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Weekly Review - October 10, 2016

Weekly Review - October 10, 2016

Guest Post - Monday, October 10, 2016


Economic news last week was highlighted by strong reports in ISM manufacturing and non-manufacturing, and a decent but not outstanding September employment situation report. The combination of data led to increased expectations for a Fed rate hike in December.

Equity markets were generally negative for the week, as was most fixed income, due to a rise in interest rates. Commodities, however, were surprisingly resilient, led by continued gains in the price of crude oil.

Economic Notes

(+) The ISM manufacturing index for September rose to 51.5, beating the forecasted 50.4 and providing a rebound from a downturn the prior month. Key components in the survey were generally positive, including the areas of production, new orders and employment, all of which ticked up a few points. However, it still appeared inventories could be a bit high. While this represents just one release, it's a move in the right direction for a segment of the economy that's been very choppy as of late.

(+) The ISM non-manufacturing index rose by the largest month-over-month increase in the history of the series of over +5 points to 57.1, close to a high for the trailing year, beating expectations calling for 53.0. Overall business activity, new orders and employment all increased sizably, in keeping with the headline move. Reversing the rebound from a poor August, this continues to show solid strength in the services part of the economy—which has never really been a problem relative to manufacturing and capex in this cycle.

(0) Light vehicle sales for September came in at 17.74 million units on a seasonally-adjusted annualized rate. This was down -0.7% from a year ago at this time, which confirms some industry flattening over the past several quarters. On the positive side, it appears an ongoing moderate gasoline price environment has resulted in a continued consumer preference for light trucks/SUVs/crossovers. Interestingly, it appears some U.S. carmakers, such as GM, have focused more on retail channels (competing on price) as opposed to traditional fleet vehicle activity (evaluated on volume), which could well be related to recent strength in the consumer part of the economy as opposed to lower business capex spending.

(-) Construction spending for August declined -0.7%, in contrast to an expected gain of +0.3%, in addition to a few prior months being revised down. The declines were relatively broad across segments, with private residential and commercial building down a few tenths of a percent and public works down -2% (and -9% on a trailing 12-month basis).

(+) Factory orders for August rose +0.2%, which was a positive compared to the expected -0.2% decline. Core capital goods orders and shipments experienced an upward revision, and inventories were a bit higher than expected.

(0) The August trade balance widened by just over -$1 bil. to -$40.7 bil, which was in the opposite direction of an expected contraction to -$39.2 bil. Volumes in both imports and exports increased, while the dollar change was largely due to a +5% rise in oil imports during the month.

(-) The ADP employment report for September came in a little weaker than expected, with a payroll gain of +154k versus expectations of +165k. Service job gains amounted to +151k, with professional/business services and trade/transports/utilities leading the way. Goods-providing jobs rose +3k, which was considered fairly weak, although it represented the first gain in six months led by a rebound in construction employment.

(+) Initial jobless claims for the Oct. 1 ending week continued to decline, to 249k, below consensus, which called for 256k. This is their lowest reading since April, which continues to hover near post-crisis lows. Continuing claims for the Sep. 24 week also declined, to 2,058k, which was below the 2,081k level expected.

(0) The employment situation report for September wasn't outstanding, nor was it a major disappointment. As it stands, according to a variety of economists, job growth appears to be at a pace that could allow the Fed to take interest rate action in December, assuming the employment data between now and then offers no catastrophic surprises.

Nonfarm payrolls came in at +156k, which underperformed forecast of +172k; in addition, the prior two months were revised down by a fairly minor -7k. Private payrolls gained +167k, of which +157k were service jobs, along with small gains in goods-producing sectors as construction gains offset losses in manufacturing. Temporary employment also experienced some gains, of +23k, which has tended to be a positive for upcoming jobs growth. Also on the 'positive' side, mining jobs (which includes energy) was flat, bucking the almost 2-year trend of declines. Government employment declined by -11k, which was a surprise on the downside, and mostly due to a drop in education-related jobs and might have been a seasonal-adjustment anomaly.

The unemployment rate rose to 5.0%, which was a tenth higher than last month due to in increase in the labor force participation rate. The U-6 'underemployment' rate was unchanged at 9.7%. On the positive side, it appeared the number of long-term unemployed as well as those who would like to work full-time but can only find part-time work, has declined. The household survey portion of this showed a gain of +354k jobs, which was a substantial gain over the prior month. The average workweek ticked up a tenth to 34.4 hours. Average hourly earnings rose +0.2%, which was a tenth lower than expected, which translated to a year-over-year gain of +2.6%—a pace just over that of inflation.

