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Weekly Review - October 31, 2016

Weekly Review - October 31, 2016

Guest Post - Monday, October 31, 2016


Economic data for the week showed mixed results, with a decent GDP report for Q3, but weaker durable goods orders. Real estate prices showed continued gains, as did pending home sales, while new home sales came in a bit weaker than expected.

Global equity markets were generally lower, with mixed earnings and economic data. Bonds lost ground as well, as interest rates rose along with expectations of a Fed hike in December. Commodities declined in line with the price of oil falling by a few dollars a barrel.

Economic Notes

(0/+) The first estimate of 3rd quarter GDP came in at an annualized rate of +2.9%, which was a few tenths higher than analyst expectations and was the largest annualized rate in two years. However, the underlying components were weaker than expected, with more growth coming from inventory accumulation (a transitory factor that tends to fluctuate significantly from quarter-to-quarter) and less from consumer spending. The latter rose +2.1%, a few tenths below expectations, and more applicable final sales figures are the lowest in about three years. Residential investment declined at a rate twice that expected at -6%, while non-residential investment made positive strides ground (this segment included items like oil rigs). Exports gained +10%, contributing to the overall figure, but this appears to be a bit of an anomaly due based on large food exports (notably soybeans, as a result of lower production in South America due to weather). All-in-all, the report showed modest growth overall with few surprises.

GDP expectations for the 4th quarter are starting in the low 2's, which would bring the growth for the whole of 2016 to about 1.5-2.0%. Additionally, expectations for the next several years are pegged at around 2%. While this appears low, it's right about at the average of quarterly results since 2000. The underlying frustration, of course, is that these growth levels are below the 3.0-3.5% achieved for each decade for the 1990s, 1980s and 1970s—which are used as a modern benchmark.

GDP graph

(-) Durable goods orders for September fell -0.1%, which disappointed slightly compared to a consensus estimate of no change for the month. Much of this was due to a -45% decline in the defense aircraft component, which is extremely volatile month-to-month. Ex-transports, goods orders were up +0.2%; while core capital goods orders, which removes lumpier defense spending, declined -1.2%. Within the core group, machinery orders were up a percent, while computers/electronics declined by about the same amount. So, much of the report depends on how you slice up the parts, but the weaker core orders reading continues to show a lack of demand for capital equipment, which has been a steady theme of this recovery.

This lack of capex has been a puzzle for economists. Some blame the secular trends of increased automation (the robots) and productivity issues, which make a difference long-term. However, in a recent conversation with a portfolio manager whose team discusses such things with company managements, the hesitancy on the part of firms to spend in the near-term appears to be more directly due to very cautious sentiment about slow global economic growth prospects, partially related to concerns over the sustainability of Chinese growth on top of the weaker spending environment in the energy segment due to lower production. This creates a self-fulfilling cycle, of course, where signs of better growth could beget more spending and create more growth.

(+) The advance goods trade balance report for September showed a smaller deficit of -$56.1 bil., compared to the expected -$60.5 bil. Exports rose +0.8% for the month, with strong showings from consumer and capital goods. Imports, on the other hand, ticked down by -0.7%. Inventory accumulation showed gains in the retail and wholesale areas by a few tenths of a percent, which was a bit better than expected.

(+) S&P/Case Shiller home price index rose +0.2% in August, which was double the gain expected, however, the summer months tend to be prone to seasonal adjustments issues. Regionally, 15 of the 20 indexed cities experienced gains, led by San Francisco up +1%, while the weakest results were minor declines in Detroit and Chicago. Year-over-year, the index shows a +5.1% gain, which is in line with recent trend.

(+) The broader FHFA house price index showed a +0.7% gain, which outperformed the +0.4% expected. Prices rose across all nine regions, led by New England and South Atlantic, both up +1%. On a trailing 12-month basis, the index is up +6.4%, which remains quite robust.

(-) New home sales for September rose by +3.1% to 593k, below the expected 600k level, on a seasonally-adjusted annualized rate; however, several previous months were significantly revised downward by -85k sales. Regionally, the South, Northeast and Midwest all gained ground for the month, while the West ticked downward. Months' supply also fell a tenth to 4.8. Interestingly, while this series can be quite volatile on a month-to-month basis, year-over-year starts have moved higher over the past year, and show decent growth since the end of the financial crisis—just not high enough to satisfy underlying demand to a full degree.

(+) Pending home sales for September rose +1.5%, which outperformed the +1.0% gain expected; however, the August figures were revised down slightly, but not enough to offset the Sept. strength. Regionally, the West and South experienced gains for the month, Midwest was flat, while the Northeast declined by over a percent. As this metric tracks signings, it bodes well for new homes sales closings for the coming few months.

(-) The Conference Board index of consumer confidence for October fell more than expected, to 98.6, relative to a consensus estimate calling for 101.5. The drop was due to consumer assessments of both their present situation and future prospects. The reported ease in finding jobs also declined, although by a lesser amount. While it reversed gains of the prior several months, levels remain close to where they've been over the past year.

