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Weekly Review - February 5, 2018

Weekly Review - February 5, 2018

Guest Post - Monday, February 05, 2018

Summary

Economic news for the week was highlighted by the FOMC keeping interest rates unchanged in their first meeting of the year, Manufacturing surveys showed a bit of a drop while remaining high, housing data showed gains, and the employment situation report came in stronger than expected.

Global equity markets declined sharply on the week, led by weakness in the U.S. coupled with higher interest rates. These same rates increases also punished bond markets, particularly on the long-term part of the yield curve. Commodities also came in lower, due to a pareback in energy prices for the week.

Economic Notes

(0) As we noted mid-week, the FOMC left interest rates alone, but made mention of the stronger economic growth dynamic and signs/hopes that inflation will pick up. As it stands now, and with the strength of the January employment situation report noted below, odds of a March hike continue to move higher. Interestingly, risks were described as balanced, although tax reform and easy levels in credit and financial conditions generally have certainly boosted asset prices.

(+) The ISM manufacturing index for fell by -0.2 points in January to 59.1, which still surprised on the upside compared to an expected fall to 58.6. Under the hood, new orders, production and employment all declined to a greater degree than the broader index; on the other hand, inventories rose as did prices paid. All-in-all, in spite of the small decline an ISM number running in the upper-50's to near 60 continues to indicate very solid economic expansion.

(0) The Chicago PMI, in similar fashion, declined -2.1 points to a still-strong 65.7 for January. New orders, production and order backlogs all dropped, while supplier deliveries and employment improved-the latter reaching a six-year high. The special question posed to survey participants for the month involved the anticipated impact of higher interest rates on business conditions-the majority were split between those anticipating no effect and those who foresee continued expansion regardless.

(0) Personal income for December rose +0.4%, a tenth better than expected, and personal spending rose at the same +0.4% pace, in line with expectations. This took the personal savings rate down a tick to 2.4%, which is a 12-year low for the measure. (As an aside, although not noted in these official government statistics, credit card debt is rising again, which tends to move in line with consumers feeling increasingly confident in employment prospects and overall growth. An item to watch.) The PCE price index gained a rounded +0.1% on a headline basis and +0.2% on a core level, in keeping with consensus estimates—appearing to be held back by weakness energy prices on a headline basis, as well as air travel and medical services pricing levels. Year-over-year PCE headline and core gained +1.7% and +1.5%, respectively, continuing to fall below the Federal Reserve's target level.

(0) Construction spending for December rose by +0.7%, beating forecasts calling for +0.4%; however, levels for the prior two months were revised down significantly. Private spending increased in both residential and non-residential, while public residential spending fell back somewhat.

(+) The S&P/Case Shiller home price index gained +0.7% in November, which outperformed forecast by a tenth of a percent. All twenty cities experienced price gains, led by San Francisco at nearly +2% and remaining an epicenter for housing unaffordability, even when higher incomes are factored in, followed by Las Vegas and Tampa, which each rose a percent. Year-over-year, the index continued to show solid progress, up +6.4%.

(0) Pending home sales for December rose by +0.5%, which matched consensus expectations. Sales in the South rose by nearly +3%, offsetting a decline in the Northeast of -5%, which could have been weather-related.

(+) The Conference Board's index of consumer confidence for January rose +2.3 points to 125.4, beating forecasts calling for 123, and reversing a decline from the prior period. While consumer assessments of present conditions deteriorated a bit, the labor differential rose by just under a point, while expectations for the future rose by several points.

(+) The final edition of the January Univ. of Michigan consumer sentiment index rose +1.3 points to 95.7, beating expectations calling for 95.0. Assessments of both current conditions and future expectations both rose in roughly equal amounts. Inflation expectations for the coming year ticked down a tenth to 2.7%, while expected inflation over the coming 5-10 years was unchanged at 2.5%.

(0) Initial jobless claims for the Jan. 27 ending week fell by -1k to 230k, which was below the 235k level expected, in addition to a revision down for the prior week of several thousand claims. Continuing claims for the Jan. 20 week, on the other hand, rose +13k to 1,953k, which was far above the 1,929k expected. No unique issues were reported by the DOL, although some factory shutdown activity could have played a small role in certain states. Overall, despite these small movements week to week as of late, levels remain at multi-decade lows.

(+) The ADP employment report for January showed a gain of +234k jobs, which far surpassed the +185k expected by consensus. Service jobs rose by +212k, with strength in education/healthcare, leisure/hospitality and trade/transports/utilities in roughly equal magnitude. This was coupled with goods-producing employment gains of +22k.

(+) The January employment situation report came in a bit better than expected. Nonfarm payrolls rose by +200k, which surpassed the +180k consensus estimate. Per the government release, employment gains were significant in construction (+36k), food services/drinking places (+31k), health care (+21k) and manufacturing (+15k). There were some manual tweaks in the data due to an annual benchmarking process conducted by the Bureau of Labor Statistics, which can play a role in the output of this data. This change in benchmarking appeared to help the numbers to some extent, as December was also revised higher, while November's number was revised downward. Weather improvement seemed to play a positive role as well.

