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Weekly Review - May 23, 2016

Weekly Review - May 23, 2016

Guest Post - Monday, May 23, 2016

Summary

  • Economic data on the manufacturing side was lackluster, with indexes contracting again. Inflation was again generally contained, and housing came in a bit better than expected, while the FOMC minutes from April surprised somewhat—being more biased towards tightening than some observers first thought.
  • Equity markets in the U.S. and developed foreign markets moved slightly higher on the week generally as investors absorbed the more hawkish set of Fed minutes, while emerging markets lost ground. Bonds declined as interest rates ticked up along the yield curve. Commodities gained with a continued recovery in oil prices.

Economic Notes

(-) The NY Empire State manufacturing index fell sharply in May, from +9.6 the prior month to -9.0, disappointing as a slight decline to +6.5 was expected. The details of the report were highlighted by a decrease in shipments and new orders, which both fell into negative territory, while employment ticked upward a bit. Prices paid also remained higher, with a comeback in commodity prices.

(-) The Philly Fed index fell by a slight -0.2 point to -1.8 for May, which was a disappointment compared to the +3.0 reading expected. Within the report, new orders fell into the negative, while shipments and employment improved—despite still falling in negative territory. This, along with the earlier NY survey, pointed to another weak spot in manufacturing.

(0) The NAHB homebuilder sentiment index for May came in at 58, which was the identical result over the prior three months, although expectations called for an increase to 59. Current sales and prospective buyer traffic were generally unchanged, but future sales expectations ticked upward a few points and served as the highlight of the survey. On the positive side, this represented the strongest May in a decade for sentiment, which can be sporadic as high hopes in winter can either be met or disappointing by spring prime time. Regionally, the index fell in the Northeast, remained steady in the West and improved in the Midwest and Southern U.S.

(0) The consumer price index rose +0.4% on a headline level and +0.2% on a core measure, removing the impacts of food and energy. Rent inflation was a partial driver, with increases within the range of a quarter-percent increase, in addition to services such as medical care and transportation. Year-over-year, headline and core CPI rose +1.1% and 2.2% respectively, remaining within recent tempered levels.

Over the past year, the biggest inflation increases have been in the medical care, transportation and other services, each gaining over +3%, while the offsetting decline in energy commodities remained substantial at -14%. Inflation data is sliced and diced by a variety of sources, including the Fed, where various branches (Atlanta and Cleveland) create their own price data based on the categories of ‘sticky’ (core-like, and slow-changing items) and ‘flexible’ (non-core, and quick response items), in addition to a ‘median’ CPI based on the long list of items in the inflation basket. Using those alternative metrics, it’s a similar story to what the official BLS numbers show. Sticky CPI rose 2.5% year-over-year, while Flexible CPI items fell by -1.8% over the trailing 12 months. Interestingly, it’s been pointed out that the Sticky price series is rising at a level more similar to periods of tighter Fed policy in 2000 and 2006. The Median CPI came in at 2.5% on a year-over-year basis, which is the highest that’s been since 2009.

(+) Existing home sales for April rose +1.7% to 5.45 mil. units on a seasonally-adjusted annualized basis, which slightly outperformed the +1.3% gain expected. On a non-seasonally altered basis, it happened to be the best April in a decade. Additionally, March sales were revised upward positively. April’s results were led by a multi-family increase of +10%, while single-family sales gained just a few tenths of a percent. Regionally, sales rose +12% in the Midwest, leading the way, the Northeast experienced low single-digit gains, while the South and West lost a bit of ground. Year-over-year, sales are +6% higher, which demonstrates some improvement in housing overall.

(+) Housing starts for April rose +6.6% to a seasonally-adjusted annualized rate of 1,172k units, outpacing expectations calling for +3.3%. The gain was led by multi-family, which rose +14%, while single-family gained just over +3% to 778k (up over +4% year-over-year). Building permits followed a similar pattern, rising +3.6% for the month, but underperformed forecast of a +5.5% gain. In that group, multi-family rose by +8%, while single family permits rose +1.5%. Interestingly, the data was skewed by the New York City housing market, in which some political wranglings were taking place regarding the renewal of certain tax subsidies. While building overall has improved, it remains far below peak levels of a decade ago and aren’t necessary meeting housing demand levels—this factor and housing price recovery gains since the financial crisis explain the strength of apartments in the past cycle.

(+) Industrial production for April rose +0.7%, which bested forecasts of +0.3%. This was led by a sharp +6% gain in utility output, which is weather-related month-to-month. The manufacturing production component of this rose +0.3%, within which motor vehicle output rose over +1%. Capacity utilization ticked up by about a half-percent to 75.4%, which outperformed expectations by about the same amount. Interestingly, since modern records on capacity utilization began in 1967, the average level over the subsequent period is just over 80%, with the average over the past 20 years just below that at 78%. After bottoming in June 2009 at 66.7 when the financial crisis period ended, over the recovery, levels peaked 78.9% in Nov. 2014 but have generally hovered in the mid-70’s—far weaker than in previous economic cycles.

