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Weekly Review - November 9, 2015

Weekly Review - November 9, 2015

Guest Post - Monday, November 09, 2015

Summary

  • Economic data came in a bit better than expected on average, with the ISM non-manufacturing index and the October employment report surpassing expectations. Conditions were less appealing on the manufacturing side, as ISM manufacturing, factory orders and related data continued to show some softness.
  • Domestic equity markets rose on expectations of a solid jobs report, while foreign equities generally lost ground with some negative impact from a stronger dollar. Bonds fell back on rising interest rates, with corporates outperforming longer-term government debt. Commodities, including crude oil, experienced weakness, due to dollar effects and lack of any positive catalysts.

Economic Notes

(0) The ISM manufacturing index for October fell a tenth to 50.1, which outperformed expectations by a tenth—so fell in a fairly narrow range all-in-all. Importantly, 50 is the magic dividing line between expansion and contraction for diffusion indexes like this, so any number above 50 demonstrates growth over the prior month, where under 50 shows contraction—so results right around this midline are typically watched more closely. In the month, new orders and production actually rose 1-2 points into more positive territory, while the employment component fell under 50 into contraction. The underlying components can be a bit volatile, and the headline number isn’t quite as weak as some feared as industrial activity continues to suffer through a soft patch of sorts.

(+) The October ISM non-manufacturing index moved higher in October, rising +2.1 points to highs seen a few months ago to 59.1, beating expectations calling for 56.5. This is actually the second strongest reading in 10 years. Most all components improved on the month, including overall business activity, new orders and employment—all of which had high index readings in line with the broader index. In contrast to the manufacturing survey, which has hit a soft spot, services have continued to show recovery strength. Considering that services are a larger component of the economy at this point than manufacturing, this is a strong positive.

(0) Construction spending rose +0.6% in September, which was a tenth of a percent better than expected. Residential investment gained +1.8%, while non-residential building fell -0.1%. This trend has been fairly typical of the past year, with housing picking up a bit, and apartment construction continuing a strong showing.

(-) Factory orders for September fell -1.0%, which was a tenth below the forecasted -0.9% decline. Core capital goods orders (non-defense, ex-aircraft) were revised up a bit by about a half-percent, while inventory accumulation came in a bit lower. This may take 3rd quarter GDP down a notch or two, when revisions changes are incorporated in.

(+) Vehicle sales in October rose to a rate of 18.2 mil. annualized units, up from 16.6 mil. a year ago and surpassed analyst expectations of a 17.7 mil. rate. Vehicle sales continue to be an area of strength in the economic recovery, bucking trends of improved auto reliability and average car age on the road (over 10 years at this point) that would point to a lower turnover cycle.

(0) The Fed’s senior loan officer opinion survey for the 3rd quarter showed some mixed results. Lending standards for commercial/industrial loans tightened a bit (for the first time since early 2012), while residential loans eased somewhat, but not as strongly as in recent quarters. Commercial standards were tighter for smaller- and medium-sized companies than for larger, which is not entirely surprising since that’s usually the case anyway. At the same time, demand for commercial/industrial real estate loans has been rising, while residential mortgage demand fell off somewhat. For consumer installment loans (e.g. credit cards and autos), demand increased during the period but banks’ willingness to lend declined. These aren’t hard loan numbers, but, per the name of the report, are based on bankers’ qualitative assessments of conditions—useful in their own right..

This survey is perhaps one example of why the Fed has been so contemplative about changing interest rate policy. Economic/monetary conditions can tighten without base interest rates themselves moving—we see this in the corporate bond market constantly and the same situation can occur with bank lending. Essentially, if the cost of loans moves higher (in the form of larger spreads added to Treasury-driven base rates) or bankers become more reluctant to lend in the first place, ‘tighter’ financial conditions are created—without the Fed having to do anything on their end. These are changes at the margin that won’t typically be large enough to completely cause a shift in a central bank’s policy, but do act as a input into their decision-making process.

(-) Initial jobless claims for the Oct. 31 ending week rose a bit more than expected, by +16k, to 276k, surpassing forecasts calling for 262k. Continuing claims for the Oct. 24 week also increased by +17k to 2,163k, which exceeded the 2,140k expected by consensus. No special factors were reported.

(+) The ADP private payroll employment report showed a gain of +182k, which surpassed the +180k expected. Services jobs gained +158k (although -24k down from September’s figure), while goods-producing employment rose by +24k (compared to +8k the prior month)—the latter included the best month for construction employment experienced in the recovery so far. Manufacturing fell at a tempered rate of -2k compared to a much steeper drop the prior month. Another -9k jobs were lost in the mining sector, which includes oil activity.

