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Weekly Review - August 1, 2016

Weekly Review - August 1, 2016

Guest Post - Monday, August 01, 2016


Economic data for the week was highlighted by no policy action at the FOMC meeting, while GDP for Q2 underwhelmed compared to expectations. Housing numbers were relatively good with home sales reaching pre-recession levels.

U.S. equity markets were mixed, and were outperformed by foreign developed stock indexes which benefitted from a weaker dollar for the week. Bonds generally gained some ground with lower interest rates. Commodities fell as the price of crude oil fell to 3-month lows based on stronger inventories.

Economic Notes

(0) As summarized in the mid-week note, the FOMC decided to keep rates on hold, which was of no surprise to markets. Probably the one surprise, if there was one, was the more 'optimistic' tone of the group, alluding to near-term risks diminishing (likely those due to Brexit) and the outlook as 'balanced'. Consequently, the threshold for raising rates has fallen again, making the case for Sept. or Dec.; however, there is a significant camp of economists who feel growth is so fragile that a rate increase isn't best explored until next year or beyond. Once again, this remains a month-by-month data assessment, but the FOMC is certainly in no hurry.

(-) The advance estimate of U.S. GDP for the 2nd quarter came in at a seasonally-adjusted annualized +1.2%, which was small improvement on the +0.8% gain in Q1 (revised down from +1.1%), but well short of the median +2.5% economist forecast. High points included personal consumption of durable and non-durable goods, which rose +7%; consumption of services also grew by +3%. On the low side, gross private domestic investment fell by -10% (the private fixed investment decline as part of this was the most dramatic drop in 7 years). The decline in investment subtracted substantially from GDP, as did a drop in inventories. The core PCE inflation measure rose +1.7%, which was spot on with expectations. This was the time for annual GDP revisions, in a continual fine-tuning of data, which resulted in overall GDP being adjusted higher for 2013, 2014 and 2015 by +0.2% (to +1.7%), +0.3% (to +2.4%) and +0.5% (to +2.6%), respectively.

As noted, this report was a surprise to some economists who believed the investment side would have looked better, but overall is very much in line with recent tempered trends of low growth and bifurcation by segment—consumer spending isn't bad, but capex spending appears to be extremely light (this can be a self-fulfilling prophecy as slow growth doesn't instill confidence for businesses to proceed with expansion plans). Some of this was naturally energy price-related, but a fair amount is not, with political uncertainty grabbing the headlines as of late as an excuse to keep expansion plans in check. Interestingly, growth projections for Q3 remain wide, in the 1.0-2.5% area, with a tilt to the higher side of this range due to expectations for inventories to recover.

(+) The Chicago PMI for July declined from 56.8 to 55.8, which was a smaller decline than expected, and keeps the index solidly in expansionary territory. The drop was almost entirely due to new orders, while production and order backlogs fell to a far lesser degree and employment improved. In other areas of the survey, inventories remained at manageable levels, inflation appear to remain at bay and few respondents expected much impact from Brexit. Overall, this is a positive report and bodes well for manufacturing, which has seen some spotty results in recent months.

(-) Durable goods orders for June fell by -4.0%, which disappointed relative to an expected -1.4% drop. The majority of the drop was due to a decline in the often-lumpy transportation equipment segment, which fell by -60% due to a weak month for Boeing aircraft orders. Excluding this piece, however, the core number showed a gain of +0.2%. Core durable goods shipments fell by -0.4%, which was the opposite result of the expected +0.4% increase for the month, and continued a weaker trend as of late. Additionally, durable goods inventories fell -0.2%. All-in-all, the report is in keeping with generally challenged U.S. manufacturing activity.

(0) The S&P/Case-Shiller home price index for May ticked down -0.1%, in contrast to an expected +0.1% increase. For the month, Portland was the largest gainer at +0.7%, while San Francisco lost just over a percent. At the same time, seasonality adjustments appear to have played a role in recent month-to-month results. Perhaps more importantly, year-over-year, the index is up +5.2%, which is little changed from the trend of recent months and represents prices moving along at a healthy clip. No doubt some of this pace is due to lighter inventories.

(+) New home sales for June rose +3.5% to 592k, which represents the third-straight month of strong data and the highest level since early 2008 on a seasonally-adjusted basis, outperforming the expected decline of -2%. The report also included upward revisions for prior months, which was a positive. Regionally, the West and Midwest experienced gains, while the Northeast and Southern U.S. declined slightly. Inventories fell a bit from 5.1 months supply to 4.9.

(-) Pending home sales for June rose +0.2%, which was less than the expected +1.2% gain. Regionally, the Northeast gained +3%, followed by +1% in the Midwest, while the West and South experienced declines for the month. Year-over-year, the pending sales index is +0.3% higher. As the index tracks home purchase signings, its value lies as a precursor to existing home sales results a few months following.