The unemployment rate rolled in at 4.1%, for the fourth consecutive month on a rounded basis, although it was just about a hundredth of a percent from being rounded up to 4.2%, for those keeping track of these details. The participation rate was similarly unchanged at 62.7%, where it's been for four months as well. The U-6 'underemployment' rate ticked up, however, by a tenth to 8.2%. The household survey rose +91k on an adjusted basis, below the pace of the prior month.

The average workweek fell by -0.2 hour to 34.3 hours for the month, while overtime levels remained consistent at 3.5 hours.

Average hourly earnings rose by +0.3% for January, just under the gain of the prior month, but higher than expectations of +0.2%. The big news that got markets moving was the change in the year-over-year gain to +2.9%. While this doesn't appear earth-shattering on the surface, and can be choppy month-to-month like many other data points, it represents a new high for this cycle and is beginning to show signs of a pace indicative of strong labor markets by outgaining inflation. However, the composition of those gains has varied. This change is part of the 'increasing signs of inflation' the Fed has been referring to, and has helped lead to higher rates, as it implies perhaps a stronger pace of Fed policy movement than previously expected.

Earlier in the week, the preliminary estimate of annualized nonfarm productivity for Q4 fell -0.1%, which surprised relative to consensus expectations calling for a +0.7% gain; additionally, Q3 productivity was revised down by three-tenths of a percent. Unit labor costs rose +2.0% for Q4, which was just over twice the forecast increase, bringing the year-over-year gain to +1.3%.

Market Notes

Period ending 2/2/2018

1 Week (%)

YTD (%)

DJIA

-4.11

3.34

S&P 500

-3.81

3.44

Russell 2000

-3.77

0.82

MSCI-EAFE

-2.75

3.61

MSCI-EM

-3.32

6.25

BlmbgBarcl U.S. Aggregate

-0.88

-1.82


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

1/26/2018

1.41

2.13

2.47

2.66

2.91

2/2/2018

1.48

2.15

2.58

2.84

3.08

U.S. stocks suffered their worst week since June 2016, due to a variety of factors, including wage gains noted above, and Fed chatter about expectations for higher inflation that sent bond yields sharply higher. Higher interest rates can be challenging for a variety of assets, including stocks, as it changes the discount rate for future cash flows and raises opportunity costs for other assets (like bonds, which become more attractive as rates rise). Then again, it's important to keep this in perspective, as years like 2017 where all twelve months experienced positive returns, are highly unusual, as is volatility being as low as it's been.

From a sector standpoint, more conservative telecom and utilities still lost ground, but to a far lesser degree to lead for the week, while energy and materials struggled with losses over -5%. Thus far, per FactSet, half of the companies in the S&P 500 have reported earnings for Q4, with 75% reporting positive earnings surprises (at a blended growth rate of over +13%) and 80% reporting revenue surprises. If the latter revenue figure holds up, it would be the best proportion in nearly a decade. Estimates for Q1 earnings also rose significantly, with help from tax reform.

Markets were also thrown for a loop on Tuesday, with the announcement of a joint venture between Amazon, JPMorgan and Berkshire Hathaway in an attempt to reduce the epidemic of rising health care costs among their employees. Consequently, several big insurers in the health care group, such as Dow member UnitedHealth, and similar firms, fell back sharply in response. On Friday, weaker earnings from energy giants ExxonMobil and Chevron weakened sentiment. It would be no surprise for volatility to continue, given that the Feb. 8 deadline for a budget deal is on the horizon, although this could be pushed out again to later February or March where it could overlap with discussions over increasing the debt ceiling yet again.

Foreign stocks declined as well, albeit to a lesser degree as domestic indexes, with good corporate earnings results being outweighed by higher interest rates-driven by yields in the U.S. Emerging markets faring worse than developed and the dollar playing a minimal role in the week's returns.

U.S. bonds suffered, to no surprise due to the spike in interest rates caused by increased inflation fears/expectations. Broader government and investment-grade corporate indexes performed similarly, losing just short of a percent for the week, while long-term treasuries lost several percent due to the typical duration effect. Floating rate bank loans actually gained ground on the week, serving their traditional anti-bond role. Foreign bonds lost ground in local terms and offered mixed results when translated back into U.S. dollar terms.

Real estate investments fell several percent, as would be expected upon higher interest rates. Returns in foreign markets in Europe and Asia were similar to those in the U.S., although domestic industrial/office fared a bit better, while retail/malls fared worse.

Commodities fell a bit along with risk assets, with little impact from the dollar for the week. Lower prices for energy, industrial metals and precious metals were offset a bit by higher prices for agricultural contracts wheat and corn. Crude oil bounced around during the week, finally declining by just over -1% to end the week at $65.45. Notoriously volatile natural gas fell -10% as warmer forecasts were anticipated in coming weeks, following a spike in price from a variety of January snow events, as well as increasing production.

On the operational side, PIMCO has announced that they'll be eliminating their current 'D' share lineup, and converting these to the already-existing 'A' shares, in an effort toward simplification and streamlining. Internal fees between the two are generally identical. All else is unchanged and this will be considered a non-taxable conversion. Shareholders will be notified this coming week, with the actual conversion slated to occur in late March.

Sources: FocusPoint Solutions, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Citigroup, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Marketfield Asset Management, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, PIMCO, Standard & Poor's, StockCharts.com, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wall Street Journal, The Washington Post. 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 January 29, 2018.

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