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Weekly Review - December 15, 2014

Weekly Review - December 15, 2014

Guest Post - Monday, December 15, 2014

Summary

  • The economic releases were focused on retail sales (which came in as a slight positive surprise), and several sentiment surveys, which also came in more positively than expected. However, oil prices were the most closely watched and discussed indicator of the week.
  • Stocks were significantly lower on the week globally, due to concerns over the repercussions of lower energy prices and forward-looking demand. U.S. investment-grade bonds gained with lower interest rates in a risk-off week, while riskier bonds sold off. Real estate fared well, however.

Economic Notes

(+) Retail sales for November came in better than expected, rising +0.7% compared to consensus estimates of a +0.4% increase. Removing volatile components, the 'core' sales figure rose +0.6%, which was a tick above expected. For the month, it appeared several areas contributed to the gain, including apparel and non-store retail (essentially online sales), both of which were up over a percent. Outside of the core, auto sales were up almost +2%, which was offset by an almost -1% drop in gasoline sales with lower pricing—both of which would be expected to act in ways contrary to each other.

We can see an ever-expanding trend from brick-and-mortar to online sales in recent years, as noted in the charts below—the share has grown from 6% of core retail sales in 2000 to an estimated 14% for this year. Some of this is generational, as younger shoppers have grown up being more comfortable with internet-based activities, and, as they build discretionary income and an increasing number of online options proliferate, the trend looks to continue. So, while the traditional 'Black Friday' has been a back-of-the-envelope indicator for the Christmas season (a bit weak to mixed this year), results have become less relevant to the overall season's success or failure.

Chart - Cumulative Online Retail Sales (Year-to-Date)

Chart - Online Share of Core Retail Sales

Source: Goldman Sachs, U.S. Commerce Department

Speaking of shopping, a recent McKinsey consulting report described the tendency of Americans' remaining reluctance to spend, six years after the Great Recession. This hesitancy is nowhere near as bad as it was at the depths of the downturn, but despite better conditions in general from an economic standpoint, spending morale remains low. Many (almost 40%, according to McKinsey survey numbers) are still worried about losing their jobs, and the percent acknowledging that they've cut back on spending has fallen from the 2/3 level at the height of the crisis down to around 40% today. So, this and other anecdotal reports show that folks are feeling slightly better about ramping up some spending perhaps, but they're certainly not ebullient about it. This sentiment is likely typical of post-crisis periods and could last for several more years, or even feature a lingering generational overhang, as the Great Depression did (albeit that was much more severe in many respects).

(0) Wholesale inventories for October rose +0.4%, which was double the forecasted gain. The biggest contributor was drugs, up +3%, while autos, computers and energy all fell during the month. Business inventories rose +0.2%, which was on target with expectations, and the industry inventory/sales ratio was unchanged for the third month in a row. This points to a decent balance in broader distribution channels.

(0) The Producer Price Index for November was weaker than expected, with the headline number falling -0.2% (compared to an expected -0.1% decline) and ex-food/energy core rose +0.2% (compared to an expected +0.1% gain). Energy prices being down -3% was the largest factor behind the headline decrease. On a year-over-year basis, headline and core PPI rose +1.4% and +1.8%, respectively, which continues to point to very subdued embedded inflationary pressures.

(0) Import prices fell -1.5% in November, about three-tenths less than expected. The bulk of the difference resulted from a -7% drop in imported petroleum, while non-petroleum prices fell -0.3%. This brought the year-over-year import price decline to -2.3% when petroleum was included but a +0.1% increase when oil was excluded. On all counts, a negative inflationary impulse from abroad.

(+) The NFIB small business optimism survey rose +2 points from the prior month to 98.1, an improvement on the expected 96.5 reading. The net percentage of responses expecting economic improvement rose by +16% into positive territory, as did the responses expecting higher real sales, albeit to a lesser degree. Worker compensation expectations were a bit higher. Small business happiness continues to move on an upward trend.

