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Weekly Review - August 7, 2017

Weekly Review - August 7, 2017

Guest Post - Monday, August 07, 2017


Economic data for the week was dominated by the employment situation report, which surprised on the upside. The ISM manufacturing and non-manufacturing indexes both declined, but remained solidly expansionary.

Equity markets gained globally, as did bonds to a certain degree with lower interest rates on the longer part of the yield curve. Commodities declined slightly, despite little net change in oil prices during the week. Overall, low volatility conditions in stock and bond markets continue.

Economic Notes

(0/-) The ISM manufacturing index declined -1.5 points in July to 56.3, which disappointed by a tenth of a point. The composition of the report was also generally weaker, with new orders, production and employment all falling in similar magnitude to the overall index. Inventories gained, however, as did prices paid. While the ISM report has fallen off of its highs, the mid-50's reading remains solidly expansionary.

(-) The ISM non-manufacturing index for services fell -3.5 points to 53.9, the weakest number in a year and short of the little-changed 56.9 reading expected. Most key segments within the index declined, including new orders and business activity, with employment falling by a lesser degree, but all remained above the over-50 level, pointing to continued overall expansion.

(-) The Chicago PMI index fell by -6.8 points for July to 58.9, the lowest level in three months, but overall stayed in solid expansionary territory. New orders and production declined by the greatest amounts, while order backlogs, supplier deliveries and employment also fell to a lesser degree—however, all key areas remained solidly above 50, well into expansion. The special research question for the month was how wages had changed over the past year, with over 70% of employers noting they'd increased pay (most by just 1-2%, with 3-4% increases less common), while a quarter had kept pay unchanged.

(+) Pending home sales for June rose +1.5%, beating forecasts calling for a +1.0% gain and reversing a trend of declines for several months straight. Regionally, the gains were broad, with the West and South leading the way, over +2%, while the Midwest fell by a half-percent. This metric tends to follow existing home sales, so could be a positive sign for coming months.

(0) Personal income for June came in flat, contrary to a +0.4% gain expected, led by wage/salary income offsetting a drop in prior month dividend income, while personal spending came in near consensus with a +0.1% gain. This brought the personal savings rate down a tenth to 3.8%. The headline and core PCE price indexes were flat and up +0.1%, respectively, which brought the year-over-year gains to +1.4% and +1.5%.

(+) The final June trade balance report showed a narrowing of -$2.8 bil. to -$43.6 bil., tighter than the expected -$44.5 bil. Both goods and services showed strong improvement, with service exports at the fastest pace in several years.

(-) Construction spending for June fell -1.3%, which disappointed relative to an expected +0.4% gain. Private residential declined slightly while non-residential gained a tenth. Public spending fell by -5% overall, as both residential and non-residential declined for the period. The past year has been hallmarked by a drop in public spending in a variety of infrastructure areas, including power, sewage/waste and water, which has weighed on the overall index.

(0) The early 3rd quarter Fed Senior Loan Officer Opinion Survey showed little change in lending standards overall for commercial and industrial borrowers. Commercial real estate tightened a bit, and demand weakened; this contrasted with residential mortgages that experienced some easing in standards along with stronger demand. Consumer installment loan demand pulled back a bit in Q2 in the areas of auto and credit cards particularly, while the share of banks willing to make such loans pulled back a bit as well. Interestingly, those responding to the survey noted, per request, that current lending standards compared to 2005 were easier on the commercial and industrial side but a bit tighter on the real estate side.

(-) The July ADP employment report showed a private jobs gain of +178k, which disappointed somewhat relative to an expected +190k; however, there were solid upward revisions for prior months, including +33k for June. From an industry standpoint, service-employment led the way as always, in professional/business services up +65k, education/healthcare +43k and trade/transports/utilities +24k. Goods-producing sectors only created +4k net of jobs, with construction and natural resources gaining while manufacturing jobs declined for the first time this year.

(0) Initial jobless claims for the Jul. 29 ending week fell by -5k to 235k, below the expected 243k. Continuing claims for the Jul. 22 week, on the other hand, rose +3k to 1,968k, which was above the 1,958k level estimated. As is often the case during the summer, plant shutdowns, such as in the auto industry appear to be related to week-to-week fluctuations in claims. The continuing claims numbers hit extremely low levels earlier in the year but have drifted upward a bit since that time, while remaining low overall.