(+) The Conference Board’s Index of Leading Economic Indicators for April rose +0.6%, leading to a similar growth trajectory of +0.6% for the prior six months. While positive, this was slower than the +1.3% pace of the prior six month period. Positive contributors for the month included financial metrics (such as interest rate spread and stock prices), manufacturing hours, jobless claims and building permits; consumer expectations was the sole detractor from the index for the month. The coincident and lagging indicators rose +0.3% each for the month. As seen below, while the trend over the past few months has flattened a bit, the broader trajectory from the depths in early 2009 continues.

Leading Economic Indicators

(0) The minutes from the April FOMC meeting were perhaps more interesting than average, with the implication being a stronger apparent willingness to boost rates earlier than was suggested by the headline communication at the time—with June remaining on the table as a possible hike point. Probabilities rose from just under 5% to nearly 30% for action in June, which is a bit higher than a few weeks ago. Participants agreed that if conditions continue to demonstrate a pickup in economic growth, strong labor market conditions and higher inflation toward the long-term target, a second rate move could be appropriate.

Comments from other FOMC members like NY Fed President Dudley also alluded to the ‘openness’ of a June or July move. Frankly, while the Fed doesn’t look to Fed Funds probability markets to set policy, probabilities in such markets for Fed actions are an interesting sentiment indicator around the time of Fed meetings, based on the collective ‘wisdom’ they possess. No doubt, it appears the Fed would ‘like’ to raise rates, but continues to keep a very cautious stance intact due to perceived weakness both in the U.S. and from foreign factors.

(0) Initial jobless claims for the May 14 ending week fell to 278k, +3k higher than expected, but down -16k from the prior week. Continuing claims for the May 7 week came in at 2,152k, which was -6k below expectations. The initial claims numbers normalized somewhat from the spike the prior week, which proved to be single-state related. Claims overall continue to chug along at low levels.

Market Notes

Period ending 5/20/2016

1 Week (%)

YTD (%)

DJIA

-0.04

1.62

S&P 500

0.35

1.31

Russell 2000

0.92

-1.52

MSCI-EAFE

0.31

-3.20

MSCI-EM

-1.36

-1.12

BarCap U.S. Aggregate

-0.62

3.24

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

5/13/2016

0.29

0.76

1.22

1.71

2.55

5/20/2016

0.33

0.89

1.38

1.85

2.63

U.S. stocks inched upward a fraction of a percent on the week, despite several weaker days caused by a more hawkish sentiment towards raising interest rates implied by the Fed’s April meeting minutes released during the week. By industry, energy, tech and financials gained the most ground, while defensive utilities and consumer staples lagged several percent each. The tech sector was boosted by a vote of confidence from Warren Buffett, where it was reported Berkshire Hathaway made a billion dollar investment into Apple.

The dollar strengthened by almost a percent on the week, acting as a headwind for foreign assets of all types. Non-U.S. equities generally gained in local turns, but still managed to outperform in USD terms by a bit. Returns were led by Japan and the U.K., while European stocks were generally in line with the U.S. Japanese GDP for the 1st quarter came in at +0.4%, resulting in a +1.7% year-over-year gain—which was far better than expected. Emerging markets lagged on the week, with Brazil and Russia posting declines, while Chinese stocks fared better. Brazilian stocks have been the star of 2016 insofar as emerging markets go, but momentum has tapered off in recent weeks as hopes for more dramatic political change have stalled somewhat, despite the impeachment of President Rousseff. A lack of Brazilian exposure has hurt some active emerging market managers this year, particularly those who focus on what they consider to be higher-quality firms (which can be more difficult to find in commodity-sensitive and politically-uncertain nations like Brazil).

U.S. government bonds sold off by 10-15 basis points across the yield curve, again due to the perceived higher (albeit still small) likelihood of Fed action over the summer. The hardest hit were longer duration treasuries, as usual, while shorter- and intermediate-term debt were less affected. High yield bonds gained some ground as spreads tightened over the week, as did bank loans to a lesser degree. In recent weeks, demand has been high for U.S. treasuries from abroad, due to uncertainty in foreign political prospects (like the potential ‘Brexit’) as well as negative interest rate conditions, which make any positive yield appear extremely attractive by comparison.

Foreign bonds lost ground, which fell in line with the rising dollar—with emerging markets faring a bit worse than developed markets. Greece is back in the news as the IMF has been pushing the Eurozone to allow Greece to skip interest and principal payments for the next 25 years on its owed €200 bil. debt, then build in a refinance at a 1.5% interest rate for several decades after that. The Europeans are naturally reluctant, but also seek IMF participation in the bailout effort to boost legitimacy.

Real estate lagged along with higher interest rates, with the U.S. segment losing a few percent. Asian REITs were off slightly, while European REITs gained for the week. Year-to-date, returns between domestic and foreign real estate have fallen roughly in line.

Commodities experienced another positive week, led by higher energy prices, although at a more tempered pace—West Texas Intermediate Crude rose from a few cents above $47 to just under $48.50. Outside of energy, the bulk of other commodity groups sold off with no help from a rising dollar and higher rates, which punished precious metals.

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 May 16, 2016.

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