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Weekly Review - March 23, 2015

Weekly Review - March 23, 2015

Guest Post - Monday, March 23, 2015

Summary

  • In a somewhat light week for economic reports, the FOMC meeting was the highlight—in which no action occurred, other than a subtle language change that stemmed the persistent rise in the dollar. Several housing reports showed lackluster results, but these could have been largely affected by extreme weather in the Eastern part of the country, artificially depressing activity.
  • Equity markets turned positive upon the Fed's tempered language and references to moderation in economic growth (which could postpone a rate increase—pleasing to markets). Bond rates also fell back sharply on the news, which was positive for bond prices. The weaker dollar served as welcome news for commodity prices.

Economic Notes

(0) As we already discussed mid-week, the FOMC made no policy changes, but did remove 'patient' from their statement. Based on past history, this lays the groundwork for potential rate increases in coming meetings. Now, it's a matter of which meeting. Following the meeting, Fed member estimates of future interest rate paths and economic growth were released, and, with the recent soft patch, these ended up being lower than expected. These very well could have helped market sentiment, due to the presumption that rate normalization could be stretched out a bit into the summer or beyond.

The 'dot plot' everyone talks about is basically a graph of opinions of the various FOMC members showing where rates are expected to be over the next few years. Markets have been focusing a lot on this dot plot, not because the estimates are accurate (they aren't), but in terms of implied changes from the prior meeting, which could signify changes in committee dovishness or hawkishness. These dot plots can change dramatically from meeting to meeting, such as the 0.50% or so drop in Fed Funds projections for the next few years—with the 2015 year-end estimate falling from over 1% to 0.625%. FOMC economic growth and inflation projections end up being just as inaccurate, so these, too, aren't useful in that regard, but do provide a snapshot as to changes in thinking.

In short, and after taking in countless opinions on the topic from a variety of global economists, no one knows when the Fed will raise rates. If growth remains a bit tempered, and dollar continues to be a headwind, later in the year could be a reasonable guess. If economic conditions re-accelerate upward and/or signs of inflation through wage growth or other areas seep into the results, June might be the time. Keeping this in context, we're talking about 0.25%. In absolute terms, this isn't enough to move the needle or stop the economy in its tracks. It actually may help, as it may incent banks to loan at a slightly higher (and more profitable) interest rate—one argument about why lending is so low currently is that rates are low enough where loan spreads are barely worth the trouble. Over Federal Reserve history, rates have often been both raised and lowered by up to 0.50-1.00% at a time, and albeit nominal rates were often higher to make the relative change less dramatic, we are living in a period of a very careful, conservative, scripted and nuanced Federal Reserve.

(0) The New York Empire manufacturing index for March came in largely in line with expectations, rising +6.9 compared to an expected +8.0, although it fell from February's +7.8 level. New orders and shipments fell by several points, while employment and hours worked rose by an equivalent amount to even higher positive levels. Capex plans remained solidly positive at +19, albeit down a bit from highs. All-in-all, this was a decent report showing growth.

(0/-) The Philly Fed index for March came in similar to February, but slightly weaker than expected, at +5.0 compared to consensus estimates calling for +7.0. Shipments were down sharply (likely were weather-related), while new orders and employment also ticked down slightly, as did capex spending plans. However, most segments remained in positive growth territory despite the tick downward last month.

(-) Industrial production for February came in weaker than expected, gaining +0.1%, compared to a forecasted gain of +0.2% and featured some negative revisions for prior months. Manufacturing production fell by -0.2%, which disappointed relative to an expected flat reading (which was almost entirely due to a -3% decline in auto production), while utilities output rose over +7% from winter heating needs, and mining production fell by -2.5% upon oil/gas softness (energy extraction is included in the natural resources 'mining' category). Capacity utilization for the month came in at 78.9%, lower than the 79.5% expected.

(0/-) The NAHB Housing Market index fell by -2 points in March to 53, which disappointed a bit compared to consensus expectations calling for 56. Expectations for present sales and prospective buyer traffic both fell, for which poor weather during the past few months may explain some of the deterioration. Expectations for future sales were flat. As this series tends to act as a preview of housing starts for coming months, the news isn't strong. On the bright side, the bulk of bad news came from the (weather-wise) hard-hit Northeast region, so conditions were stronger elsewhere.

(-/0) Housing starts fell off by -17.0% in February, sharply underperforming the -2.4% hit expected. Single- and multi-family both declined, and activity in the Northeast and Midwest regions fell by almost half—indicating that the impact of weather was extreme. Building permits actually rose +3.0%, outperforming the forecasted +0.5% increase.

