-in-all, claims levels continue to run very low and point to minimal layoff activity.

(-) The big government employment situation report for March came in weaker than expected, a bulk of which appeared to be weather-related, due to some severe conditions for part of the country during the month. (Interestingly, it seemed several million American workers were unable to work a full work week due to bad weather—the largest number of reports of this happening since 1976. So, no doubt it played a key role.) From a macro view, the lower payrolls number may be an anomaly, although there is very wide room for error in the initial data release. If taken at face value, the lower payrolls number could keep the Fed somewhat dovish, while the lower unemployment rate would be more of a hawkish signal—both generally appear to offset each other on net this month.

Nonfarm payrolls rose by +98k, which was far below expectations calling for +180k; in addition, earlier months were revised down by nearly -40k. Goods-producing segments fell off quite a bit from the prior month, adding +28k jobs, mostly in manufacturing and mining/logging (which includes the energy extraction industries), while construction fell off, in keeping with the weather effects. Jobs in service industries were the largest portion, as they typically are, the pace declined to +61k—business services experienced solid gains, but results were led by far weaker performances from education/health, leisure/hospitality and retail.

The unemployment rate fell by -0.2% to 4.5%, in contrast to expectations for no change at 4.7%, which was a decent improvement considering minimal change in the labor force participation rate. The U-6 underemployment measure also fell from 9.2% to 8.9%, which is a low for the recovery. The household survey measure showed a gain of +472k jobs, on par with the previous several months, showing a bit more strength than the nonfarm payrolls figure. Average hourly earnings rose +0.2%, which was on target with median forecast, and brought the year-over-year change down a bit to +2.7%. Average weekly hours were flat at 34.3.

(0) The March FOMC meeting minutes didn't contain a lot of surprises in terms of tone, but was more optimistic in terms of economic conditions (activity expanding at a moderate pace), elevated consumer sentiment and potential gains from fiscal policy. At the same time, several members did not that equity valuations were 'quite high', at least based on metrics they were using. The one area it did surprise investors somewhat was with the broader-than-expected coverage of one topic—normalization of the Fed's balance sheet (discussed in more depth below).

(0) The March FOMC meeting minutes didn't contain a lot of surprises in terms of tone, but was more optimistic in terms of economic conditions (activity expanding at a moderate pace), elevated consumer sentiment and potential gains from fiscal policy. At the same time, several members did not that equity valuations were 'quite high,' at least based on metrics they were using. The one area it did surprise investors somewhat was with the broader-than-expected coverage of one topic—normalization of the Fed's balance sheet (discussed in more depth below).

Read the "Question of the Week" for April 10, 2017

What does the Fed mean when it talks about reducing its balance sheet?

Market Notes

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U.S. stocks came in a bit lower on the week for most indexes, with large-caps losing less ground than small-caps. Volatility picked up a bit with U.S. missile strikes in Syria (which pushed oil prices higher), Trump's meeting with Chinese leadership, and comments from Speaker Ryan and others about the increasing potential timetable for tax reform and frustration with lack of progress. A mixed jobs reports added some volatility towards the week's end as well, in addition to the uncertainty surrounding the Fed's balance sheet as noted in the released FOMC minutes—as discussed above. With a gain in oil prices, energy stocks experienced the strongest gains, followed by materials; consumer cyclicals and technology ended up as the only losing industries for the week.

Interesting Fed news surfaced that Jeffrey Lacker, President of the Richmond Fed, had leaked sensitive information in 2012 about the Fed's stimulus plans to an analyst. No charges are expected, but Lacker resigned. As a non-voting FOMC member this year, this doesn't play a role in Fed policy, but this could bring more scrutiny by Trump and others who want more Fed accountability and moves to a more 'systematic' process.

In foreign markets, emerging market stocks performed best in local terms, followed by flattish results in Europe and negative returns from Japan. A stronger dollar generally took all returns lower, with the exception of Japan, where the dollar weakened. Chinese stocks gained as it appeared foreign currency reserves rose again, as outflows seem to have subsided.

U.S. bonds were largely flat to slightly positive as interest rates ticked downward a bit, after a round of some volatility later in the week, where the 10-year Treasury fell below 2.3% before reflating higher. Longer treasuries fared slightly better in that environment, with investment-grade governments and credit performing similarly, as did high yield. Safe haven assets such as treasuries have tended to fare well under news of military action, in conjunction with a frequent sell-off in riskier assets.

Foreign bonds in developed markets gained some ground due to a flight to quality in areas such as Germany, but were negatively affected by a strong U.S. dollar, which gained nearly a percent. This also pushed USD-denominated emerging market bonds higher, but negatively affected local debt.

The big news of the foreign market this week was a major downgrade in the debt/currency of South Africa by S&P, from investment-grade to below-investment grade (BB+), while Moody's kept the rating just a notch into investment-grade. These dramatic changes were set in motion by recent cabinet reshufflings and political uncertainty—all of which can cast doubt on the ability or willingness to pay outstanding sovereign debt (even if still likely more than not). This is one of the larger nations in the emerging market space, and the issue with such a downgrade is that buyers who are typically forced to only operate in investment-grade debt can be forced to unwind positions when this occurs, exacerbating the pricing problems. At the same time, it is a reminder that EM nations are still often wildcards, with very unique, hard-to-predict risks.

Real estate generally fared well, with gains domestically around the one-percent range and a bit better abroad.

Commodities experienced a solid week, with the energy sector leading the way, followed by precious metals which also rose. West Texas crude gained a few dollars to about $52.25, which represented roughly a 3% increase, due to reports of stronger refinery demand and U.S. missile attacks on Syria. Historically, any military action in the Middle East has boosted oil prices (and precious metals to a certain degree) due to a 'conflict premium' of sorts, and is one of the reasons commodities are a useful diversifier in a portfolio. Gains there offset losses in agriculture and industrial metals on net.

Sources: FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger's, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder's, Standard & Poor's, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research. 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 Weekly Review for April 3, 2017.

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