(+) The employment situation report for July came in stronger than anticipated. Nonfarm payrolls ended up at +209k, stronger than the +180k expected, with minimal revisions to prior month data. Goods-producing employment was higher by +22k, with service industry employment rising by +183k, led by leisure/hospitality, education/healthcare and professional/business services. Areas of note were a small gain for retail, up only +1k, and decent gains for construction and government jobs.

The unemployment rate fell a few hundredths of a percent, at least enough to take the rounded result down from 4.4% to 4.3%, matching a 16-year low level, and making the change appear more dramatic than it really was. The labor force participation rate rose a tenth to 62.9%, which helped create the result. The U-6 measure of underemployment was flat at 8.6%. Interestingly, other data showed a decline in the share of voluntary job departures, however.

Average hourly earnings gained +0.3% for the month, matching expectations, and bringing the year-over-year rate of change to +2.5%. This is above the rate of recent inflation, but still disappointing somewhat to economists wanting stronger wage growth. Average weekly hours were flat at 34.5.

Market Notes

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U.S. stocks rose, with continued decent Q2 revenue and earnings reports. The mega-cap Dow Jones Industrial Average was the best performing stock index, reaching another round number milestone at 22,000, with good reports from several individual members such as Apple (it's only a 30-stock index, as opposed to 500). Overall, decent stock earnings were the primary driver, with a lack of other geopolitical or other events during the week to move the needle. From a sector standpoint, financials and utilities led the way, while energy and materials lost the most ground for the week.

Volatility continues to trail along at low levels, especially so, even for light summer trading sessions. Interestingly, year-to-date, investors have pulled $11 bil. out of U.S. equity funds (with some of this going towards foreign equities, granted), while adding $210 bil. to taxable fixed income. Skepticism continues surrounding the durability of equity markets, which higher valuations likely have a role in; however, sentiment has never reached the 'exuberant' stage at any time during this recovery.

Foreign stocks generally outperformed the broader U.S. market, with developed areas outperformed emerging. European stocks were similarly helped by earnings growth improvement, which have come in over +10%, which slightly better than that of U.S. stocks.

U.S. bonds gained a fraction of a percent overall, as rates ticked down at the longer end of the yield curve. As a result, longer treasuries outperformed credit slightly, while high yield returns were just above zero. A slightly stronger dollar was a headwind to foreign bonds, which still ended with minor gains in line with U.S. bonds—developed outperforming emerging for the week. The Bank of England left interest rates unchanged, as expected.

The most recent emerging market crisis is unfolding in Venezuela, with difficult economic conditions and attempts at consolidating political power are resulting in violent anti-government protests. The nation earns over half its annual revenue from petroleum, so economic conditions there are even more closely tied to energy market prices than Russia or similar commodity-dependent nations. When times were good, the fatter coffers were spent at an unsustainable rate, including social programs to keep the government in the public's good graces; of course, as oil prices collapsed, this put the nation into a cash crunch and persistent depression characterized by high inflation and essential food/consumer good shortages. Cash reserves have been dwindling for some time, which has called into question the possibility of foreign debt default. It's also been a strong performer this year, and a hedge fund favorite. However, many active managers have been anticipating a negative scenario, and have avoided the nation's debt despite its cheap price and high yield (as default risks have been steadily rising in keeping with these falling reserves). Nevertheless, Venezuelan debt remains at about 2-4% of emerging market bond indexes (weighting dependent on the index used), so is a component of many ETFs tracking that asset class. There is certainly more to come, as default doesn't mean the end of the road for bondholders—recoveries would offset any losses, but are also dependent on the political environment. It's important to remember that foreign governments, despite self-serving rhetoric and obstinate behavior, consider foreign debt repayments among their highest priorities (along with staying in office). If a country is violates one or several of the big 'C's', it can be locked out of bond markets for some time and/or be forced to pay an exorbitant interest rate on new debt, so there is incentive for positive outcomes. On the positive side, there is far less concern over carryover of this crisis to other Latin American nations, which have stronger fundamentals than they did decades ago during similar scenarios.

Real estate lost a fraction of a percent overall in the U.S., but returns were positive in Europe and Asia, in keeping with recent trend. Domestically, malls and retail gained sharply in a bit of a recovery, as did mortgage REITs, while apartments and health care struggled.

Commodity indexes lost about a half-percent, with slight declines in energy (due to natural gas more than crude last week), coupled with drops in wheat, soybeans and silver, while industrial metals and softs fared well—in one of the more divergent weeks recently. Oil was generally flattish on the week, for a change, with West Texas crude ending at $49.58, near where it started.

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 31, 2017.

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