(+) The October employment report was closely-watched as ever, and results came in much better than expected. Nonfarm payrolls came in at +271k, which bested forecasts calling for +185k, and reversing the trend of weaker job growth over the prior several months (although there were some minor revisions upward for those months). Gains for October were broad-based, with goods-producing employment rising +27k, reversing a decline the prior month, and private service payrolls sharply increased to +241k. Leading groups included business services (up +78k) and retail (+44k), as well as construction (+31k).

The unemployment rate fell a tenth, as expected, to 5.0%. Additionally, the U-6 ‘underemployment’ measure declined by two-tenths to 9.8%. As the labor force participation rate remained unchanged at 62.4% (40-year low), the monthly decline appeared to be a productive one, as opposed to one of the statistical variety. As we can see from the chart below, the past decade has almost come full circle, from full employment-like numbers in the pre-crisis period to again near full employment recently. Over the past year, there still has been improvement, but the pace appears to be slowing for marginal gains—not surprising this at this more ‘normal’ level.

Average hourly earnings rose +0.4% for the month, twice the rate of growth expected, bringing the year-over-year change to +2.5%. Those looking for wage growth will see a bit of an uptick in the chart below, which is seasonally-adjusted for better clarity. The average workweek was flat at 34.5 hours.

(+) Nonfarm productivity stats, released earlier in the week in the form of a preliminary estimate, rose +1.6% for the 3rd quarter, contrary to forecasts calling for a -0.3% decline, mostly due to weakness in hours worked (which fell -0.5% in the period, but was partially due to some technical adjustments made by the DOL which have to be discounted). Unit labor costs rose +1.4% for the quarter, falling short of the +2.5% expected.

We have to remind that, especially when it comes to payroll figures, these are samples with a lot of room for statistical error (like +/- 100k) and subject to later revisions, so can either end up a lot better or a lot worse than originally reported. But... markets react to the initial release, and the partially surprising drop in equities that coincided with the report on doubt part of the sporadic ‘good news is bad news’ theme we’ve experienced probably more often than not over the past few years as investors realized the probability for Fed tightening of rates in December just went up.


Read the "Question for the Week" for November 9, 2015:

Will we ever see inflation again? Where’s all this deflation coming from?


Market Notes

Period ending 11/6/2015

1 Week (%)

YTD (%)

DJIA

1.52

2.58

S&P 500

1.02

3.76

Russell 2000

3.29

0.68

MSCI-EAFE

-1.54

0.56

MSCI-EM

0.55

-10.86

BarCap U.S. Aggregate

-0.80

0.34

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

10/30/2015

0.08

0.75

1.52

2.16

2.93

11/6/2015

0.08

0.90

1.73

2.34

3.09

U.S. stocks generally rose during a bumpy week, as signs of life from ISM non-manufacturing data and a very positive employment report on Friday spurred sentiment higher. From a sector standpoint, financials and energy led with gains of several percent each, while utilities lost ground. This isn’t a surprising pattern considering interest rate dynamics—yields moving higher over the week.

Foreign stocks experienced a mixed week. Emerging market ‘BRICs’, including China, Brazil and Russia. Weakest showings originated from developed market nations in USD-terms, including in Japan, Europe and the U.K.

U.S. bonds lost ground as interest rates rose sharply, mostly on Friday, as the positive employment report raised the market-implied probabilities of a December Fed rate hike. On the positive side, floating rate, high yield corporates and GNMAs held up quite a bit better, while long duration governments and TIPs suffered a bit worse than the BarCap Agg. Outside the U.S., the strength in the dollar played the primary role, so USD-denominated debt outperformed local debt on the order of several percent, with USD developed market and emerging debt experiencing minimal losses on less interest rate volatility as seen in the U.S.

Real estate experienced a mixed but generally negative result, with U.S. indexes falling several percent, with higher interest rates weighing on sentiment—a common short-term phenomenon. Foreign indexes experienced sharper losses with the dollar effect.

Commodity indexes generally fell on the week, in line with a stronger dollar. Industrial metals fared best with losses, while precious metals lost quite a bit of ground (with higher interest rates and hike probabilities, which hurt relative demand for gold/silver). Crude oil moved upward mid-week by a few dollars after Baker Hughes rig counts hinted towards declines in production, before falling again in broader commodity weakness, at just over $44.

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 November 2nd, 2015.

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