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Weekly Review - August 10, 2015

Weekly Review - August 10, 2015

Guest Post - Monday, August 10, 2015

Summary

  • Economic data for the week was generally decent, with the ISM manufacturing and non-manufacturing reports showing expansion, an improved willingness of bankers to lend, and a jobs report generally on par with expectations—showing continued growth in a variety of areas.
  • Equity markets in the U.S. fell with a few mediocre earnings reports and fears of a Fed rate hike sooner than expected. Bonds were oddly mixed, with results dependent on yield curve status. Crude oil continued to struggle, with lower pricing on the week, which brought down commodity markets overall.

Economic Notes

(-) The ISM manufacturing report for July came in at an expansionary 52.7, a bit weaker than the expected 53.5. However, the underlying components were relatively mixed, with production and new orders improving, while inventory and employment falling off more dramatically (although the employment portion still showed expansion

(+) The ISM non-manufacturing 'services' report rose +4.3 points to 60.3 for July—its strongest showing in 10 years—beating expectations calling for a still-good 56.2. Every major component of the index improved, including employment, new orders, export orders and overall production/business activity. It’s hard to take too much from a single month, but trends have favored broader strength in areas such as health care and media, as the segments continue to take on more and more economic importance.

(+) New motor vehicle sales rose to 17.46 mil. seasonally-adjusted annualized units, which was better than the 17.25 mil. expected. This represented a +6.5% gain on a year-over-year basis, and, in fact, was the strongest trailing 12 month period in nine years.

(+) Personal income for June rose +0.4%, which was a tick better than expected. Spending was on target, at +0.2% growth. The headline and core PCE price indexes rose a similar +0.2% and +0.15% for the month, which brought the year-over-year changes to +0.3% and +1.3%, respectively. The latter were another indication of very little inflationary pressure.

(0) Construction spending for June rose +0.1%, defying expectations of a +0.6% gain. However, some earlier months were revised upward meaningfully to skew the comparison (reminding us to keep these month-to-month economic data releases in perspective). The net effect is a possible upward tweak to Q2 GDP as those fixes are factored in.

(-) Factory orders for June rose +1.8%, which just fell short of the +2.0% gain forecasted. The underlying number was helped by a +9% gain in transport equipment, while the non-durable goods portion rose just short of a half-percent. There were some other revisions, accounting for a few tenths here and there for a prior month, but these weren’t overly substantial.

(+) The Fed Senior Loan Officer Survey for the 3rd quarter showed easier/loosened lending standards across both commercial and industrial loan segments, as well as stronger demand from a variety of potential borrowers. Commercial real estate loan standards tightened in some areas (land and development) but loosened in others (non-residential as well as multi-family residential), and demand remained high across the board. Mortgage loan standards continued to ease as well, and demand showed continued strength—not only on the prime side but, interestingly, also in sub-prime as well. After hitting a low point earlier this year, supply and demand for consumer installment loans—including auto and credit card—also showed demand gains.

This is perhaps more important of a survey than is let on, as it's not often in the headlines, but does provide an interesting periodic perspective of lending standards from those making the decisions. Stats have been especially interesting in recent quarters/years due to the tempered level of additional leverage being taken on by both consumers and businesses post-recession. While it is assumed that some of this is reluctance from the borrower side in taking on additional debt, it was also a tightening of standards from lenders. This is particularly the case in mortgages, where there's been a natural lender reluctance to being burned again, although they're fighting the last war (sources of credit trouble seem to change from cycle to cycle). Some of this appears to be turning around, although housing continues to be subject to other hurdles, such as millennials' reluctance to leave their parents' basements, and, when they do, to rent for a longer period of time as opposed to buy. Housing/mortgage demand remains below (at perhaps 2/3 or so) where it likely needs to be in order to keep pace from a long-term demographic growth standpoint.