Interestingly, a separate government report on U.S. home ownership and rentals showed that the home ownership rate fell to 62.9%, which is the lowest level since the report was created in 1965; however, the increase in renters appears to be more of a driver than an actual decrease on the ownership side.

(0) The final University of Michigan consumer sentiment index release for July moved slightly higher by +0.5 to 90.0, which was just under the 90.2 expected. Consumer expectations for the future rose slightly, as did their assessment of current conditions. Inflation expectations for the coming 5-10 years were flat at 2.6%.

(+) The Conference Board consumer confidence index ticked down by -0.1 point to 97.3, but was still better than the 96 level expected by consensus and remained within a general range of where it's been over the past year. While the current conditions component improved, the forward-looking expectations piece worsened by just over a point (we wonder how much political conventions play into this element). The labor differential, which measures the ease in finding employment, ticked up a bit back into positive territory.

(0) Initial jobless claims for the Jul. 23 ending week ticked upward to 266k, a gain of +14k, and +4k more than expected. Continuing claims for the Jul. 16 week came in at 2,139k, which was just +3k higher than anticipated. Planned summer auto plant shutdowns are likely still influencing the figures a bit—the increases over the week largely originated from CA and MI. Overall, claims levels remain low and indicative of decent labor market conditions.

Market Notes

Period ending 7/29/2016

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U.S. stocks were mixed with large-caps down slightly, but small caps ended higher. Technology stocks rose +1.5% on the week, with positive earnings reactions from Alphabet/Google, Apple, Amazon and Facebook (the latter of which was told it owned billions in back taxes); health care also earned positive returns. Laggards included energy, with falling oil prices, and consumer staples. Earnings results haven't been outstanding, but have beaten expectations, which has helped stock prices retain their momentum. Revenues are also weak, but may actually end up positive year-over-year, which has been a bit of a surprise on the upside and hasn't happened since Q4 of 2014.
Foreign developed market returns in Europe and Japan were slightly positive, but a weaker dollar translated these returns to several percent higher for U.S. investors. Interestingly, U.K. GDP growth for Q2 improved to +0.6%, a few tenths better the prior period, and calmed some fears about slowing post-Brexit momentum which could affect the timing and magnitude of any central bank policy response.

Results of the 51-bank European stress test came out after the close Friday, with some banks performing better than others. All banks but one 'passed'; the exception being the world's oldest bank, Banca Monte dei Paschi di Siena, which showed a loss of tier 1 capital under a simulated adverse economic scenario. As we've discussed, Italian banks have been pressured with high debt levels and worsening loan performance metrics, which will likely require a bailout at some level. (For Banca Monte, this wouldn't be the first time help was needed, as losses from over-expansion just a few years ago required a bailout package from the Bank of Italy, and it's also failed prior stress tests—so the outcome was in line with expectations.)

The Bank of Japan announced further stimulus. This was largely expected, but base monetary policy through interest rates was left unchanged, with rates already being at negative levels. Instead, the BOJ will be ramping up purchases of exchange-traded fund assets from ¥3.3 tril. to ¥6 tril. (about $60 bil.) a year. This appears a bit unconventional, but further BOJ statements alluded to the need to remain flexible due to a worsening growth situation, and analysts have noted that further buying of traditional government bonds could be limited due a lack of available supply, hence, the focus on ETFs and other financial instruments, like equities and REITs. Debate continues about the effectiveness of these measures, due to the sole focus on inflation. A few other metrics in Japan, such as employment, are in decent shape, but like the U.S. in a more extreme sense, there is a large demographic headwind impeding growth. A persistently strong yen, which has acted in opposite fashion to what many would expect with Japan's low growth and low rate situation, has also challenged the economy as a headwind to exporters.

U.S. bonds fared well on the week as interest rates declined again, back under 1.5% for the bellwether 10-year treasury note. Markets were no doubt reassured by the lack of Fed action, but likely more so by the weak GDP report, which cast doubt upon the probability of near-term rate increases. Although all bond segments generally experienced gains to one degree or another, long duration debt outperformed short. Foreign bonds gained similarly to U.S. issues in local terms, but a -2% decline in the dollar boosted USD-denominated returns, although this was more pronounced in developed markets than in emerging markets.

Real estate earning positive returns globally, with half-percent gains or so in the U.S. and better abroad, with the impact of a weaker dollar. European REITs and U.K. REITs outperformed Japan, although all ended the week strongly.

Commodities lost ground on the week, led by a -6% decline in crude oil back to the $41-42/barrel range (a 3-month low) as oversupply concerns have again come to the forefront. Interestingly, this represents close to a -20% 're-correction' in oil prices back from recent highs in the $50 range. Natural gas, on the other hand, gained +8% in one day during the week, with stockpiles coming in lower than expected—the opposite of the situation with oil. Precious metals, mostly in silver, saw gains on the week due to falling rates and a weaker economic outlook.

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 July 25, 2016.

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