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Weekly Review - January 8, 2017

Weekly Review - January 8, 2018

Guest Post - Monday, January 08, 2018


Economic data for the first week of the new year showed strength in manufacturing, a weaker result for services ISM, and a mixed result in employment, with strong jobless claims and ADP employment numbers, while the government employment report disappointed with challenging winter weather.

Equity markets started the year with significant gains globally, with optimism for the new year running high in both the U.S. and abroad. Bonds faced a more challenging week, as interest rates increased along with these expectations. Commodities rose to a more tempered degree, as crude oil again gained in price.

Economic Notes

(+) The ISM manufacturing index rose +1.5 points in December to 59.7, contrary to an expected unchanged result at 58.2. New orders and production both rose by several points, as did inventories by over a point, while employment declined. The broader index and its components all solidly remain in expansionary territory, pointing to continued manufacturing sector strength.

(-) By contrast, the ISM non-manufacturing index fell in December by -1.5 points to 55.9, underperforming the slight bump to 57.6 expected. Business activity overall and new orders declined by several points, while employment and supplier deliveries ticked upward. All-in-all, all segments and the overall index remained solidly in expansion.

(+) Factory orders rose +1.3% for November, which slightly outperformed expectations calling for a +1.1% increase. The gain was led by a +6% gain in petroleum, while core capital shipments were revised down for the month and prior month.

(+) Construction spending for November rose +0.8%, which beat forecasts calling for a more tempered +0.5% rise; in addition, figures for Sept. and Oct. were revised upward decently. Private activity on the residential and non-residential side gained +1%, while public residential spending gained a substantial +5% for the month. This could serve as a positive driver for GDP in the fourth quarter.

(0/+) Initial jobless claims for the Dec. 30 ending week rose by +3k to 250k, which was above the expected level of 240k. Continuing claims for the Dec. 23 week sharply fell by -37k to 1,914k, below the 1,928k expected by consensus. The rise for initial claims appeared to be dominated by claims activity in Puerto Rico, which continues to recover from the impact of recent hurricanes, but is otherwise a minor contributor, while other states largely offset each other.

The December ADP employment report measuring private employment showed a payroll gain of +250k, surpassing the +190k level expected by consensus; the November number was revised down by a meager -5k to +185k. Within the report, service employment was responsible for the bulk of the increase, as usual, at +222k, which was led by professional/business services, education/healthcare and trade/transports/utilities, although information services jobs fell for another month. Goods-producing jobs rose by +28k, due to a combination of gains in construction and manufacturing. There is likely some post-hurricane activity accounting for some of the strength here, in addition to some adjustments from winter weather effects, but the underlying trend for ADP job growth is quite good.

(-) The big government employment situation report for December was a bit of a disappointment, with cold winter weather the primary culprit. Nonfarm payrolls rose +148k, which disappointed relative to the median forecast calling for +190k. It appeared that heavier winter snowfall during the period may have played a role in the poor result, with service jobs only rising by +90k. This was led by retail jobs falling by -20k, professional/business services gaining a tempered +19k, while construction and leisure/hospitality each gained +30k. Manufacturing jobs rose by +25k.

The unemployment rate was unchanged at 4.1%, which many economists now believe is below the level of full employment. The labor force participation rate is also unchanged at 62.7%, as labor levels have tightened on a variety of levels, including those on the fringes of labor markets. The household measure of employment rose by +104k, which was almost +30k higher than the prior month, despite a larger number not at work as the result of weather.

Average hourly earnings rose +0.3%, which was on par with expectations, while November earnings gains were revised down a bit. This brought the most recent year-over-year wage gains to +2.5%. Average weekly hours were unchanged at 34.5.

(0) Minutes from the December FOMC meeting offered little in terms of changes in policy opinion, but a few nuances were noted. The passage of tax reform was noted as a significant growth factor by a greater number of participants, including those who might have been more restrained in providing an opinion prior to its prospects for passage looking less clear. In keeping with this, assessments for economic growth have been revised higher, and the unemployment rate lower over the coming year or two. Inflation continues to be the wildcard, confounding participants, who continue to be wrestling with the causes for tempered levels as well as seeking catalysts for potential improvement. There was also a discussion of the treasury yield curve, in light of its recent flattening activity—a few members appeared more concerned with this than others. It still appears odds of a rate hike at the next ‘major’ meeting in March are higher than not, although a lot of data is to be released between now and then. This would bring the pace of hikes to 3 in 2018, which is about the median of economist estimates, which are generally in the 2-4 range currently.

It appears FOMC members also discussed alternative measures of determining monetary policy milestones, including something called ‘nominal GDP targeting’, which has surfaced sporadically in other meetings in recent years. Essentially, as opposed to a central bank focus on inflation targeting, which has been the traditional approach, this would call for a focus on total overall spending—which can be a byproduct of both inflation and/or economic growth. In fact, this would result in inflation being a floating indicator, and could be allowed to run higher if economic growth was especially slow, or targeted lower if economic growth was higher. Specifically, it would be done using a comparison of current overall economic growth levels relative to the longer-term trend—and adjusting policy based on the current trajectory, so could result in smoother policy in an ideal world. If growth falls below trend, for example, monetary policy would be made more accommodative, via lower rates and/or other quantitative easing measures; growth running hotter than trend would warrant tighter policy through higher rates or removal of other accommodation. A variety of policymakers and economists have been in favor of a GDP targeting, since it targets what really matters in an economy, which is nominal spending trends, as opposed to the single inflation metric, that can suffer from periodic quirks and lack of direct usefulness. Other central banks, such as the Bank of England, have also looked at the idea, so we could see more about this in the future.

Market Notes

Period ending 1/5/2018

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U.S. stocks gained across the board sharply for the first week in 2018. The Dow Jones Industrial Average reached another round number, the 25,000 level, which naturally raises attention to the higher levels of the index and propelling investor momentum. From a sector standpoint, cyclical tech and materials led the way, while defensive utilities lost ground as interest rates rose. Interestingly, the VIX volatility index also reached a new record low during the week. It would not be surprising to see this tick back upward with deadlines on the budget and debt ceiling forthcoming over the next few weeks.

Foreign stocks rose broadly to the same or stronger degree as U.S. equities, with some help from a moderately weaker dollar. Japan and emerging markets fared best, followed by Europe, and the U.K., where gains were modest. Sentiment in Europe and Japan has been helped, as in the U.S., by stronger economic results and possible winddown of economic stimulus this coming year, while recent success of commodities markets has boosted equity markets for key BRIC members Russia and Brazil. China has also performed well as of late, as manufacturing and services indexes have shown gains, which has kept sentiment strong in spite of government promises to pull the reins in on credit.

U.S. bonds declined for the week across the investment-grade side as interest rates ticked higher, led by weakness in the longest-term treasuries. High yield corporates and floating rate bank loans, on the other hand, ended up with positive returns. Foreign developed market bonds were flattish for the week, while emerging market debt gained sharply, in keeping with trends in other pro-risk assets.

Real estate in the U.S. declined for the week, in keeping with higher interest rates, while foreign REITs continued their string of gains, particularly in the Asian region.

Commodities were up slightly for the week, in about the same magnitude of the drop in the dollar. Precious metals fared best, with gains near a percent, followed by energy. For the energy sector, crude oil rose another dollar to close the week at $61.44, while natural gas fell -5% as weather normalized somewhat around the nation. Declines in the price of copper led industrial metals to negative returns for the 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, 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 January 2, 2018.

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