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Weekly Review - September 12, 2016

Weekly Review - September 12, 2016

Guest Post - Monday, September 12, 2016

Summary

In a light week for economic data, the key release was a disappointing ISM non-manufacturing number, while JOLTs and jobless claims showed continued labor market strength. A key question focused on by market participants is how these various reports will affect the probability of a Fed interest rate move in a few weeks.

U.S. equity markets declined, as did most investment-grade bonds, as a result of comments implying a sooner-than-later Fed interest rate move. Foreign developed markets fell to a lesser degree, while emerging markets bucked the trend with gains. Commodity markets rose with help from a weaker dollar and higher energy prices.

Economic Notes

(-) The non-manufacturing ISM index covering service industries disappointed for August, coming in at 51.4—the lowest level in six years—compared to an expected continued-strong 55.0 reading. Several key areas experienced declines, including new orders (down -9 points) and general business activity (down -7.5 points), while employment and supplier deliveries were little changed. However, on a positive note, the over-50 reading continues to indicate expansion, albeit at a slower rate than previously. Due to the well-followed nature of the ISM series, this weak report was thought to have put further pressure on a Fed rate hike delay and push September out of the equation, but that remains to be seen based on other comments.

(+) Wholesale inventories were revised higher, to no change for July, which was below the +0.1% change expected by consensus. The ratio of inventory-to-sales came in at 1.34, up slightly from the prior month, but below peak levels for the recovery. This is not a very dynamic report generally, but stronger inventories could act as an upward driver to Q3 GDP and is the primary value of looking at this minor report—as quarter-to-quarter differentials can be largely driven by inventory changes.

(+) The JOLTs job openings measure for July came in at a new high of 5,871k, a gain of +3.9% over the prior month, and surpassing expectations of a 5,630k number. The rates for both layoffs and discharges were unchanged at 1.1%, as was the hiring rate at 3.6% and quits rate at 2.1%. While 'all time high' is a bit relative, considering the report has only been produced since 2000, the release reinforces strength seen in other labor market indicators and pointing to possible 'near full employment' levels. Economists are now watching for a deceleration in improvement, which could imply the cycle is peaking.

(+) Initial jobless claims for the Sept. 3 ending week declined to 259k, lower than the 265k level expected. Continuing claims for the Aug. 27 week came in at 2,144k, also below expectations calling for 2,151k. No special factors were reported by the DOL, and claims generally declined nationwide, including the Gulf region, which had been previously affected by higher claims due to some flooding. This series continues to plug along at very low levels, demonstrating underlying strength.

(-) The Fed Beige Book, which outlined anecdotal economic information from around the nation from July-August, showed a bit more softness than in recent editions. The bulk of districts (8 out of 12) described growth rising at a moderate/modest pace, NY and Kansas City were flat, and Philadelphia and Richmond experienced slowing. Consumer spending did not radically change, but results in retail sales were mixed, with some tapering off in auto sales strength but also better real estate activity. Manufacturing was slightly improved, albeit capacity utilization being low in some areas. The story in employment was the same, with continued expansion seen through tighter labor markets nationwide and some upward pressure in wages for higher-skilled workers in some industries/locations, but not on a widespread basis for all (which has been an ongoing problem). Inflation pressures were described as modest, which is little changed from prior descriptions. Overall, there were few surprises, although the tone was less optimistic.

Market Notes

Period ending 9/9/2016

1 Week (%)

YTD (%)

DJIA

-2.15

5.87

 

S&P 500

-2.36

5.71

Russell 2000

-2.59

8.42

MSCI-EAFE

-0.13

1.83

MSCI-EM

1.08

14.50

BarCap U.S. Aggregate

-0.38

5.30

U.S. Treasury Yields

3 Mo.

2 Yr.

5 Yr.

10 Yr.

30 Yr.

12/31/2015

0.16

1.06

1.76

2.27

3.01

9/2/2016

0.33

0.80

1.20

1.60

2.28

9/9/2016

0.35

0.79

1.23

1.67

2.39

In a Labor Day-shortened week, equity markets continued their stretch of low volatility until Friday, when stocks fell sharply in response to hawkish comments from key FOMC members and a well-known but controversial bond fund manager, which raised questions about a sooner-than-expected rate hike—contrary to recent market expectations. The North Koreans also announced another nuclear missile test, which is always a geopolitical wildcard, depending on the number of other newsworthy events in a given week. From a sector standpoint, U.S. equity returns were led by gains in energy, in keeping with higher oil prices during the week, while all other sectors lost ground—the worst being consumer staples and materials.

