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Weekly Review - May 30, 2017

Weekly Review - May 30, 2017

Guest Post - Tuesday, May 30, 2017

Summary

Economic data last week was led by a weaker durable goods report, an upward revision to first quarter GDP, weakness in housing, and generally neutral results from sentiment and jobless claims.

Equity markets gained for the week, with U.S. stocks outperforming developed foreign markets, but under performed emerging markets with a recovery in Brazil. Bonds were generally flat with little change in yields in the U.S., while emerging market bonds outperformed. Commodities lost ground following declines in oil prices.

Economic Notes

(0/-) Durable goods orders for April fell -0.7% for the month on a headline level, better than the -1.5% drop expected. Core capital goods orders, however, were flat, which disappointed relative to a +0.5% gain expected. Core capital goods shipments were also weak, falling -0.1% for the month, compared to a similar +0.5% forecast gain.

(0/+) The 2nd estimate for 1st quarter GDP came in at +1.2%, which was better than the initial +0.7% growth rate quoted last month in the first estimate and the +0.9% expected for this release. Improvement occurred in business capex and personal consumption, while inventory investment fell a bit. Underlying PCE inflation was revised up a tenth to +2.1% on an annualized rate for the quarter, which was not meaningful. First quarter GDP has been weak for the past several years, which has been blamed to some extent on weather, seasonal adjustment issues and other measurement difficulties. This appears to again be the case this year. However, 2nd quarter estimates have been more optimistic, in the range of +2.5-3.0%, although initial optimism and later revision downward have been more the rule in recent years. The Federal Reserve Bank of Atlanta publishes a statistic called 'GDPNow', designed to be a more reliable real-time indicator of economic activity, which is flashing +3.7%—largely based on stronger expected fixed business investment results, as well as gains in intellectual property, which has been a challenging segment to measure. Expecting high 3's to low 4's type of economic growth on a perpetual basis, however, may not be realistic, as labor force growth and productivity.

(+) The FHFA house price index for March rose +0.6%, a tenth higher than expected. Prices rose in about half of the nine U.S. regions, with the biggest gains occurring in the Pacific states, and Atlantic states from MD southward through FL. Year-over-year, home prices have risen +6.2%, which remains very strong relative to history.

(-) Existing home sales for April fell -2.3%, which fell below the forecasted decline of -1.1%. Single-family units fell just over -2%, in line with the broader number, while condos/co-ops fell just under -2%. Regionally, the South fared the worst, down -5%, the West and Northeast also declined, while sales in the Midwest rose +4%.

(-) New home sales for April fell -11.4% on a seasonally adjusted basis to 569k, short of the 610k level expected; however, sales for the prior three months were revised upward a bit. Regionally, the West experienced the largest level of declines, although all four key regions saw weakness. Inventory rose +0.8 to a level of 5.7 months available supply. Although new home sales are +15% higher than a year ago, there appears to be an ongoing weakness in new housing data, which could be related to higher levels of supply from the prior boom as well as a hesitancy in single-family building (which stands in contrast to the large boom in multi-family housing during the last few years). Essentially, less building is holding down inventory that is driving up home prices in a variety of key cities.

(-) The advance goods trade balance for April showed a widening of the deficit by -$2.5 bil. to -$67.6 bil., compared to the forecasted level of -$64.5 bil., which had assumed narrowing of the gap. Imports rose +0.7% for April, with strength from consumer and 'other' goods (areas other than food, industrial, capital goods, consumer and cars). Exports fell by just under -1%, with lower volumes in autos and consumer goods. Wholesale inventories also fell, by -0.3%, which disappointed relative to a +0.2% gain expected, with declines in non-durable goods and raw materials.

(-) The Univ. of Michigan consumer sentiment index fell -0.6 of a point from the initial to the final reading for May, to 97.1, which disappointed relative to the 97.5 level expected. Assessments of current conditions fell a point, and was the primary catalyst for the decline, while future expectations declined to a lesser degree. Inflation expectations for the coming year were flat at +2.6%, while those for the coming 5-10 years rose a tenth to 2.4%. Sentiment in general remains at a high point for the cycle, while inflation expectations remain tempered to a large degree.

