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Weekly Review - November 6, 2017

Weekly Review - November 6, 2017

Guest Post - Monday, November 06, 2017


Economic news for the week was dominated by a Fed meeting that resulted in no policy change, mixed manufacturing results, stronger optimism and a below-par employment situation report—several releases continue to demonstrate the effects of recent hurricanes.

Equities continued their run of success, with gains in the U.S. and foreign markets, on the back of strong earnings and economic growth. Bonds also fared well as rates decreased. Commodities gained on the week, in keeping with higher oil demand and lower production.

Economic Notes

(0) As noted mid-week, the FOMC stayed the course on the monetary policy front, announcing no changes. The only item noted in hindsight by some observers was the use of the term 'solid' to describe economic growth—for the first time in several years. Otherwise, inflation remains at levels low enough to be considered 'soft', and remain a key discussion point. Odds for a hike at the more formal mid-December meeting (with press conference) range from 85-95%, based on market implied probabilities and economist opinion.

As an aside, it was announced by the administration that Jerome Powell will be nominated as the new Fed chair to replace Janet Yellen. Powell has been a member of the Federal Reserve Board of Governors since 2011; prior to that, worked as an attorney, in the private equity industry and as Undersecretary of the Treasury for domestic finance under the original Bush administration. He's viewed as a 'centrist', which implies his policy tilts are neither 'dovish' (or accommodative, like the reputation of Yellen) nor 'hawkish' (prone to being more concerned about inflation influences, and thereby more prone to hiking rates at a faster rate, such as John Taylor, the professor and economist also in the running for the job). Interestingly, he'll be the first FOMC chair without a Ph.D. in economics since Paul Volcker, who occupied the role during the early- to mid-1980s. He is seen as a strong and succinct communicator, with a tilt toward practical business sense and stronger market savvy, based on his days in private industry. It's also assumed that this background could push him to favor fewer financial regulations. While he has been somewhat more hawkish than Yellen over the last few years, few changes to current policy are expected, now that a path to higher interest rates and policy normalization has been started. The Yellen Fed experienced a fairly benign environment of recovery, compared to her predecessor Ben Bernanke, who presided over the fallout and immediate aftermath of the financial crisis. The coming years, from what we can tell so far, may include continued normalization of interest rates as well as the careful job of carefully winding down the size of a very large balance sheet.

(-/0) The ISM manufacturing survey fell -2.1 points in October to 58.7, below the 59.5 level expected. New orders, production, inventories and employment all fell to some extent, reversing gains seen from the prior month. Prices paid also declined, adjusting back from highs in Sept. While several of these figures were likely in response to hurricane-related disruptions and their aftermath, the near-60 level continues to signify a solid level of manufacturing expansion.

(+) The ISM non-manufacturing survey for October rose +0.3 of a point to 60.1, compared to an expected decline to 58.5. The individual segments also showed strength, with gains in overall business activity, employment and inventories, while new orders softened somewhat and supplier deliveries stayed flat for the month. Like the manufacturing edition, this services data points to continued economic strength with little disruption from recent hurricanes.

(+) Chicago PMI for October rose +1.0 point to 66.2, to reach its highest level in over six years. Optimism was centered on strength in new orders and production, which represent over half of the index while order backlogs also increased. On the negative side, employment fell under 50 into contraction. The vast majority of businesses—a larger number than typical—also expected business to continue on an upward track through the fourth quarter.

(0) The final trade balance report for September showed a more-than-expected widening to -$43.5 bil., compared to consensus estimates calling for -$43.2 bil. The month's figures were led by both exports and imports rising by more than a percent each, particularly in the non-petroleum category.

(0) Personal income for September rose +0.4%, which was on par with expectations. Personal spending rose a more solid +1.0%, which was tenth better than consensus. This caused the personal saving rate to fall to +3.1%, which, interestingly, happens to be a 10-year low. PCE inflation on a headline level came in at +0.4% for the month, while core prices gained a more muted +0.1%, on par with expectations, and brining the year-over-year changes to +1.6% and +1.3%, respectively.

(+) The S&P/Case Shiller home price index for August showed a gain of +0.5%, which outperformed forecasts by a tenth of a percent. Prices gained in almost all of the 20 cities, led by San Diego, Las Vegas and Charlotte. Year-over-year, the index rose +5.9%, which was a tick higher than the pace of the prior month and continues to show very strong cyclical growth. As noted in other housing data releases, this price increase trend could well be and is likely related to a decrease in available inventory, coupled with stronger demographic demand to some extent.

(+) Factory orders for September rose +1.4%, beating forecasts calling for +1.2%. For the most part, this was the result of a +30% gain in commercial aircraft, which tends to be a lumpy series in the near-term, as is defense, which gained +3%. Core capital goods orders as a subset of the broader release were revised higher to +1.7%, as were core shipments to just under +1%. There has been decent performance in several manufacturing segments of this series, which again reinforces fundamental strength.

(+) Construction spending rose +0.3% for September, relative to expectations calling for a -0.2% decline; at the same time, August spending was revised downward a bit. Private non-residential construction fell a percent, while residential was unchanged; on the public side, both residential and non-residential rose in the low single-digits to account for the broader gain during the month.

(+) The Conference Board's index of consumer confidence rose a sharp +5.3 points to 125.9, beating forecasts calling for 121.5—representing a new high for this recovery cycle. Perceptions of current conditions as well as expectations for the future both rose by similar amounts to contribute to the total. The labor differential, which measures ese of finding employment, rose sharply as well, to a multi-decade high.