Stock and bond have an unpredictable and somewhat schizophrenic relationship with the specter of rising interest rates. This is easy to forget, but higher rates are technically a positive development, implying that growth is strong enough for an economy to warrant and absorb them (moves also tend to be positive for markets over the intermediate-term); while a lack of rate action is indicative of weak conditions, and, in theory, offers mixed messages for stocks and bonds. However, when the moment finally arrives, short-term fears of the punchbowl being removed from the party can generate some volatility, as it's something we haven't seen in over a decade in any meaningful way. Unfortunately, the Fed's over-communication in recent years can mean a hair trigger after any comment from any FOMC member. Traditionally, no one spent much time worrying about the various Fed governors and their opinions (they were relatively anonymous). Today, though, many are household names, and their various tendencies (hawkish, dovish, subtle, exaggerative, etc.) are overly-documented, to the point of their discussions being scrutinized through key word search algorithms for changes in tone.

It's important to note that, whether a rate hike comes in September and/or December, the pace of rate movement upward is likely to be very tempered—based on how things look today. A significant spike in growth and/or a significant rise in inflationary pressures could cause the Fed to speed up their pace, but current data doesn't look threatening on that front.

Overseas, the ECB decided against any further easing last week directly, keeping their current stimulus program in place; although, it's assumed that further easing could happen in the latter part of this year if continued lackluster conditions persist. This news and weak German and French economic data prompted European stocks to fall off, although not to the same degree as in the U.S., being driven by different dynamics. By contrast, Japanese stocks were pushed higher by a positive GDP revision upward and other economic data turning out a bit better than expected.

Emerging markets gained on the week, as positive returns in China, other Asian markets and Russia offset weakness in Brazil and Mexico—EM equities have been supported by recent investor flows chasing the strong returns year-to-date. Oddly, a negative week in Mexico was related to the resignation of certain politicians following a Trump visit, as well as fiscal spending cuts that were likely unrelated to the visit.

U.S. bond prices generally fell on the week with rising rates, mostly at the longer end of the yield curve. Governments slightly outperformed investment-grade credit, but high yield actually fared better with flat returns and floating rate bank loans gained ground. There has been higher new supply activity in corporate bond markets—partially a seasonal thing with summer being over and partially a nod to companies wanting to take advantage of low rates before they're assumed to inch higher. In foreign bond markets, a weaker dollar turned a negative return for developed market debt into a positive one, with strong gains in Japan offsetting losses in the U.K. Emerging market bonds fared positively overall.

Real estate lost several percent on the week, a bit worse than broader equities, which was no doubt related to the 'fears' of an interest rate increase. Such an event is a common risk for REIT returns over short-term periods, as we've discussed in the past, although the longer-term implications of which (e.g. economic growth, tenant demand) have generally been good for the asset class. Within the U.S. group, cyclically-sensitive lodging/resorts suffered the worst, while other core sectors industrial, residential, etc. fared better. Foreign REITs outperformed, with help from a weaker dollar, but the bulk of positive returns were due to Japan.

Commodities experienced a positive week, led by the energy sector, although agriculture and precious metals also proved their diversification benefit with positive results. West Texas crude rose to just under $46/barrel due an unexpected drawdown in U.S. inventories and continued talk of Russian/Saudi cooperation to 'rebalance' (decrease) production. All of these producers want higher prices, but not so high as to shoot themselves in the foot. Following the early 2016 tumble in oil prices, early April through now has proven far less exciting for the energy segment, with price movements limited to a fairly precise round-number trading range of $40-50/barrel. However, the week-to-week results can look far more exciting as a $4-5 rise or fall in pricing at those levels represents a 10% gain/loss in either direction. Predictions continue to be mixed from firm-to-firm, but on consensus seem to be in the $50-60 range over the next few years, which implies supply reductions from current levels and/or some improved demand from emerging markets. Targets in the near-term tend to reflect current pricing sentiment, so are naturally subject to ongoing change. Oddly enough, and a reminder that charts can tell any story you want them to when you change the dates, both spot crude oil and unleaded gasoline are nearly unchanged on a year-over-year basis despite the drama in between.

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 September 6, 2016.

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