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Weekly Review - July 5, 2016

Weekly Review - July 5, 2016

Guest Post - Tuesday, July 05, 2016

Summary

Economic data for the week was highlighted by stronger manufacturing results in the ISM and Chicago PMI surveys and higher consumer confidence, while real estate activity was mixed—a combination of higher home prices but weaker building activity for the prior month.

Investment markets recovered sharply following the 'Brexit' surprise last week, with equities higher globally. Interestingly, bonds also fared well with bond yields falling on net for the week in both developed and emerging markets. Commodity prices, including crude oil, generally showed continued strength during the week.

Economic Notes

(0) The third and final estimate of first quarter GDP was revised up a few additional tenths of a percent from +0.8% to +1.1%, which was generally on target with expectations. Consumer spending growth was revised down by almost a half-percent, although revisions upward took place in non-residential investment, which declined less than first estimated, and exports, which actually gained ground (no doubt with some stabilization in the dollar). The fluid inventory component was not largely changed, therefore, carryover effects to 2nd quarter estimates are minimal. Speaking of which, estimates for 2nd quarter GDP appear to run the gamut, from the lower to upper 2's.

(+) The ISM Manufacturing index rose in June to 53.2, which outperformed forecasts by +2 points and pointing to expansion. The underlying components of the report showed strength as well, with gains in production, new orders and employment. Anecdotally, a supplement survey after the primary survey showed that Brexit was not expected to have much more than a negligible impact on U.S. business activity. Interestingly, the manufacturing sector only accounts for about 10% of real GDP, so it's less meaningful than it used to be, but this index does help indicate economic turning points.

(-) Construction spending for May fell by -0.8% month-over-month, in contrast to a +0.6% gain expected, and a few prior months were revised lower as well. Private non-residential spending fell by -0.7%, while state/government expenditures declined -3% on the month.

(+) The June Chicago PMI rose +7.5 points to 56.8, the highest level in a year and a half. This result offset a few months of prior weakness, led by strength in new orders, order backlogs and production. However, some confidence about future orders deteriorated a bit, and demand for labor fell—the employment segment fell by the most in several years and came in at a contractionary sub-50 result. While this single month represented a sharp recovery in this series, recent trends continue to point to lower-to-moderate growth levels in the manufacturing sector.

(x) The advance goods trade balance report for May showed a wider deficit than expected, at -$60.0 bil., an increase of -$3 bil. over the prior month. Goods exports declined by a few tenths of a percent (down -6% year-over-year), while imports rose by nearly +2% (but down -4% over the last 12 months). Industrial supplies imports was the key affected segment, which includes petroleum products.

(0) The S&P/Case-Shiller home price index rose +0.5% in April, which was a tenth lower than forecast. Sixteen cities experienced increases, led by Detroit, Seattle and Portland, which approached +1%; four cities saw prices decline, led by close to half-percent drops in Cleveland and San Francisco. However, some seasonal-adjustment factors may have convoluted some of the monthly data. Year-over-year, the index showed an increase of +5.4%, which is strong on both a nominal and real/inflation-adjusted basis.

(-) Pending home sales in May fell -3.7%, which was a deeper decline than the expected -1.1% drop. This was the largest monthly decline in six years, but strong gains and revisions from prior months tempers the dramatic impact, as usual, causing the change over the past several months to be close to flat on net. Regionally, sales fell in all four areas, led by the Northeast down -5%, while the South and West held up a few percentage points better. The 'pending' nature of this report points to a mixed result for 'existing' home sales in coming months.

(+) The Conference Board consumer confidence index for June rose almost +6 points to 98.0, which was far higher than the expected 93.5. Consumers' assessment of both current conditions as well as expectations for the future both improved, accounting for the underlying change. The labor differential, which measures how easy or difficult jobs are to find, was just slightly higher.

(0) Personal income for May rose +0.2%, which was a tenth lower than forecast, and was led by a small rise in wages/salaries. Personal spending rose +0.4%, which was on target with expectations and represented a decent increase. The relationship between the two, which translates to the personal savings rate, ticked down a bit to 5.3%. The PCE headline and core price indexes, which are similar to CPI but offer a slightly different composition, each rose +0.2%, bringing the year-over-year change to +0.9% for the headline and +1.6% for the core.