Market Notes

Period ending 10/7/2016

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U.S. stocks ended up with a down week, with a number of cross-currents continuing, such as the highly-anticipated September employment report, continued election speculation and comments from Fed members about rate-hike prospects. Rising interest rates as a result of several of these factors helped financial stocks (which need higher rates to some degree, and a steeper yield curve for sure, to operate normally) and higher oil prices boosted the energy sector; conversely, utility stocks, seen as a high-dividend bond proxy of sorts, were hit hard due to the rate moves.

Twitter was in the news more than usual, as it courted a myriad of rumored suitors, including Salesforce, Alphabet/Google, Apple and Walt Disney—however, towards the end of the week, hopes had dissipated with one CEO's comment about the company's severe challenges. This is the conundrum with new media firms like Twitter—while a widely-used technology, with envied customer counts, can these counts be adequately monetized into actual sustainable profits?

Foreign stocks were mixed, with all areas positive in local terms. However, after taking account the stronger dollar, only emerging markets ended up with positive returns for the week, while developed Europe, U.K. and Japan ended negative and lagged the U.S.

U.K. results were accentuated by a drop in the British pound, which has fallen to a new 30-year low. This began as being related to concerns over Britain proceeding with Brexit as early as March 2017, but, specifically, a 'hard Brexit', where they would retain more autonomous control over items like borders (e.g. a Switzerland-like model), as opposed to a 'soft Brexit', where a type of EU-lite arrangement would remain in place (e.g. Norway). Naturally, a harder Brexit could create a tougher transition, but provide U.K. citizens a bit more of what they originally wanted, which largely focused on labor and immigration control. On the positive side, a weaker pound helps their cause as it benefits exporters during this time of transition. Also, the pound wasn't helped by a nearly -10% 'flash crash' in the course of just a few minutes on Friday—the cause of which is still currently a mystery. It could have been due to a 'fat finger' trade error, a 'rogue' algorithm that takes advantage of certain market conditions, a series of currency option expirations, bank hedging, or something else entirely that could remain unexplainable.

European results were harmed by concerns over a possible 'tapering-off' of ECB stimulus, despite denials from officials. There has been an increasing groundswell of skepticism that continued QE, and the resulting ballooning fiscal debt load as a result of it, fails to be as effective over long-term periods as initially hoped—with the byproduct of a high national debt burden creating more problems down the road than it's helping. But this is really nothing new.

The International Monetary Fund's most recent World Economic Outlook, released last week, featured a lower global growth forecast than expected that could also have soured the mood. Global economic projections remained at 3% for 2016 and 3.4% next year, as U.S. growth was downgraded and offset by upgrades for India and Russia (as well as a slight upgrade for the U.K., interestingly). However, the global economy at large was described as 'moving sideways' and a victim of its own poor momentum. Oddly, the IMF has been criticized for being too optimistic on such projections in recent reports. U.S. investment-grade bonds lagged across the board, unsurprisingly, due to the sizable rise in interest rates during the week. This was naturally more pronounced at the longer end of the yield curve. U.S. high yield and floating rate bank loans, however, bucked the trend with positive gains—no doubt helped by stronger pricing in energy. Foreign bonds in developed markets were especially hit hard with higher rates in other key markets, such as the German bund moving back from negative to positive, coupled with a stronger dollar. Emerging markets tended to fare better than developed by comparison.

Real estate has taken it on the chin in recent days, as rising interest rates have prompted some investors to head for the exits and capture some strong gains earned this year. U.S. REITs ended the week about -5% lower, with returns slightly worse in developed Europe and slightly better in developed Asia. This is not a big surprise, as the asset class has historically been prone to volatility in the wake of short-term interest rate moves; however, it's also important to remember that the environment that results in higher interest rates has also been largely beneficial for real estate fundamentals—an improving economy, tenant demand and cash flows.

Commodities moved a few percent higher for the week, despite the headwind of a stronger U.S. dollar. West Texas crude oil moved up over +3% to just under $50/barrel—its highest level since June. Livestock also gained for the week, agriculture was flat, while both industrial and precious metals declined. In the latter group, gold fell by -5% and silver by nearly -10% as higher rates and correspondingly stronger dollar rendered their ownership less compelling.

In product news, several ETF sponsors, including Blackrock and Schwab, announced an upcoming cut in fees. For Blackrock, this included over a dozen iShares ETFs, including the well-known S&P 500-tracking IVV from 0.07% to 0.04% and the Barclays Aggregate-based AGG ETF being cut from 0.08% to 0.05%. Normally, such changes wouldn't warrant mention, but the move was reportedly done in response to the new DOL fiduciary regulations, which are prompting fee review on an industry-wide basis, but also no doubt as part of a price war between major competitors in the quickly-growing ETF market. Obtaining pure asset class 'beta' has truly become a commodity, with broad market exposure now available in many cases for 4-10 b.p. (and falling).

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 3, 2016.

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