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Weekly Review - May 8, 2017

Weekly Review - May 8, 2017

Guest Post - Monday, May 08, 2017


Economic data for the week was highlighted by a decline in but still-strong ISM manufacturing numbers, continued strength in ISM non-manufacturing, and continued strength in labor metrics, including the April employment situation report. The FOMC meeting resulted in no policy action, which was as expected, although chances for a June rate increase appear to have again risen.

Equity markets rose over the week, with foreign stocks in Europe especially strong with sentiment improving prior to the French election. Bonds pulled back a bit in the U.S., as rates rose, while foreign bonds benefited a bit from a weaker dollar. Commodities generally lost ground due to continued weakness in crude oil prices.

Economic Notes

(-/0) The ISM manufacturing index for April fell -2.4 points to 54.8, falling below estimates calling for 56.5. New orders and employment each fell -7 points, which were fairly sizeable, while production and inventories rose somewhat. Prices paid fell a bit, while the gap between new orders and inventories narrowed. While the overall figure was a bit below expectations, 16 of 18 industries reported growth, and overall results in the mid-50's continue to demonstrate expansion in the manufacturing sector.

(+) The ISM non-manufacturing index, on the other hand, rose +2.3 points for April to 57.5—stronger than the 55.8 level expected. The bulk of the underlying segments showed improvement for the month, including new orders, business activity and new export orders; however, employment contracted a bit, while still remaining expansionary. This measure continues to run at a solid expansionary level.

(+) The trade balance for March tightened a bit by +$0.1 bil. to -$43.7 bil., contrary to the expected widening to -$44.5 bil. Imports fell more than exports, accounting for the difference, mostly in the real goods segment outside of petroleum.

(0) Personal income for March rose +0.2%, a tenth below forecast, while personal spending was flat, in contrast to expectations calling for a +0.2% increase. The savings rate subsequently rose two-tenths to 5.9%. The PCE price index for the month fell -0.2% and -0.1% on a headline and core level, respectively, generally on par with expectations, with prices across a variety of categories softening. These brought the year-over-year change in inflation to +1.9% for headline and +1.6% for core. The different composition of the PCE (with less housing) accounts for much of the inflation difference compared to other metrics like CPI.

(0) Construction spending for March fell -0.2%, which disappointed relative to the +0.4% gain expected, although revisions took prior month data higher. In the details, non-residential building fell just over -1% while residential gained just over +1%.

(-) Factory orders for March rose +0.2%, which was half of the expected +0.4% increase; while growth for the prior month was also revised up by +0.2%. Durable goods orders rose nearly a percent, with help from several revisions. Manufactured goods inventories were unchanged for the month, which disappointed a bit

(+/0) The ADP employment report for April showed a gain of +177k jobs, which outperformed the +175k expected, while the report for the prior month was revised downward by -8k. The service segment again dominated the numbers, with +165k added, with gains in professional/business services, education and healthcare. Goods-producing job creation fell off dramatically to +12k from a pace of 80-100k just a few months ago, with construction jobs actually declining, which could have been weather-related.

(+) Initial jobless claims for the Apr. 29 ending week fell by -19k to 238k, which was below the 248k expected. Continuing claims for the Apr. 22 week fell by an even larger amount, -22k, to 1,964k, compared to a level of 1,990k expected. While no special factors were reported, adjustment issues for Easter and spring break may have played a role. Overall, these claims numbers continue to support a very robust labor market.

(+) The monthly employment situation report for April came in a bit better than expected. Nonfarm payrolls rose by +211k, compared to about +190k expected by consensus. Job gains were more pronounced in leisure/hospitality (+55k, a big part of which was restaurants), health care (+20k), financial activities (+19k) and mining (+9k, which includes energy). February jobs were revised up, which those for March were revised downward, resulting in a net decline of -6k for the two months. There did seem to be a weather-related rebound compared to the prior month, and 'breadth' of industries with improving payrolls also improved by a few percentage points.

The unemployment rate ticked down slightly to 4.4%, below the expected 4.6% level, matching the lows in 2006-2007, and now a few tenths below the general region for what's considered to be 'full employment'. Labor force participation fell a tenth of a percent as well to 62.9%. Additionally, the U-6 measure of underemployment fell by -0.3% to 8.6%, which is a new low point for the current business cycle, and reflected a decline of both part-time workers for economic reasons and marginally-attached workers.

