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Weekly Review - July 25, 2016

Weekly Review - July 25, 2016

Guest Post - Monday, July 25, 2016

Summary

In a slow week for economic news, home sales and housing starts surprised on the upside, while the index of leading economic indicators has shown some flattening of momentum as of late.

Stocks gained for the fourth straight week, as a flurry of earnings reports came in better than expected, with U.S. equities outperforming foreign due to a strengthening of the dollar. Bonds ended up with generally tempered returns, as interest rate volatility calmed down from prior weeks. Commodity prices slipped across the board, with oil ticking down a few dollars upon higher inventories.

Economic Notes

(-/0) The Philadelphia Fed survey declined from close to an expansionary +5 or so in June to -2.9 in July, contrary to expectations of a little-changed +4.5 reading. Oddly, the underlying components of the survey were much more positive, with new orders, shipments and employment all improved by 5-10 points to flat to expansionary levels. Therefore, this is less contraction of a report than it appears on the surface perhaps.

(-/0) The FHFA house price index for May rose +0.2%, compared to an expected +0.4%. Regionally, the Mountain region gained over +1%, with the Mid-Atlantic not far behind, while New England lost just over -1% for the month. More importantly, year-over-year, house prices have shown a gain of +5.6%—a pace that remains quite robust.

(+) Existing home sales for June rose +1.1% to 5.57 mil., reaching the highest level since Feb. 2007, contrary to expectations of a -0.9% decline. However, May results were revised downward by -0.4%. Single-family home sales rose +1%, while multi-family increased +3%. Regionally, The Midwest and West rose by several percentage points each, the South was little changed, and Northeast lost ground by just over a percent. June is traditionally one of the busiest months of the year for sales activity; tight inventory due to lack of building activity could be the one variable keeping growth ('only' +3% year-over-year) somewhat contained.

(+) Housing starts rose +4.8% in June to a seasonally-adjusted 1,189k, just below the post-recession high of 1,123k. While this sharply surpassed the +0.2% gain expected, prior month levels were also revised down by almost -30k. Single-family starts rose +4% (+13% from a year prior), reversing a decline the prior month, while multi-family starts rose over +5% (but -22% from a year before). Regionally, the single-family gains in the Northeast U.S. led the way, while the other key regions showed moderate gains. There have been some unusual impacts from the expiration of tax credits in the New York City area, which affected the timing and causing 'bunching' of some starts, convolution of the relative growth metrics a bit. Building permits rose +1.5% to 1,153k, which was three-tenths of a percent stronger than the gain anticipated, with single-family permits up +1% and multi-family up +2.5%.

(-) The NAHB homebuilder index for July declined a bit from the prior month to 59, compared to an expected 60. Current sales, future expectations and buyer traffic all declined by at least a point, balancing the result. Regionally, the South accounted for the bulk of the decline, down -4 points, while the other three regions all gained ground by a bit. Overall, this index tends to be a well-regarded leading indicator of housing start activity and it remains near cycle recovery highs, which is positive for that sector.

(+) The Conference Board Leading Economic Index for June rose +0.3%, following a decline in May. Key areas of improvement included initial claims, building permits and financial indicators (interest rate spread and stock prices). The coincident index rose a similar +0.3% for the month, while the index of lagging indicators declined by -0.1%—after several months of increases. The coincident measure was helped by non-farm payrolls and industrial production, while the lagging measure was held back by duration of unemployment as well as commercial/industrial loans outstanding. Overall, the report was somewhat positive, but as you can also see from the chart below, improvement has decelerated as of late in keeping with recent data that's demonstrated a flattening of several key economic metrics. Year-over-year, the leading index growth rate tempered to +0.7%, which is the lowest such rate of growth since late 2009.

None of the data in the various leading, coincident and lagging indicators is anything we don't know about already, but the 30,000-foot business cycle view and timing component is the most useful contribution of this series. Opinions continue to differ as to whether we're still in mid-cycle, late-cycle or even 'extra innings' (as was alluded to recently by a well-known finance professor with an academic focus on the high yield and distressed bond market). Regardless, we're seeing growth on a variety of metrics slow down somewhat.

Conference Board Economic Index July 25, 2016

(+) Initial jobless claims for the Jul. 16 ending week declined by -1k to 253k, and below the 265k expected. Continuing claims for the Jul. 9 week came in at 2,128k, which was -9k below expectations. Claims overall remain low, although some of the seasonal adjustments might reduce some of the precision of these figures due to typical summer auto plant retooling shutdowns, the timing of which can vary.

(-) The International Monetary Fund issued their Global Growth Outlook report last week, and to no surprise, lowered their forecasts for global GDP a tenth from 3.2% to 3.1% for 2016—matching the growth level from last year. The forecast for 2017 was lowered a tenth as well, to 3.4%. These include a positive 'minor fallout' scenario from Brexit, while more contentious or punitive treaty re-negotiations could take growth down to just below 3% for the next few years. On a global level, economists tend to look at growth of under 2-3% as being 'recessionary', in contrast to the sub-zero growth we tend to typically think of for typical recessions—the difference is a reflection of the far higher growth rates experienced by emerging nations, and the need to adjust for that. Some of this decline was naturally due to the uncertainty and assumed economic headwinds as a result of Brexit, but also general slow growth trends worldwide—including continued slower trend growth from China.