(-) The June trade balance widened by about -$3 bn. to -$43.8 bn.—just a bit worse than expected. Much of this was in the non-oil area. In total, imports rose +1.2%, while exports fell a tenth.

(-) The July ADP employment report of private payrolls showed a rise of +185k jobs, which fell short of the +215k expected. In the major categories, trade/transport/utilities jobs slowed to +25k.

(+/0) Initial jobless claims for the Aug. 1 ending week ticked up by +3k to 270k, which was still -2k below expectations. Continuing claims for the Jul. 25 week fell a bit to 2,255k, which ended up a bit higher than consensus expectations of 2,249k. No special factors were reported by the Dept. of Labor, but weekly results of the past few weeks were likely distorted by auto plant shutdowns that tend to occur during summer.

(0) The government employment situation report wasn't bad, and offered few surprises compared to expectations. Nonfarm payrolls rose +215k for July, which fell short of the +225k anticipated; however, some upward revisions of +14k for prior months brought these closer in line with overall expected levels. Job gains were seen primarily in retail trade (+36k), health care (+28k) and professional/trade services (+27k), while manufacturing added +15k. Services continue to be a key jobs driver.

The unemployment rate was unchanged at 5.3%, on par with consensus and about a percent lower than last year at this time (a -15% decline), and a -27% decline from the 7.3% level two years ago. While improvement has leveled off in recent months, conditions inch toward that theoretical place of 'full' employment, so incremental improvements have been increasingly more difficult to come by. The U-6 measure of 'underemployment' fell a tenth to 10.4%—its lowest level since mid-2008—driven by a drop in involuntary part-time work due to economic conditions. The labor force participation rate stayed at 62.6%, which is a cyclical low point for the series. Other labor stats were mixed. Average hourly earnings rose +0.2% for July, on par with expectations. The average workweek ticked up a tenth to 34.6 hours, which was a positive. While it appears small, economists have equated such an increase to a ~3% gain of GDP growth.

Wage growth is one area that has remained tempered in this recovery thus far. While the relationship isn't always well-correlated between wage growth and inflation in the shorter-term, it is used by the Fed in determining how much 'slack' is left in labor markets. Naturally, as labor markets tighten, demand for labor begins to even out with supply, allowing employees better bargaining power with wages—so this tends to be one of the later pieces of the puzzle to come together. As it stands, it appears the continuation of labor market improvement could be in line with Fed tightening as planned.

Market Notes

Period ending 7/10/2015

1 Week (%)

YTD (%)

DJIA

-1.65

-1.10

S&P 500

-1.18

2.14

Russell 2000

-2.54

0.90

MSCI-EAFE

-0.54

7.13

MSCI-EM

-1.84

-7.45

BarCap U.S. Aggregate

0.06

0.65

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2014

0.04

0.67

1.65

2.17

2.75

7/31/2015

0.08

0.67

1.54

2.20

2.92

8/7/2015

0.06

0.73

1.59

2.18

2.83

U.S. stocks ended slightly lower on net, with disappointing earnings results and pressure from oil markets. Expectations for the Friday labor numbers played a role, as did comments from a FOMC member suggesting economic data was strong enough to support a September rate hike (earlier than some had hoped

From a sector standpoint, defensive utilities actually gained a percent and outperformed, while energy and consumer discretionary lagged. Some of the ‘glamour’ stocks of the recent period, including the edgier part of biotech, cybersecurity and issues like Tesla. At the same time, high expectations from blue chips Apple and Disney are being downgraded (due to lower growth targets in China in some cases), creating some negative carryover in sentiment.

