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Weekly Review - August 8, 2016

Weekly Review - August 8, 2016

Guest Post - Monday, August 08, 2016

Summary

Economic data for the week was highlighted by weaker than expected but still-expansionary ISM manufacturing and non-manufacturing reports, while the July employment situation report was much stronger than anticipated, pleasing investment markets.

Equity markets were higher in the U.S. and somewhat mixed globally. Government bonds declined with interest rates moving higher, with the exception of a high yield corporate, which gained. Commodities were mixed with oil little changed on the week on net.

Economic Notes

(0) The ISM manufacturing index for July ticked town to 52.6, just below the forecast of 53.0, but remained in expansionary territory. The key underlying components were generally stronger, however, as production rose nearly a point to the mid-50s, new orders were little changed, employment ticked down a point and supplier deliveries fell several points—accounting for the broader ISM decrease. The release was generally positive, compared to recent months of sporadic manufacturing activity.

(-) The non-manufacturing ISM index for July fell -1 point from the previous month to 55.5, disappointing a bit compared to the expected 55.9 reading. However, the index remained solidly expansionary. In the underlying data, new orders ticked upward a half-point to over 60; on the other hand, supplier deliveries, business activity and employment moved downward a bit.

(-) Construction spending for June declined -0.6%, compared to a forecasted gain of +0.5%. Additionally, some revisions for prior months were somewhat negative. During June, private non-residential spending declined over -1%, including manufacturing spending falling -5%, while public construction falling a half-percent, were major catalysts.

(0) Factory orders for June fell by -1.5%, which was a bit less than the anticipated -1.9%. Core goods shipments (used in GDP calculations) were revised upward, but inventories were revised down on both the durable and non-durable side. In general, this measure continues to be affected by weak activity in the oil/gas sector, although things have picked up there a bit over prior months along with a move higher in oil prices.

(0) Personal income for June rose +0.2%, aided by a gain in wages/salaries, but overall fell short of forecast by a tenth of a percent. Personal spending rose +0.4% for the month, which beat expectations by a tenth. On net, the personal savings rate fell to 5.3%, which is about a percent lower than it was a quarter ago. The headline and core PCE price indexes each rose +0.1% for the month, bringing year-over-year increases to +0.9% for headline and +1.6% for core inflation based on those particular metrics. There was little new here, with inflation continuing to track at low levels.

(+) The ADP employment report for July showed a gain of +179k, which beat the forecasted figure of +170k; additionally, the June figure was revised upward by +4k. Service jobs gained +185k in the month, with professional/business services and trade/transports/utilities accounting for major gains; on the negative side, goods-producing jobs fell by -6k (with construction a negative driver), which was the 4th consecutive month of decline for that group.

(-) Initial jobless claims for the July 30 ending week rose a bit to 269k, which was +4k higher than expectations. Continuing claims for the July 23 week came in at 2,138k, which was +8k higher than forecast. Based on the state-level data (Michigan, for example), it continues took like claims have been affected by seasonal-adjustment factors and summer auto plant shutdown activity.

(+) The employment situation report for July came in better than expected. Nonfarm payrolls grew by 255k, which was much larger than the forecasted 180k number; additionally, two prior months were revised higher by +18k. Job gains appeared to be decently balanced across industries, with gains of +201k in service-providing and +16k from goods-production. Business services (+70k), leisure/hospitality (+45k) and manufacturing (+9k) were among the leaders, as was government employment, which gained +38k.

The unemployment rate was flat at 4.9%, despite an expected drop by a tenth of a percent, and the labor force participation rate rose a tenth to 62.8%. The U-6 measure of underemployment ticked upward by a tenth of a percent to 9.7%. The household survey, tabulated differently from the nonfarm payroll number, showed a gain of +420k gain in jobs, which was another sign of strength. Average hourly earnings rose +0.3%, which was a tenth higher than expected. This brought the year-over-year change to +2.6%, which is a pace just higher than inflation. Average weekly hours rose a bit to 34.5.

