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Weekly Review - July 11, 2016

Weekly Review - July 11, 2016

Guest Post - Monday, July 11, 2016

Summary

Economic data for the week took a turn for the better, with strong results from non-manufacturing ISM as well as an improved employment situation report on Friday.

Equity markets in the U.S. gained as Brexit returns were tempered by the stronger jobs report, but foreign stocks struggled. Bonds rallied globally with interest rates falling to low if not record-low levels in many locations. Crude oil prices fell backward with shorter-term supply disruption concerns fading and production rising again.

Economic Notes

(+) The non-manufacturing ISM index rose +3.6 points in June to 56.5 to its highest level in about eight months, to levels about where they were a year ago, and surpassing the 53.3 reading expected. Under the hood, business activity, new orders and employment all showed increases. The impact of Brexit was noted as 'negligible' on an anecdotal level, with fewer impacts on the service side than the manufacturing side. Overall, services continue to show broader strength than manufacturing, which is encouraging since this is a much larger part of the economy.

(-) Factory orders fell -1.0% in May, which was a weaker than the -0.8% drop expected. Core orders for durable goods were also revised downward by about -0.2%; orders from the oil industry continue to appear soft.

(0) The May trade balance widened by about -$4 bil. to -$41.1 bil., with was wider than the -$40.0 bil. expected. On a real basis, imports rose +1.0%, while exports fell -1.5%. Much of the change was the result of higher imports of industrial supplies, related to the oil category and sensitive to price changes, while other categories saw rising imports as well.

(+) The June ADP private employment report surprised on the upside, showing job growth of +172k, compared to +160k expected, while the May number was revised down slightly by -5k. The resolution of the Verizon worker strike helped the overall number, by about +35k. Otherwise, service jobs grew by +208k, trade/transports/utilities gained +55k and professional/business services rose +51k. Goods-producing sectors fell -36k, led by weakness in manufacturing employment.

(+) Initial jobless claims for the July 2 ending week fell to 254k, lower than the 269k estimate. Continuing claims for the June 25 week also fell to 2,124k, which was +4k higher than expected. No special factors were reported by the DOL, but auto plants embark on planned retooling beginning this time of the year, which has a tendency to affect results.

(+) The June employment situation report surpassed expectations, and proved the poor May report to be a one-off, although there is a large amount of error baked into these reports month-to-month, so markets often take these more seriously than statisticians do. Nonetheless, it was a stronger overall report than expected, which could create some additional pressure for Fed action in coming months, although the Brexit and global growth concerns provide a strong offset in their minds on the negative side. Nonfarm payrolls for June rose by +287k, surpassing the +180k expected by consensus. Key areas of growth were leisure and hospitality (+59k jobs), health care (+39k), financial activities (+16k) and manufacturing (+14k, a reversal of last month). The biggest gains appeared to be in more seasonally-affected employment, alluded to by strength in retail and hospitality. Telecom payrolls rose by +44k, but much of this was a byproduct of Verizon workers returning from a strike, so has to be discounted. On the negative side, jobs in mining (which also includes oil drilling activities) fell by -6k—this segment has lost well over -200k jobs since peaking in the fall of 2014 in keeping with the decline in oil prices. The household measure rose by a less exciting +67k, so more similar to last month's lackluster gains.

The unemployment rate ticked up by +0.2% to 4.9%, compared expectations this would only rise a tenth. The labor force participation rate ticked just slightly higher to 62.7%, so this played a lesser effect in the results. The U-6 underemployment rate fell a tenth, on the other hand, to 9.6%, with a drop in involuntary part-time employment. Interestingly, the level of spread between the U-3 unemployment and U-6 underemployment rates has fallen back below 5%, which is in line with longer-term averages, and implies a tightening of labor market slack.

Average earnings rose $0.02 (barely +0.1%) to $25.61, following a much larger increase in May, which brings the year-over-year gain in earnings to +2.6%. The average workweek was flat at 34.4, where it's been for five straight months.