(-) The final October Univ. of Michigan consumer sentiment index came in lower than expected, declining -0.7 points to 87.2, missing estimates calling for a slight gain to 88.2. This was the sole result of a downgrade in current conditions, while future expectations actually rose slightly. Interesting, expectations for inflation for the coming 5-10 years came in at 2.4%, which is a record low for the series.

(0) Initial jobless claims for the Oct. 22 ending week fell by -3k to 258k, which was just a touch higher than the 256k expected. Continuing claims for the Oct. 15 week came in at 2,039k, which was below consensus expectations of 2,052k. It still appears that the aftermath of Hurricane Matthew has elevated claims levels somewhat in a few states, and likely explains the current levels running about +5k higher than the four-week moving average, that most use as a smoothed method for analyzing this series. Regardless, levels otherwise remain very tempered.

Market Notes

Period ending 10/28/2016

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BarCap U.S. Aggregate



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U.S. stocks were down on net for the week, as third quarter earnings reports and various economic data points came through mixed. On one hand, large index weights such as Apple and Amazon, some of which carrying high growth projections, disappointed; while firms with more tempered expectations, such as Procter & Gamble, surprised on the upside. The good news, per FactSet, is that the S&P is slated to have positive year-over-year earnings growth for the first time in a year and a half. This hope alone has likely buoyed stock valuations. From a sector perspective, defensive consumer staples and utilities led the way with positive gains, while healthcare and consumer cyclicals lost the most ground. Large caps outperformed small caps, which sold off sharply on the week.

M&A activity has continued to pick up as we near the end of the year, as top-line revenue growth has been very difficult to come by—resulting in a scramble for growth wherever firms can find it. Sometimes deals get a bad rap, with few net efficiencies added, but well-designed and synergistic deals can actually work. However, the bigger the potential deal, the larger the profile. The proposed AT&T/Time Warner merger in the headlines last week, which would be the largest of the year, could face a good deal of regulatory scrutiny. The FTC has been particularly tough (per the opinion of some experts) in ensuring deals are not compromising any industry's competitive environment—particularly in oligopoly areas such as cable TV—where pricing has been under the microscope anyway from the consumer side.

In foreign markets, Japan ended with positive results, while Europe and the U.K. sold off in keeping with the magnitude of U.S. equities. A slightly weaker dollar helped matters a bit. In Japan, rising yields may have a played a role in improving sentiment, as it translates to a lessening of headwinds for financial firms. Returns for the week were largely country-specific, as neither developed nor emerging markets outperformed the other by any meaningful degree overall. It's interesting to note, though, that European earnings have been surprisingly good so far (again, compared to very low expectations).

U.S. bonds experienced a poor week as interest rates rose, based on decent economic data and improved chances of FOMC action in December. Shorter-maturity securities naturally outperformed longer, with long treasuries the worst performers. Credit marginally underperformed governments, with high yield bond returns in a similar range to broader indexes, but bank loans ending up with a positive week.

Floating rate bank loans have experienced a resurgence as of late, which goes along with the recent spike in interest rates. Due to the variable rate and faster-reset nature of the underlying loans, higher rates tend to help this asset class, which act counter in many ways to other fixed income, providing valuable diversification to portfolios in times like these. The one knock on bank loans over the past few years (other than the fact that rates have fallen, as opposed to rising) is that, in addition to their rates being tied to LIBOR with a spread, newer loans had been issued with what are referred to as 'LIBOR floors'—essentially, rates wouldn't be reset higher until base rates reached 0.75% or 1.00% in many cases. However, now that money market reform has caused a mass migration from prime commercial paper to government paper (along the lines of $1 tril.), the extra supply of corporate paper has pushed LIBOR higher, indirectly improving the yield picture for bank loans. Based on interest rate movements, floating rate could potentially offer more durability over time, even after traditional high yield makes less sense at some point.

Foreign bonds also lagged, in both developed and emerging markets. The German 10-year rose to nearly 0.2%, the highest yield seen since spring. Much of the foreign bond concern surrounds the ability of central banks to provide any additional boost through stimulus programs, about which there is increasing skepticism. If these programs pull off the gas pedal to any degree, this also removes a downward force on rates.

Real estate fared poorly on the week, which is typical when interest rates move higher. Real estate in Asia, particularly Japan, fared better than in the U.S. and Europe. Those in turn fared better than Canada and Australia, which tend to be driven by oil price movements. Year-to-date in the U.S., REIT returns have been led by mortgage REITs (as rates are still lower than they were at the start of the year), healthcare and industrials; more challenged sectors include retail (due to a mixed environment for brick-and-mortar spending) and residential (where rental rates and begun to peak in some key markets).

Commodities declined on net for the week, with industrial metals gaining sharply, and positive returns from precious metals, offset by energy price declines. The West Texas Intermediate crude oil spot price fell from nearly $51 to just under $49, as doubts surfaced about the planned OPEC production cuts actually coming to fruition. This isn't a surprise, as OPEC producers have incentives to 'cheat' by producing more than their agreed-upon quotes. It's no secret that many oil-reliant nations, including and especially the larger producers like Saudi Arabia and Russia, badly need the revenue either higher oil prices or more volume brings, in order to balance their fiscal budgets.

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 24, 2016.

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