Market Notes

Period ending 7/22/2016

1 Week (%)

YTD (%)

DJIA

0.35

8.18

 

S&P 500

0.64

7.72

Russell 2000

0.64

7.68

MSCI-EAFE

0.00

-1.91

MSCI-EM

0.17

9.46

BarCap U.S. Aggregate

0.13

5.48

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

7/15/2016

0.32

0.71

1.15

1.60

2.30

7/22/2016

0.33

0.71

1.13

1.57

2.29

Equity markets experienced another positive week, with earnings results coming in better than expected and continued M&A activity. From a sector basis, technology and utilities led the way with the best returns, while energy lost over a percent, followed by industrial.

So far with 125 companies in the S&P having reported for the 2nd quarter, 80% have beaten earnings estimates (which were admittedly quite tempered in many cases). This still doesn't mean earnings are in great shape, as absolute results show flat to even slightly negative growth on a year-over-year basis, which would be the 5th straight quarter of declines—a pattern last seen during late 2008-early 2009. Of course, the largest negative impact has come from the energy and materials sectors, for which earnings suffered dramatically in the wake of extreme commodity price declines. However, such impacts are expected to 'trail off' and normalize in coming quarters assuming recent price gains hold. Other sectors are nowhere near in as bad a shape, with mid-single digit earnings growth seen in a variety of areas, such as healthcare, industrial and consumer stocks. Higher stock P/E ratios as of late are a factor of both the low interest rate environment, but also market expectations that better earnings 'E' in coming quarters will catch up to the price 'P', and bring the ratio back in line to lower levels. However, this process rarely seems to happen smoothly.

Internationally, developed markets earned gains in line with domestic equities last week in local terms, but a stronger dollar created a headwind, resulting in flattish performance on net. Economic data in Europe tended to be on the weak side, particularly in the U.K., where PMI fell into contraction territory. The ECB took no policy action last week, but alluded to further stimulus if needed. The post-Brexit topic of the hour is the Italian banking system, which is facing solvency issues due to a growth in nonperforming loans and general high levels of debt. While a bailout is likely required, concerns continue regarding populist sentiments there especially due to elections there later this year.

Emerging markets outperformed developed, with the strongest gains in Latin America, with Brazil taking no central bank action. Turkey was pummeled with nearly a -20% loss in the aftermath of the prior weekend's coup attempt and subsequent crackdown on citizenry in a variety of areas, from waivers of unreasonable detentions to closures of schools, charities and other institutions as part of a broader state of emergency. The fear in Turkey is that President Erdogan is using the coup attempt as an excuse to consolidate power, punish opponents and/or move from a traditionally secular mindset to one that appeals increasingly to the Islamic side—a move that naturally concerns global politicians as well as investors. At the same time, even leaders in less stable nations understand the importance of keeping access to financial markets; a perception of lessened liquidity or asset safety could cause a dramatic spike in credit spreads, or cut of needed external capital flows completely, restricting a nation's borrowing capability for years to come.
U.S. bonds were relatively flat on net with interest rates moving very little, in contrast to recent weeks. In addition to longer-term treasuries, corporate bonds, especially high yield and bank loans, earned the strongest returns as investors continued to seek yield wherever they could find it.

The dollar strengthened by almost a percent on the week, affecting foreign bonds as much as any other asset class. This was the most substantial factor, as results in local currency terms were generally flat to slightly positive—emerging market debt was the most affected to the downside. From a practical standpoint, such move favors USD-hedged and USD-denominated strategies and penalizes locally-denominated ones; ETFs and some active foreign bond strategies can be targeted to either extreme, but many of the more well-known active managers tend to 'cross-hedge' strategically, ending up somewhere in the middle. Such activity with currencies can cause performance differentials to be somewhat larger than one would expect in the short term compared to other asset classes.

Real estate experienced sharp gains globally, outperforming broader equity markets. In the U.S., cyclical lodging and healthcare REITs led the way, while Asia and Europe lagged, albeit will still-positive returns. Year-to-date, the +15% gain for the domestic REIT group remains one of the better asset class performances thus far, due to lessened fears about rising interest rates, as well as continued strong tenant demand and low vacancy activity.

Commodities lost several percent during the week, with no help from a stronger dollar, and weaker energy prices as inventories were reported to be a bit larger than expected. Accordingly, West Texas crude declined from just over $46 to $44. Other groups also lost ground, including metals and agriculture, but to a lesser degree than did oil. Unsurprisingly, the U.S. oil rig count has picked up in recent months, in keeping with higher prices—on the order of about 10 additions per week (twice the rate expected)—which could put U.S. production levels back into positive growth levels by next year.

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 18, 2016.

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