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Weekly Review - June 13, 2016

Weekly Review - June 13, 2016

Guest Post - Monday, June 13, 2016


In a quiet week for economic data, inventories rose, which was a positive for forward-looking GDP, jobs data was decent but consumer sentiment dropped a bit.

Equity markets in the U.S. ended generally flat, while foreign markets lost ground, with global growth and Brexit fears. Bonds ended higher with interest rates falling around the world. Commodities gained with strength outside of crude oil, which was little changed on the week.

Economic Notes

(0) The Nonfarm productivity for the final Q1 estimate was revised up from -1.0% quarter-over-quarter to -0.6%, so the decline wasn't as severe as first thought. Unit labor costs were also revised higher by +0.4%, to growth of +4.5% for the first quarter (+3.0% on a year-over-year basis), with the boost coming from employee compensation. There has been much discussion over the productivity conundrum during this cycle. In short, it's been poor, with reasons ranging from weaker overall demand, low capex spending on both the public and private side, as well as more-difficult-to-quantify demographic and technology shifts. At the same time, for perspective's sake, current manufacturing output remains near its all-time high. Compared to 40 years ago, this is twice the output with less than two-thirds of the workers, meaning the output per worker has increased significantly. The lesson here, if there is one, is that longer-term trends are the key factor.

(+) Wholesale inventories rose +0.6% for April, which was much higher than the expected +0.1% increase. Excluding petroleum, the inventory number also grew by +0.6%. This was the largest increase in nearly a year, which implies higher-than-expected GDP growth for the second quarter, based on early estimates. Inventory fluctuations remain a significant source of quarter-to-quarter estimate changes in GDP growth assumptions, as inventories rise and fall from month to month.

(0) The preliminary June University of Michigan consumer sentiment index ticked down almost a half point from last month, to 94.3, but was still better than the expected 94.0. Forward-looking consumer expectations fell by a few points, while assessments of current conditions rose a few. From an inflation expectations standpoint for the next 5-10 years, results fell to an all-time series low of 2.3%. Usually, events like the recent spike up in gasoline prices would have created the opposite results, but regardless, this is considered by policymakers as an input to their evaluation process.

(0/+) The government JOLT's job openings report for April showed a gain to 5,788k, which was larger than the 5,675k expected, as the job openings rate equaled 3.9%, matching its post-crisis high of last July. The hiring rate fell by -0.2% to 3.7%, which was a negative, while the quits rate fell a tenth to 2.0%. With mixed underlying data, the report less positive than was implied by the headline.

(+) Initial jobless claims for the Jun. 4 ending week fell to 264k, below the 270k expected. Much of the claims anomalies remain state-specific. Continuing claims for the May 28 week also declined, to 2,095k, below the 2,171k forecast—this represented a low point for the recovery thus far, as well as the lowest level since Oct. 2000. Despite a weak employment report last week, claims have remained very low, which implies little layoff activity.

(0) Fed Chair Yellen gave a speech at the World Affairs Council of Philadelphia, which was watched as the last major commentary before the mandated 'black out' period prior to FOMC meetings. The tone was unchanged from recent other comments, with an upbeat view on the economy overall, and especially labor markets (particularly wage growth), and that additional rate hikes are likely appropriate—although timing wasn't mentioned (as opposed to the 'in coming month' as it was last month). Consensus continues to see July or September as more likely for hike announcements than June, although we'll see after the Fed meeting this week.

Read the "Question of the Week" for May 31, 2016:

What's the probability of the Fed taking action this summer?

Market Notes

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U.S. stocks were flat last week on net, on both the large and small cap side, due to weaker results on Thursday and Friday. Energy and consumer staples were the leading sectors for the week, while financials and health care (namely biotech) suffered the most significant losses.

Overseas, a stronger dollar on the order of two-thirds of a percent affected non-U.S. returns negatively somewhat, but returns were generally poor in Europe and the U.K. in local terms anyway, with stocks down close to -4%, with Brexit fears outweighing stronger industrial numbers. Emerging market stocks were the leaders on the week, with recovery performances from South Korea, which cut interest rates by a quarter-percent to a record low of 1.25% (in a still-emerging market no less) in an effort to stimulate growth; this effect carried over to several Asian neighbors.

Brexit fears have been an overhang for markets, especially in Europe and the U.K., as a recent poll showed a stronger-than-expected chance of a British exit. Recent polls have been split on the issue, making this a closer call than many would prefer. The Bank of England announced that it has prepared emergency liquidity for banks, just in case, as it did prior to the Scottish referendum in Sept. 2014 that also appeared close but failed. Generally, should the initiative pass, analysts expect some short-term disruptions, volatility and general uncertainty as trade linkages and agreements are re-negotiated, but don't foresee longer-term hurdles that can't be overcome. While the U.K. has always retained a degree of separation from the rest of Europe (retaining its own currency is a big one), a remaining concern surrounds other nations who might opt for the same path within the eurozone, with messier results due to a shared currency. This is essentially another chapter of the same story: will the EU survive? This and slower growth have certainly led to continued tempered sentiment in this part of the world.

Speaking of developing and emerging markets, index maintainer MSCI will make its annual announcement this week about index compositions, namely, where nations fall in the respective developed vs. emerging vs. frontier status, and what weightings should be. Some of this is quantitative (based on market cap sizes in various nations) but some is also qualitative, and relies on investment industry input. Current areas of evaluation include how to treat China's large but generally domestically-focused 'A share' market, and how to handle transitions of certain upcoming nations (like Pakistan) and deteriorating ones (like Peru). Some of these market weights are so small that they don't seem to matter, but as emerging market active managers and index funds alike frequent benchmark strategies to MSCI's decisions, tweaks can mean larger inflow or outflows for less liquid nations. Often, a year is dedicated to making large transitions, which could matter significantly in the case of Chinese A shares—on a market cap basis, it would be an immediate 20% weight, with a total of 40% considering the already-included H-shares—but such a radical addition would never be undertaken. Instead, these would be scaled up over time. So, while passive investors don't often think of using index ETFs as being 'managed' in any way, the actual management of the index includes some very human subjective elements.

U.S. bonds rose on the week, as rates fell across the yield curve. Investment-grade treasury and corporate debt both gained, as did high yield, with continued higher and moderating energy prices. Developed market foreign bonds fell, with the dollar impact, although in local terms, German 10-year bonds fell to their lowest yields yet—at 0.02%. The ECB began their corporate bond-buying effort last week, and caused a decline in the euro, which is not surprising considering the 3 tril. euro size of the central bank's balance sheet.

Commodities rose with strength in agriculture, gold and natural gas, the latter of which enhanced returns in the energy sub-group, resulting from lower-than expected supplies as summer demand season is about to begin. Crude oil inventories fell, but this was offset later in the week with a rise in the Baker Hughes rig count, which led to the West Texas price rising above $50 briefly than back below it—for a net minimal change. Saudi Arabia has also announced price cuts for European customers on the order of 10-35 cents or so a barrel, similar to what the Russians have done, as competition for production exports has intensified.

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 6, 2016.

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