Accordingly, strong headline data like this raises the probability of Fed action in September, although it's still not anywhere near a 50/50 proposition, according to the opinion of many economists. Month-to-month employment numbers, while reacted to strongly by markets, have a great deal of embedded room for error, so watching trends in multi-month data is more important. Year-over-year, private sector job growth has been slipping from 2.6% in late 2014 to 1.9% currently, so the general improvement in labor appears to be slowing.

Market Notes

Period ending 8/5/2016

1 Week (%)

YTD (%)

DJIA

0.65

8.07

 

S&P 500

0.49

8.19

Russell 2000

0.96

9.35

MSCI-EAFE

-1.35

-0.94

MSCI-EM

1.38

11.51

BarCap U.S. Aggregate

-0.52

5.43

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2015

0.16

1.06

1.76

2.27

3.01

7/29/2016

0.28

0.67

1.03

1.46

2.18

8/5/2016

0.28

0.72

1.13

1.59

2.32

U.S. stocks ended positively on the week, buoyed by the strong employment report on Friday that lifted investors' spirits. While large-caps reached new record highs again, small-caps reached new highs for the year but have yet to surpass their peak from 2015. Financials and technology gained the most ground, while utilities declined sharply. Certain defensive sectors with high dividends have been in strong investor favor as of late, with valuations for 'bond proxies' like utilities reaching much higher levels, especially relative to their typically-low growth rates.

In developed markets, stocks from Europe and the U.K. ended positively in local terms, but these turned negative for U.S. investors as the dollar strengthened by almost a percent on the week. The Bank of England decided to cut its key interest rate from 0.50% to 0.25% (the lowest in the over-300 history of the institution), as well as to buy bonds and offer a program for banks to facilitate low-rate short-term loans to households and businesses. These measures are all in order to keep credit eased in the aftermath of Brexit and generally slow growth conditions. While projections for economic growth in the U.K. were reduced to below 1%, the BOE tried to dispel fears of a recession (as one would expect they would). Private economists are divided on that issue, however. Japanese stocks lagged considerably, due to a strong yen and pessimism concerning prospects of success for the recently-approved dramatic stimulus package; the lack of unanimous support by all committee members also raised concerns over the level of commitment to stimulus.

Emerging markets continued to show strength with strong gains on the week from Brazil (perhaps with some Olympic effects), Indonesia and China—the latter being buoyed by talk of additional interest rate cuts and again lowering bank reserve requirements to further stimulate the economy. Year-to-date, emerging markets have dramatically outperformed their developed market counterparts, largely due to the perception of fundamentals 'bottoming' somewhat. The long-term story of emerging markets growing faster than developed continues to hold, especially in an environment of very slow global growth, despite the occasional bumps along the way that EM investments are prone to experiencing.

In fixed income, U.S. government and investment-grade credit lost ground as interest rates ticked higher along with improving employment reports, which raised the probability of sooner Fed action. High yield bonds bucked the trend, gaining ground, with strong investor cash flows due to better stability in the oil pricing environment (and which has stayed resilient despite more recent price declines), continued low default rates, and as importantly, a lack of other yield alternatives. Spreads in high yield have tightened from the low 7+% area in the earlier part of the year to the 5.5% area today, much more in line with long-term averages. The rally this year has been led by the lowest-quality CCC and under credits, largely in energy and materials, but that's also the segment with the highest default rates, so a large amount of risk has coincided with it.

Foreign bonds suffered due to a stronger dollar, which gained close to a percent on the week, causing a negative return for developed market indexes to turn more negative. Emerging markets fared better, with positive returns, with tighter spreads in keeping with a move toward risk during the week and a lesser impact from USD currency movements.

Commodities gained ground on the week, led by energy and agriculture, while metals lost some ground, notably on the stronger dollar. West Texas crude briefly fell below a technically-important $40/barrel level mid-week, before bouncing back after inventory reports and gaining some positive ground near $42. Traders continue to hash out differentials between demand and inventory supply levels, which appear much more aligned in the $40's than in the upper $20's.

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 1, 2016.

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