(+) The final University of Michigan consumer sentiment survey for December rose to 93.8, outperforming the forecasted 89.5. Consumer assessments of the current environment and future both rose several points, due to improved employment/wage conditions as well as cheaper gasoline. Inflation expectations for the year ahead actually rose a tick to +2.9%, matching expectations for the next 5-10 years—all near the long-term average.

(+) The government JOLTs job openings survey for October came in better than expected, rising +149k to 4,834k, and outperformed expectations by +39k. This brought the year-over-year gain in the JOLTs survey to +21%. For the month, leisure/hospitality openings rose, while government job openings fell. The hiring rate came in unchanged at 3.6%, while the quit rate fell a tenth to 1.9%.

(+) Initial jobless claims for the Dec. 6 ending week fell to 294k, -3k below expectations. Continuing claims for the Nov. 29 week came in +142k higher than the prior week and +170k higher than forecast, to 2,514k (the largest weekly increase in a few years). The Department of Labor didn't mention any idiosyncrasies with the results but seasonal adjustments and temporary employment an occasionally result in higher week-to-week volatility around this time.

Market Notes

Period ending 12/12/2014

1 Week (%)

YTD (%)

DJIA

-3.69

6.69

S&P 500

-3.47

10.48

Russell 2000

-2.50

0.24

MSCI-EAFE

-3.54

-5.36

MSCI-EM

-4.80

-6.41

BarCap U.S. Aggregate

0.72

6.06

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2013

0.07

0.38

1.75

3.04

3.96

12/5/2014

0.02

0.65

1.69

2.31

2.97

12/12/2014

0.02

0.56

1.53

2.10

2.75

U.S. stocks suffered their worst weekly loss in two years as sharply lower energy prices topped the headlines. For the week, utilities was the only sector with positive results, while consumer staples and consumer discretionary ended up with the lightest losses. On the negative side, energy stocks lost -8%, followed by materials which also fell off sharply. After OPEC's lowered demand estimates, the International Energy Agency did the same last week. This appeared to provide more of a scare about energy company earnings than it did provide enthusiasm about the economic benefits of lower crude prices (a dilemma we've discussed several times and will again below).

Despite the US dollar index falling a percent on the week, foreign stocks fared worst, with developed markets faring a bit better than emerging. Japanese stocks lost about -3%, with Europe down just over -5%, and the U.K. down near -7%. Japanese GDP was revised downward for Q3 by 3 more tenths to -1.9%, much of which was attributed to the aftermath of sales tax hikes, although recent improvements in employment and lending tended to keep sentiment tempered. Greek stocks suffered, losing -20% as parliamentary elections were called two months early, spurring fears that more political strife might be in the mix—notably concerns that far-left elements may fare well and attempt to negotiate better debt write-off terms with core Europe.

Russia fared poorly as well, alongside oil price declines. The Russian central bank raised interest rates by a percent to 10.5% in response to rising inflation expectations directly as a result of a weakened ruble. In the midst of a recession (no doubt fueled by sanctions and oil prices), why would they do this? The Russian ruble has plummeted dramatically this year against a basket of developed market currencies (and -65% against the U.S. dollar). As we know from prior discussions of currencies, an extraordinarily weak one can lower a nation's purchasing power and raise domestic inflation (from higher-priced imported goods) much more than it will help boost exports in this case (in Russia's case the main exports are crude oil and other commodities, which are priced in dollars). To boost a currency's value, central bankers may attempt a rate increase, which is hoped to attract the 'carry trade'—the tendency for currency traders to seek out high-interest rate paying nations. (It happened not that long ago in Turkey.) On the negative side, intuitively, raising interest rates at a time when a recession is already in full force doesn't sound like a great plan—and it isn't from that perspective—but is done as a last resort to choose the lesser of two evils.

In emerging markets, Chinese stocks suffered early in the week, tempering their recent run, as a repo clearinghouse changed their collateral policy to some degree (bonds rated under AAA wouldn't be accepted; however, their definition of 'high yield' is quite different from ours). Chinese CPI also fell to 1.4% on a year-over-year basis, which was lighter than expected and pointing to some cooling.