Abroad, equities in key areas such as Japan, continental Europe and the U.K. all gained, despite some negative influences of the dollar, which trimmed returns for U.S. investors. The British central bank left rates unchanged, despite some calls for action upward, considering higher wage growth and improved economic conditions. Even China fared well (especially local A shares), despite a sub-50 PMI report, which implies additional government stimulus help to stabilize conditions. In other regions, Brazil also suffered under the scope of a broadening corruption scandal, as did commodity-sensitive regions Australia, Russia and Canada. The reopening of the Greek stock market was disastrous (-30%), with several banks suffering horrendous losses—several of which were capped at daily loss limits. Interestingly, this was one instance where ETFs provided a useful ‘price discovery’ function, as U.S.-listed GREK continued to trade while the Greek market remained closed. This naturally led to some mismatches in fair valuations, since no one had any idea what Greek valuations would look like when markets reopened, but allowed the expression of ‘views’ in the interim (interestingly, GREK amended its prospectus to deal with this issue—allowing for accounting ‘estimates’ of fair value in such cases). The result was the ETF experiencing their big decline before local Greek markets did (which probably would have if they could at the time).

U.S. bonds performed oddly, with lower rates in the cash portion of the curve, higher rates in the middle, and lower rates on the long end. Consequently, long governments gained a few percent, bringing their year-to-date returns to just over zero, high yield bonds lost ground, while most other areas were little changed as a whole. High yield bond indexes have been affected negatively by further declines in energy prices, which affect credit quality of some of the more challenged members of that sector. Developed market foreign bonds were little changed in local currency terms, but lost additional ground due to a stronger dollar. Emerging market spreads widened, resulting in negative returns. This was particularly the case in Brazil, where scandal probes have intensified, affecting pricing of both equity and fixed income markets.

Real estate indexes in the U.S. were generally flat, while Japan and Europe gained. On the negative side, both domestic lodging/resorts and mortgage REITs suffered. This year has been a mixed bag so far, largely reflecting index composition and as a byproduct of M&A activity in the fairly concentrated asset class. Based on recent manager conversations, conditions have continued to demonstrate moderate strength, as tenant demand has grown alongside moderate economic growth—yet to show broad signs of overheating. The supply side—one which we watch closely as this has been a bellwether for any ‘exuberance’ building up (literally as construction cranes everywhere you look at peaks of past cycles)—has remained low with a few exceptions in selected urban pockets. Recent interest rate uncertainty has again pushed broader indexes from near ‘fair’ to again discounted valuations to some extent.

Commodities continued to deteriorate on the week, led by crude oil falling another -7% to just under $44/barrel. Unleaded gasoline plunged by -10%, with other factors such as summer refining activity being a driver. The agriculture bucked the trend with higher prices of wheat and soybeans reacting to reports of higher-than-expected foreign demand, while gold came in flat.

Several energy/materials earnings calls have seen some ‘bottoming’ activity in terms of commodity pricing affecting business activity, and, at some point, and demand/supply balance may again find a sweet spot. However, for now, lower oil prices presumably due to high supplies but also challenged Chinese demand are punishing commodity markets. While this has lowered capex activity in the oil patch over the past year, as operations that were profitable at higher prices aren’t looking as attractive now, this appears to be tapering off somewhat (you can only shut down so many projects). We still seem to be getting used to these new pricing levels (assuming they stay put)—at some point, the damage will have been done and a new set point will have been found. At the same time, the benefits of low energy prices to consumers and businesses continue to be overlooked, which has left a few economists scratching their heads, although this effect can take several quarters to seep through.

Speaking of sentiment, the weekly American Association of Individual Investors survey is one that’s often looked to as a baseline for general market bullishness, bearishness, or neutrality (the latter being those who don’t know what to make of things in a given week—not typically the majority). Looking over recent weeks, we’ve seen this undecided camp grow to surpass the other two. This might not be a complete shock, as investors have grappled with cross-currents of slowly improving economic data in the U.S., albeit with rising valuations, along with geopolitical jolts from Greece and China. Not to mention the specter of rising interest rates. It should also come as no surprise that high levels of ‘bullishness’ accompany (rather, follow) recent strong stock market performance, and vice versa for ‘bearishness.’ As contrarians, an absence of excessive bullishness we see as a positive for risk assets.

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 August 3, 2015.

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