Housing markets have continued to struggle, and this has been another frustrating byproduct of the housing bust-oriented Great Recession. The weakness in this important segment of the economy has some economists stumped. Some contributing factors appear be a tightened availability of credit following the overly loose behavior of the 1990s and early 2000s, something we already know too well. In typical fashion in being burned so severely not that long ago, lenders/financiers appear to have reverted to the opposite extreme in reaction to what just happened. This helps partially repair overdone conditions (although some of the same structural problems are still intact as before) but does, unfortunately, penalize the next generation of borrowers, who won't have things as easy. Higher levels of student loan debt are also serving as a headwind to taking on even more debt.

There have been some signs of life in household formation, and a continuation of this recovery trend to higher levels of owner-occupied housing as opposed to 'investor'-owned stock should have a stabilizing effect in theory. It's also possible that the government's longtime goals of a high homeownership rate (which has generally wavered in the range of 2/3 of total households for decades, plus or minus a few percent, per the accompanying charts showing outright level and year-over-year change in level) may not be sustainable with current demographics, or even desirable in a more dynamic job market where being tied to a single location may not work as well as it did in years past. But someone has to own the homes...

Source: U.S. Census Bureau, Federal Reserve Bank of St. Louis

(0) Initial jobless claims for the Mar. 14 ending week came in at 291k, very close to the expected 293k figure. Continuing claims for the Mar. 7 week came in just a bit lower at 2,417k, which was just above consensus expectations of 2,400k. There appeared to be no special factors involved now that weather conditions have become less severe.

Market Notes

Period ending 3/20/2015

1 Week (%)

YTD (%)

DJIA

2.13

2.29

S&P 500

2.67

2.86

Russell 2000

2.79

5.37

MSCI-EAFE

4.01

6.82

MSCI-EM

3.19

1.38

BarCap U.S. Aggregate

0.79

1.48

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2014

0.04

0.67

1.65

2.17

2.75

3/13/2015

0.03

0.68

1.60

2.13

2.70

3/20/2015

0.01

0.60

1.42

1.93

2.50

In response to the Fed's language following the conclusion of their Wed. meeting, the U.S. dollar index fell nearly -2%, the largest such move in six years, resulting in the worst full week performance for the dollar in two years. This may have been part of the point, as continued strength in the dollar could certainly throw a wet blanket over U.S. export activity and earnings, while benefitting Europe and Japan (as the other primary traded currencies). Keeping the possibility of rate increases somewhat at bay lowers the strong dollar risk somewhat.

U.S. stocks gained on the week, with small- and mid-caps outperforming large-cap blue chips. Sector results were led by health care and utilities, while materials lost nearly a percent. Biotech has been a strong contributor to returns in health care due to the combination of strong earnings (over +30% growth last quarter, several times that of the S&P 500), as well as M&A transaction activity and some interesting drug trial news for conditions such as Alzheimer's. In fact, almost all of the small cap strength this year has originated from the health care and tech sectors as well, with other segments performing largely in line with each other. While perhaps not in bubble territory yet, this sub-sector continues to be one of high investor interest, along with social media.

Foreign stocks largely performed in line with U.S. equities in local terms, but outperformed when translated back for a weaker dollar. Problem areas of the emerging markets, notably Turkey and Brazil outperformed with stronger risk-on sentiment (tied to the Fed), followed by peripheral and core Europe, while Asian equities lagged with slighter gains and less of a currency impact.

Bond prices gained, with rates falling after the FOMC announcement, which bought some time for those hoping for continued lower rates. The dollar weakened a bit on the week, which gave a small boost to locally denominated foreign debt over USD-pay bonds, with the difference being about a percent.

Real estate experienced solid gains across all sectors upon lower interest rates and an accommodative-to-neutral stance from the Fed. Additionally, underlying fundamentals continue to look strong in this segment, which is an intermediate-term positive.

Another positive from the dollar pullback following the FOMC announcement was a corresponding uptick in commodity prices (which tend to have an inverse relationship to the dollar), but the bump wasn't enough to slow a largely negative week. Precious metals gained a few percent on the assumed longer Fed timeline for easing (which lowered real interest rates—gold's nemesis), while crude oil continued to look strained under high inventories in the U.S. The WTI crude contract fell a bit on the week towards $40 before recovering again just above $46, as storage levels continue to build despite a slowdown in rig counts (producers can't just flip a switch and turn off production). Industrial metals also weakened generally with a still-strong dollar and less optimistic economic growth projections coming out of China, a primary consumer of these.

Have a good 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 March 16, 2015.

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