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Weekly Review - February 12, 2018

Weekly Review - February 12, 2018

Guest Post - Monday, February 12, 2018

Summary

Economic news for the week was light, relative to that of financial markets, but highlighted by gains in the ISM non-manufacturing survey and continued strong labor market data.

Continuing a trend begun the prior week, stock markets lost more ground, passing through the -10% correction threshold. Bond markets were slightly negative as rates fluctuated before returning to their starting point. Commodities lost ground led by declines in crude oil.

Economic Notes

(+) The ISM non-manufacturing index gained +3.9 points to 59.9, higher than the more modest increase to 56.7 expected. In fact, this services bogey is at its highest level since mid-2005. Under the hood, new orders and employment gained sharply, followed by a moderate increase in business activity, while supplier deliveries were flat. The services portion of the economy (far larger than manufacturing in size) continues to show expansionary tendencies.

(0) The trade balance widened to -$53.1 bil., compared to the -$52.1 bil. expected. Both imports and exports increased—the former a bit more than the latter. Imports in petroleum fell by over -9% while imports from other segments rose by +4%.

(0) Wholesale inventories rose +0.4% in December, which was twice the +0.2% forecast; however, this was tempered by a revision downward for November. The sales ex-petroleum measure led the way, up nearly +1%, on par with a similar increase the prior month. The inventory-to-sales ratio ticked down a hundredth to 1.22.

(0) The Fed's Senior Loan Officer Opinion Survey, conducted quarterly, showed a continued easing of lending standards at a moderate pace for Q4 2017. Details of the report showed that standards on the commercial/industrial side eased for large banks lending to larger-sized companies represented the bulk of the change, while smaller banks and smaller borrowers were little changed. However, standards on commercial real estate in the multi-family area for development and construction tightened a bit (in a reflection of that sector's maturity perhaps). Residential real estate standards for lending were little changed, but demand for mortgages continued to fall off (likely related to lower inventory availability for single-family homes). Interestingly, in the 'special question' section, many banks expected demand for commercial loans to continue to grow, to tighten standards for commercial real estate and for a deterioration in the quality of credit card lending. Several of these expectations would be consistent with typical late cycle tendencies.

(-) The government JOLTs job openings report for December showed a decline to 5,811k, which fell below the expected level of 5,961k. It appeared that professional/business services and construction were the primary culprits. The openings rate fell by a tenth to 3.8%, as did the layoffs rate to 1.1%. The hiring rate was unchanged at 3.7%, while the quits rate ticked up a tenth to 2.2%. All of these point to an increased tightness of the labor market, ratified by other measures as well.

(0) Initial jobless claims for the Feb. 3 ending week fell by -9k to 221k, relative to expectations of a slight increase to 232k. Continuing claims for the Jan. 27 week fell by a more dramatic -33k to 1,923k, compared to expectations of 1,940k claims. It appeared that Missouri was responsible for a bulk of initial claims activity over the last few weeks, which could be related to factory retooling.


Read the "Question of the Week" for February 12, 2018

What should we make of the pullback in equities? What should we make of the move higher in interest rates?


Market Notes

Period ending 2/9/2018

1 Week (%)

YTD (%)

DJIA

-5.08

-1.90

S&P 500

-5.10

-1.84

Russell 2000

-4.47

-3.69

MSCI-EAFE

-6.19

-2.80

MSCI-EM

-7.15

-1.35

BlmbgBarcl U.S. Aggregate

-0.10

-1.92


U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2017

1.39

1.89

2.20

2.40

2.74

2/2/2018

1.48

2.15

2.58

2.84

3.08

2/9/2018

1.55

2.05

2.52

2.83

3.14

U.S. stocks began the week on a lackluster note, with the DJIA dropping by 1500 at one point (we hesitate to even acknowledge the point total, without going into another counter-media explanation of how a thousand points is quite different on a starting point of 25,000 than at 5,000). Nevertheless, the week ended up being the worst in two years and with declines falling into the official -10% correction point. Other than being 'overdue' for a pullback, blame is coming from the direction of higher wage growth, resulting in inflation fears and the eventual effect of higher rates. Interestingly, the wage growth change was not all that dramatic, so perhaps this falls back on the need for some 'excuse' to create the small avalanche. Some of the damage may have been stemmed by senate passage of budget deal, which would avert a debt ceiling crisis in a few weeks.

Unfortunately, selling exacerbates more selling on a behavioral and quantitative side, as it's been reported that algorithms and ETF trading has represented a good portion of recent volume. In addition, more exotic strategies, such as those targeted to certain volatility levels or tied to volatility itself (the VIX) have stemmed an intensity of selling. The VIX spiked from a low of just over 11 (which lies in the bottom 5th percentile since the VIX began in 1990) to the higher-30's (95th percentile) in the matter of just a few days. Due to the tendency of equity declines to occur more rapidly (i.e. as volatility) than increases, investing in the VIX is sometimes seen as a method of 'hedging' against equity drawdowns. Unfortunately, the dynamics of such strategies reliant upon futures curve pricing for the VIX and need for spot-on timing can make implementation quite challenging. In fact, rapid changes in volatility (in the opposite direction) essentially wiped out 95% of the value of a popular inverse volatility ETF within minutes of market activity over the past week, with one of the products being terminated by the sponsor.

Foreign stocks fared similarly to U.S. equities in local terms, with negative sentiment carrying across the globe, but ended a bit worse when returns were translated back to account for a dollar that gained a percent and a half on the week. Aside from the negative influence of poor U.S. markets, economic and earnings growth continue to show improvement in Europe and Japan. The only newsworthy item was the conclusion of the Bank of England's meeting, where rates were held at 0.50%, but it was indicated that increases were likely down the road to combat rising inflation.

U.S. bonds fell slightly for the week, as a dip in yield for the 10-year treasury was followed by a recovery to near its starting point. Government and investment-grade corporate bonds performed similarly, with longer-duration bonds and high yield faring worse and floating rate faring better than broader indexes. Foreign bonds were similarly flattish in local terms, while a stronger dollar turned results sharply negative for both developed and emerging market debt.

Real estate also lost ground, albeit to a lesser degree than broader equities. Foreign real estate fared worse, in keeping with the dollar effect.

Commodity indexes generally fell with a negative influence from a rising dollar and weakness in energy. Crude oil prices fell nearly -10% for the week to $59.20, bringing prices back to levels seen in late December. Natural gas prices fell to a similar degree. Reports on rising U.S. production continue, and threats of higher production by Iran, which point to higher supplies in months ahead and are now being taken more seriously by market speculators. Precious metals fell to a lesser degree, as would be expected with market volatility, while prices for several agricultural contracts, such as wheat and corn, rose.

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 February 5, 2018.

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