(0)The June FOMC meeting minutes showed some mixed results. Members of the committee appeared on board with a small rate hike initially 'in the absence of significant economic or financial shocks'; however, the Brexit vote and poor May employment report gave them pause (the much better June report may reverse some of that sentiment). The committee seems to be in a bit of a bind in regard to labor conditions, as tightening job markets appear to be nearing a peak in employment growth. This is consistent with an environment closer to one of their goals of 'full employment'; however, areas like business fixed investment are not as strong as hoped (some of that being due to the energy sector). Additionally, global concerns appear to have assumed a higher priority as of late. Due to Brexit, a summer rate hike appears to be a low probability event, but many economists believe that one could still occur later in the year. The mantra of 'lower for longer' appears to be the base case for now.


Read the "Question of the Week" for July 11, 2016:

Stock and bond markets seem to be flashing different signals about the economy. How should we interpret this?


Market Notes

Period ending 7/8/2016

1 Week (%)

YTD (%)

DJIA

1.16

5.66

 

S&P 500

1.33

5.45

Russell 2000

1.80

4.50

MSCI-EAFE

-1.75

-5.38

MSCI-EM

-1.24

4.37

BarCap U.S. Aggregate

0.60

6.16

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

6/24/2016

0.28

0.59

1.00

1.46

2.24

7/1/2016

0.28

0.61

0.95

1.37

2.11

On a holiday-shortened week, stocks started slowly with a resurfacing of Brexit concerns but improved by Friday with the positive surprise of a decent June employment report with the S&P closing again near record highs. Several M&A transactions also buoyed sentiment.

In the U.S., small-caps outperformed large-caps. From a sector perspective, consumer cyclicals and healthcare led the way, gaining over +2%, while energy was the sole industry with negative returns on the week, reflecting a pullback in oil prices. Earnings season for Q2 will be unfolding in coming weeks, and estimates are generally pointing to generally negative growth outright for the quarter and compared to a year ago, although better than last quarter, and much of this negativity is due to the energy sector.

In foreign equities, Japanese stocks ended up with positive gains in USD terms, while Europe and the U.K. lost another few percent in the aftermath of Brexit speculation, which appears to wax and wane as prognosticators analyze the potential impact of the vote and ultimate path of the separation process. Accordingly, consumer confidence in the U.K. has reached at 20-year low, which naturally could have carryover effects into spending and business investment. Too much of a pullback has the potential for driving the economy into recession, which is the biggest fear of policymakers at this point, and why the central bank is making liquidity more readily available. This includes reducing banks' required capital reserves as well as potentially lowering interest rates as needed.

The biggest victim so far, however, has been the British pound, which is down over -15% from a year ago. Much of this decline was in the aftermath of the referendum, but had been eroding slowly prior as investors digested the possibility. The good news, of course, is that this represents a boost to British exporters, which may offset the potentially negative impact of less-optimal trade agreements forged after the break from the EU.

U.S. bonds gained ground with rates falling again across the curve, and the 10-year treasury reaching new lows under 1.4%. While investment-grade bonds gained, high yield fared well also as investors sought out income wherever it can be found.

Interestingly, the 'shape' of the yield curve has moved to its flattest point in about nine years, at least as measured by the 0.80% differential between the 10-year and 2-year treasury notes. The short part of the curve is obviously not moving, so the flight to quality in the longer end has acted as the driver of this.

Despite a stronger dollar on the week, foreign bonds also rose as rates fell lower—deeper into negative territory for several developed markets. In Japan, not only has the 10-year bond been pulled below zero, but now the 20-year has as well.

Real estate was mixed on the week, with positive returns in the U.S. accompanied by negative results from Asia and Europe, in keeping with trends in equity markets. In recent weeks, residential/apartment REITs have continued their strong performance as buying homes has become increasingly expensive in certain parts of the country and rental units are taking up the slack.

Commodities generally lost ground due to a pullback in energy. Crude oil fell from the cusp of $50/barrel by about -8% down to just above $45, as supply concerns again faded away with rig counts rising for the fifth straight week. Precious metals rose a few percent, as low interest rates (and low real yields) make the competition for 'safe' capital less of a negative for non-interest paying items like gold.

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 July 5, 2016.

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