(0) The FOMC minutes from the May meeting reflected current conditions, which were a weaker-than-expected 1st quarter in terms of economic growth, which was seen as 'transitory', but stronger employment. The key areas of investor focus are the probability of a June rate hike (which appears to be fairly high, according to many economists), as well as the assumed late-2017 beginning of 'balance sheet normalization'. This refers to the Fed discontinuing the practice of reinvesting maturing proceeds of treasury and agency mortgage bonds into new bonds, essentially keeping the quantitative easing process intact.

The pulling back on reinvestments seems like a relatively minor step, which it is in theory, but due to the sizable participation of the Fed, the dollar volumes remain large. The Fed almost certainly realizes that careful communication and transparency are critical to avoid upsetting bond markets. Essentially, if bond markets know what is set to happen, such a policy may have more tempered effects on bond prices and yields. By contrast, a surprise decision to sharply reduce or discontinue reinvested proceeds would dramatically reduce overall demand, so could cause prices to drop and yields to spike—it's this type of market reaction the Fed would like to avoid. This is anticipated to be rolled out in Sept. or Dec., with perhaps the use of monthly 'caps' to limit the amounts of securities that could be run off at one time.

(0) Initial jobless claims for the May 20 ending week ticked up +1k to 234k, but this result was still below the 238k expected. Continuing claims for the May 13 week rose +24k to 1,923k, but came in below the 1,925k median forecast. No special factors appeared to be involved, and overall levels remain very low—a sign of labor strength.

Market Notes

Period ending 5/26/2017

1 Week (%)

YTD (%)

DJIA

1.35

7.78

 

S&P 500

1.47

8.81

Russell 2000

1.11

2.35

MSCI-EAFE

0.20

13.68

MSCI-EM

2.14

17.94

BlmbgBarcl U.S. Aggregate

0.03

2.08

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2016

0.51

1.20

1.93

2.45

3.06

5/19/2017

0.92

1.28

1.79

2.23

2.90

5/26/2017

0.94

1.30

1.79

2.25

2.92

U.S. stocks gained with positive sentiment, with continued decent results but no major economic or company news during the week—as well as a perhaps-welcome lack of any new troublesome news on the political front. By sector, utilities, technology and consumer staples led with gains over +2%, while energy lagged with losses over -2%, which was related to oil price volatility.

Foreign stocks were mixed, with developed market returns coming in weaker than in the U.S., led by negative returns for Europe and the U.K. in USD terms (although performance was positive in local terms). Interestingly, some signs of a slow resurgence in Europe have become apparent, such as German business confidence registering its highest-ever level. While policymakers on the continent continue to push the need for an accommodative monetary policy and growth remains sub-par overall, signs of life have been a positive development for markets—especially when coupled with less-expensive equity valuations. Emerging markets moved sharply higher on the week, with a recovery in market sentiment in Brazil following a difficult political week. While such shorter-term events are a common characteristic in these markets and can add to volatility, long-term EM trends favoring growth and policy 'improvement' (even if gradual) remain in place.

With minimal change to the yield curve, U.S. bond returns ended up quite flat for the week for both governments and investment-grade corporates. High yield corporates fared slightly better, as did emerging market debt, particularly as the dollar declined against EM currencies. In credit news, China's debt was downgraded from Aa3 to A1 by Moody's, the first such event for China since 1989, and a minor deterioration in the whole scheme of things, but a reflection of underlying financial strength concerns as well as a trend of slowing economic growth. At the same time, the degrade was minor, and puts China back down at the same rating as Japan.

Real estate saw slight gains for the week, with far strong returns in Asia and Europe—the opposite pattern compared to broader stock markets. Mortgage, lodging and industrial experienced gains, while health care fell back.

Commodities declined on the week overall, with negative return in energy and several soft commodities, while precious metals saw gains. For the week, crude oil ended up down a relatively minor -1.7%, after spiking above $51 upon hopes for extensive production cuts during the week's OPEC meeting. However, rather than rising, oil prices fell dramatically later in the week to end at $49.80, presumably due to the length and magnitude of the planned cuts being smaller and of a shorter duration than hoped. OPEC (as well as non-OPEC) members announced a 9-month extension of their crude oil production cuts, in an effort to stem the global glut.

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 22, 2017.

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