(0) Initial jobless claims for the Jun. 25 ending week rose by +10k to 268k, which was just a thousand more than expected. Continuing claims for the Jun. 18 week, on the other hand, ticked down to 2,120k, which was -31k less than consensus expectations. Initial claims levels remain on the low side.

Market Notes

Period ending 7/1/2016

1 Week (%)

YTD (%)

DJIA

3.18

4.45

 

S&P 500

3.27

4.06

Russell 2000

2.67

2.65

MSCI-EAFE

3.47

-3.70

MSCI-EM

4.14

5.68

BarCap U.S. Aggregate

0.76

5.53

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

0.27

0.64

1.08

1.57

2.42

7/1/2016

0.28

0.59

1.00

1.46

2.24

Global equities rose several percent on the week as 'Brexit' fears dissipated with investors moving back into 'risk' asset classes. In addition, the Fed announced that most banks passed their most recent stress tests, which helped sentiment. If this wasn't enough, central banks (notably the Bank of England) alluded to additional monetary easing measures to help with the Brexit 'transition' period. Markets often tend to respond well to central bank easing, especially when the promises are open-ended. There are also new calls to cut Britain's corporate tax rate, which could also help ease the pain, although the success of these types of ideas is dependent on Parliament.

In the U.S., defensive sectors continued to lead, however, with the largest gains coming from utilities, telecom and health care. Materials lagged, while the other groups fell within a fairly tight range.

Foreign stocks outperformed domestic issues, with emerging markets leading the way, although U.K. and European shares were not far behind, with Japan as the laggard. Peripheral Europe performed especially well, with hopes for interest rate easing. Latin America also performed well, even though Mexico raised interest rates by a half-percent to 4.25% in order to combat inflation pressures brought on by a depreciated peso (an example of how currency fluctuations can impact inflation readings).

It was an interesting week where both risk assets and less risky 'flight to quality' assets each performed well. U.S. bonds experienced a solid week, with the 30-year treasury hitting an all-time low yield and the rate on the 10-year note continued downward, back again under 1.5%. Investment-grade bonds were surpassed, however, by high yield corporates, which earned several percent on the week. Consequently, recent portfolio bond adjustments in government and corporate towards a broader universe of issues and slightly longer duration band has been effective in this type of environment.

The news in muni markets was the upcoming set default by Puerto Rico of almost $2 bil. in debt payments, about half of which are in the island's general obligation bonds. This result, although part of a much longer story, was due to the U.S. territory's sorry financial position and political infighting—the drama was intensified as the governor declared the moratorium on G.O. debt payments minutes after President Obama signed the law regarding the territory's restructuring process with all finances under a federal oversight board. Long-story-short, the oversight board is a desired outcome for creditors (including a lot of muni mutual funds), but the price impact on Puerto Rican bonds has muted as bad conditions here, including default and partial restructuring, have been priced into bond quotes for quite some time.

Foreign bonds gained several percent as well, led by emerging market bonds, mostly due to EM currencies strengthening against the dollar. Much of the developed market move was related to continued dovish language—this time by Bank of England governor Mark Carney mentioning that a rate decrease might be necessary this summer to assist with Brexit-related uncertainties.

Real estate continued to perform strongly, up several percent in keeping with general equity returns globally. Regionally, the U.S., Japan and Europe all performed in line, while the U.K. lost ground, bringing year-to-date real estate returns in Britain to just under -20%. Real estate activity depends on liquid lending conditions and free movement of capital from both domestic and foreign sources, so a Brexit could serve to hamper that.

Commodities were up several percent on the week, with strength in a variety of areas. Crude oil gained a few percent with prices moving up again just above $49 towards the technically significant $50 level once again. However, natural gas has been in the news much less frequently, but spot prices are up +50% over the last quarter as summer demand has strengthened relative to current supply levels. Metals also gained, particularly silver and nickel, while agriculture was slightly down on net—despite higher volatility of various items within that basket as of late. It may be a surprise to some, but commodities ended up as the best-performing asset class of the 2nd quarter, with gains into the double-digits, in a continuation of the trend that began around mid-February with the bottoming of crude oil prices.

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 June 27, 2016.

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