(+) The ADP employment report of private jobs showed a gain of +235k jobs in October, relative to expectations for a more tempered +200k increase. On the negative side, September employment was revised down by -25k. Per usual, the most sizable increases were in the service area—which experienced a gain of +150k, led by professional/business services, leisure/hospitality and education/healthcare. Goods-producing employment experienced a strong increase of +85k, the best result since early in the year, with construction and manufacturing appearing to gain traction in the post-hurricane recovery. However, trade/transports/utilities positions declined (by -50k), as did and information services.

(+) Initial jobless claims for the Oct. 28 ending week fell -5k to 229k, below the 235k level expected. Continuing claims for the Oct. 21 week also fell, by -9k, to 1,884k, below the 1,894k expected by consensus. It appeared that claims fell in several southern states, including those affected by the hurricane, which points to a return to normalcy in job conditions, while Puerto Rico is still experiencing weakness. Aside from those one-offs, the underlying trend of strong employment low layoffs remains firmly intact.

(0) The employment situation report was mixed, with payrolls coming in lower, as effects from recent hurricane activity continued to normalize in several industries, while the unemployment rate again drifted a bit lower towards 4%. Nonfarm payrolls came in at +261k, which trailed expectations calling for +313k. However, prior month payrolls were revised upward by +90k, which offset some of the disappointment. By segment, the rebound appeared to be related to the recent hurricanes, with leisure/hospitality gaining +106k; other services segments in professional/business services experienced a gain of +50k, followed by education/health care. Additionally, goods-producing jobs rose +33k, which included manufacturing and construction. Government payrolls also rose by just under +10k.

The unemployment rate fell again by just over a tenth to 4.1%, reflecting a half-percent decline in the labor force participation rate to 62.7%, and bucking expectations calling for no change. The U-6 underemployment measure fell even more dramatically, by -0.4%, to 7.9%, which was last matched in late 2006. The household survey fell -484k for the month, a reversal of course from the sharp increase the month prior.

Average hourly earnings were unchanged for October, which disappointed a bit relative to expectations calling for a gain of +0.2%, while earlier month increases were also revised down. This took the closely-watched year-over-year increase in wage growth down a bit to +2.4%. Average weekly hours were unchanged at 34.4.

Earlier in the week, nonfarm productivity came in showing a gain of +3.0%, which outperformed forecasts calling for a rise of +2.6%. Unit labor costs for the third quarter rose +0.5% (while falling -0.1% on a year-over-year basis) which beat expectations by a tenth, as compensation per hour rose at a faster pace than inflation for the three-month period. Otherwise, labor costs continue to run at a rate around that of broader inflation, confounding many economists expecting wages to rise at a faster rate as the unemployment rate ticks lower—in line with typical historical behavior of the classic Phillips Curve.

Market Notes

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U.S. stocks ended slightly higher during the week on the large cap side, with the S&P experiencing gains for the eighth week in a row, while small caps suffered declines. From a sector perspective, technology and energy led the way, with gains approaching +2% for the week, while consumer cyclicals and industrials lagged with declines. Earnings continue to come in as expected for Q3, in the high single digits overall, led by energy and technology, and the mid-single digits when energy is removed. Next year's results are expected to continue to be in the ~+10% range, with pressure on the upside if tax reform is completed.

Market sentiment was held back a bit by indictments by Robert Mueller in the Russian probe, with uncertainty about how far up the chain this could ultimately go. Other negative contributors included the initial thought that tax reform could be 'phased in' over the next several years, as opposed to being implemented immediately. The release of the initial plan draft alleviated these concerns, while there still appears to be many areas of possible negotiation to come over the next few months. Speculation at this point probably isn't overly productive; key elements continue to be a focus on lowing corporate tax rates while not dramatically doing so for high-income households—to keep potential populist anger at bay. Debate continues and evidence is mixed about the effectiveness of lowering corporate tax rates in promoting trickle-down economic stimulus and job creation, although they would certainly boost company earnings on a bottom-up level.

Foreign stocks in developed regions generally rose, as did emerging markets to a lesser degree. Economic statistics and earnings continue to improve, which has kept sentiment buoyant in Europe and Japan particularly. The Bank of England raised interest rates another 0.25% over the week, in an effort to keep inflation at bay, although forward guidance is more tempered about future activity. Emerging markets ended the week as the highest performing, as strong gains in Asia outweighed weakness in Latin America.

U.S. bonds experienced a solid week as yields drifted lower in longer maturities, while inching higher for shorter issues. Treasuries outperformed credit, as spreads widened, most sharply noticed in high yield and bank loans, which lost a bit of ground. Bond yields had also been driven higher by speculation about who the next Fed chair might be, and the selection of Powell—discussed above—seemed to alleviate concerns. With little change in the dollar for the week, foreign bonds were driven by internal dynamics, and experienced price gains with falling yields abroad. The exception was emerging markets, where USD-denominated debt came in flat, and local currency bonds declined sharply.

Real estate fared well during the week, with Europe outperforming U.S. issues, which in turn outperformed Asia. This strength occurred in spite of continued weakness for retail REITs and regional malls, which are in the crosshairs of the internet effect.

Commodities saw gains for the week, as most key segments rose, led by energy and industrial metals. Oil gained just over +3% as West Texas crude ended at $55.64. Other than a drop rig counts last week, as measured by Baker Hughes, sentiment continues to be led by the same factors as in prior weeks—which is increasing global demand as economic growth gains steam and uncertainty exists about OPEC production cuts for the coming year.

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 October 30, 2017.

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