Bonds experienced a strong week. Interest rates fell by almost a quarter-percent towards the longer end of the yield curve in a risk-off environment. Unsurprisingly, long-term treasuries gained several percent, while most investment-grade debt ended up positively. High yield lost several percent on the week due to risk-off sentiment and uncertainty about energy exposure. Foreign bonds were mixed, as local foreign bonds, with a weaker dollar tailwind, performed well, while emerging market debt sold off.

Real estate was led by domestic residential names, which bucked the trend of other U.S. equities, with positive returns, but general U.S. REITs fared well with lower interest rates. European REITs fared the worst, on par with other international equities.

Commodities experienced another challenging week, with the GSCI losing -7%, naturally led by West Texas crude dropping from $63 to $57.50—by far the worst-performing commodity. On the positive side, precious metals (mostly silver, but also gold) gained several percent, as did corn, in a bit of a reversal after the biggest corn crop in history was harvested this fall.

In short, the energy price implications on the economy and markets are complicated as we've discussed a few times. Everyone seems to have a different opinion, but most economists and analyst seem to think the negative price declines of certain investment segments is overblown (and perhaps have overshot fundamentals) relative to the positives gained from lower pricing. To keep perspective, it's not likely world oil demand has fallen or supplies grown by the same dramatic -45% degree over the same timeframe that West Texas intermediate crude spot prices have.

Negative effects:

  • Naturally, sustained lower energy prices are a headwind for certain energy-related operations. 'Upstream' energy producers—like drillers—were hit hardest, due to their commodity price sensitivity. These firms benefit when prices are higher as their higher costs incent further drilling at high price levels. Low oil prices don't incent much of anything for at-the-fringe drilling.
  • Foreign nations heavily dependent on petroleum exports for revenue. This includes the obvious gulf nations and African exporters, but also Russia, Venezuela and even developed nations like Norway and even the U.K. to a lesser degree (due to North Sea impacts). For the less diversified emerging market nations, sustained low oil prices can cause budgets to become imbalanced, and consequentially threaten interest payments on debt. As we've seen in the ruble, this can result in currency volatility, and often not in a good way.
  • Commodity investments, especially those pegged to the GSCI (energy exposure is 2/3 of index), but most commodity futures strategies have some energy component, since this is the largest sub-sector by world trade volume.

Mixed effects:

  • Energy infrastructure firms, like midstream pipelines, etc., have been hit in price due to investor perception, but in reality, cash flows are more heavily influenced by oil volume than price (MLP's earn money on the royalties earned on amounts carried through the pipes, regardless of price). At the same time, decreased volumes from lower demand/flow would be a negative. With their high yields, pipelines can also be interest-rate sensitive, so lower rates have been a positive as of late.
  • High yield bond indexes consist of about 15% energy sector names. Another benefit of active management here is that the weaker issuers can be weeded out, but this is a general liquidity risk to the market.
  • Equities in general. While 10% of the S&P is represented by the energy sector, uncertainty in or volatile swings in any price over a short amount of time can carry volatility over to risk assets in general.

Positive effects:

  • Energy users, such as chemical and fertilizer companies but also many others, naturally benefit from lower input costs. Lower oil means lower transportation costs, which affect industrial companies at large, from manufacturing to shipping to airlines.
  • Inflation. Lower commodity/oil input prices keep general inflation measures low on a headline level (and can carry into downward pressures on core measures as well).
  • Consumers and businesses in general. Stronger consumer spending, on the order of $75-100 billion/year, dependent on the level and length of the lower oil price environment. Most simply, money not spent on oil (specifically, gasoline) is saved or spent back into the economy—both of which offer benefits. This impact, felt over time, could add a significant amount to GDP growth, which, in turn, carries down to better corporate earnings.

More to come, no doubt, based on how the oil situation continues to unfold.

Have a good week.

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, McKinsey & Company, 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 December 8, 2014.

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