The average workweek ticked +0.1 higher to 34.4 hours for the month. Average hourly earnings rose +$0.07 to $26.19, or +0.3%, on par with expectations, which brings the year-over-year increase of that metric to +2.5%, just a bit above broader inflation.

In other data released earlier, nonfarm productivity came in at -0.6% for Q1, which was even worse than the -0.1% level forecast; however, Q4 productivity was revised up by +0.5%. This brought the year-over year change to +1.1%, which is an improvement. Unit labor costs rose +3.0% for Q1, which was three-tenths of a percent above expectations; however, this appeared to be related to some downside revisions to Q4.

Overall, the stronger results could be a catalyst for keeping the Fed on track for inching interest rates higher again in June, barring any other news pulling sentiment back downward. With overall employment now reaching cyclically strong levels, concerns now exist about 'overheating' conditions; however, the quantity of jobs added continues to outshine the quality—measured by a large bulk of jobs being added at the lower end of the pay scale. There is other talk about the measurement accuracy of the point of NAIRU (the non-accelerating inflation rate of unemployment, or 'natural' rate). If it's close to where we are now, Fed action could be warranted, but if it's a bit below current levels and there remains labor market slack, excessive monetary policy tightening could be inappropriate.

Read the "Question of the Week" for May 8, 2017

Where are we from a business cycle perspective? Any closer to recession?

Market Notes

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U.S. stocks gained in a week highlighted by a federal government funding bill and initial press with a replacement healthcare reform bill—which has, although early in the process, provided a sentiment boost to those hoping tax reform will also come together with better legislative cooperation. The final polling results for the French election favoring Macron (who won Sunday) also played a part in global sentiment as the chances for a EU breakup declined dramatically, and chances for modern, market-friendly reforms increased.

First quarter earnings have been rolling in, with nearly two-thirds of S&P 500 companies having reported. According to FactSet, earnings growth has registered in the ~13% range year-over-year for Q1—the third consecutive quarter of positive growth and the highest rate since Q3 2011. The energy sector led the way, but even with this sector removed, the index produced earnings growth of over +9%. In fact, the vast majority of firms have beaten expectations by a fair amount. A weaker dollar for the quarter was one catalyst, but better global conditions have been a more notable trend. For the full 2017 year, estimates remain in the range of +10%, with revenue growth of just over +5%.

Foreign stocks fared better than those in the U.S., with especially strong returns in Europe, although the U.K. and Japan fared decently as well. Emerging markets offered positive returns, but lagged all other key areas for the week. European equities were helped by stronger economic data, better earnings numbers as well as sentiment settling down with French election results favoring Macron. Greece also completed an agreement with creditors to receive the next installment of their bailout program.

While some of the concerns over an off-the-wall outcome had dissipated over the past few weeks, these weren't put to bed until the 2nd/final round of the French presidential election yesterday. While the extreme outcome of a populist LePen has been put to bed, there does appear to be support for structural reforms in labor markets, reduction of an over-burdensome regulatory environment, a large welfare system and elsewhere to streamline and modernize the economy, in addition to bringing down deficits and overall debt levels. France is a bit of an enigma, in that it shares some of the stronger tie-in with global trade with Germany (although to a much lesser degree) and is the home of a variety of world-leading firms; however, it also features some of the inefficiencies of the periphery, like Spain and Italy (but also to a much lesser degree), such as higher labor costs and rigidity with hiring/firing workers. However, it appears the majority of the French prefer to stay in the European Union, which lowers the chances of a 'Frexit' vote anytime soon.

U.S. bonds fell back as interest rates ticked upward across the yield curve. Governments, investment-grade corporates and high yield all generally fared within a few basis points of each other. A slightly weaker dollar helped the USD returns for both developed market and emerging market debt.

Real estate lost ground a bit in the U.S. as rates ticked higher; however, Europe fared significantly better, along with broader equities.

Commodities generally declined on the week, led by the energy group. West Texas crude oil prices fell about -7% to the $46.20 area; pricing has been pressured by not only high supplies as we've noted several times but also commentary from well-known analysts (such as those at Goldman) that have noted continued price pressure downward if these conditions persist. This is mostly due to OPEC production cuts (which are set to expire soon) being offset by rising U.S. production. How this plays out is the ongoing significant wildcard in the energy space. Precious and industrial metals also declined, which detracted from overall index returns.

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 1, 2017.

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