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Weekly Review - September 5, 2017

Weekly Review - September 5, 2017

Guest Post - Tuesday, September 05, 2017


Economic news for the late summer week was focused on a revision higher in Q2 GDP results, continued expansionary manufacturing numbers, mixed housing results, and a somewhat disappointing employment report.

Equity markets fared positively for the week, with U.S. stocks outperforming both foreign developed and emerging. Bonds were flattish with credit outperforming, as did emerging market debt. Commodities saw positive returns with gains in a variety of categories, with the hurricane impact mostly affecting gasoline prices.

Economic Notes

(+) The preliminary second estimate of the Q2 GDP report came in much better than expected, up an annualized +3.0%, compared to the +2.7% consensus estimate, and the strongest level of growth in two years. The key differences were revisions to personal consumption growth, which was moved a half-percent higher to +3.3% and business fixed investment, which was substantially higher at nearly +7%. Real final sales was also revised higher, while other areas were little changed, other than a downward tweak to government spending. Inflation from a core PCE standpoint was revised just slightly lower to an annualized +0.91% for the quarter, which remains low. Estimates for the current quarter appear to be at about a similar 2.5-3.0% pace. Natural disasters can certainly affect GDP, both through lost output during the period of the storm in a negative way, but also can positively affect economic growth from rebuilding efforts. The Hurricane Harvey-affected areas represent about 3% of U.S. GDP (almost all of which is the result of Houston being included) so the impact on either side could amount to a few tenths of a percent.

(0) Personal income for July rose +0.4%, which was a tenth of a percent stronger than expected, due to growth in wages/salaries along with a stronger labor market. Personal spending, on the other hand, increased +0.3%, which was a tenth slower than expected, although there were some prior month revisions higher. This brought the July savings rate to 3.5%, down -0.1% from June. The PCE price index rose just +0.1% for the month on both a core and headline level. This brought the year-over-year change to +1.4% for both, well under the Feds target—notable as they use the PCE as their preferred inflation measure.

(+) The ISM manufacturing index rose +2.5 points to 58.8 for August, beating expectations calling for 56.5. In fact, the current report represents the highest level in over six years. Under the hood, new orders fell a tenth of a point (but remained above as solidly-expansionary 60), while employment and production rose a bit. Inventories also rose five points to the mid-50s. All in all, this high index level continues to point to positive conditions in American manufacturing.

(+) The Chicago PMI for August came in unchanged at 58.9, but beat expectations calling for a slight decline to 58.5. By sub-sector, new orders and production rose, while employment and order backlogs declined—the labor component fell under 50 into contraction for the first time in several months. Inflation pressures appeared to ease again, in keeping with general trends seen in other price index measures. Overall, a number in the upper 50s continues to signal a healthy economic expansion.

(-) The advance goods trade balance for July widened by -$1.1 bil. to $65.1 bil., which was wider than the -$64.5 bil. expected. Exports declined by just over -1%, mostly in autos; imports were just slightly lower, due to drops in both imported autos and industrial supplies/petroleum.

(0) The S&P/Case-Shiller home price index rose +0.1% in June, matching expectations. Nationally, prices increased in all markets but four, with West Coast cities Seattle, Las Vegas and San Diego leading the way with over half-percent gains for the month; declines of a similar magnitude were seen in New York, Cleveland and Chicago. Year-over-year, the index gained +5.7%, which was just a touch below pace of the prior month and remains strong from a historical standpoint.

(-) Pending home sales for July fell -0.8%, disappointing relative to an expected gain of +0.4%. Most national regions saw declines, with the South leading the way at nearly -2%, while the West experienced over a half-percent gain. Naturally, this bodes negatively for existing home sales over the coming several months, when 'pending becomes 'real.

(-/0) Construction spending for July fell -0.6%, in contrast to the +0.5% gain expected. At the same time, revisions upward for prior months helped temper the result. In July, on the private market side, non-residential fell -2% while residential rose almost +1%. Public spending fell over a percent with declines in the residential and non-residential segments.

(-) The Univ. of Michigan consumer sentiment index fell -0.8 of a point to 96.8, below the unchanged 97.6 level expected. Assessments of current conditions fell just a tenth of a point, while future expectations declined more than a point. Inflation expectations for the coming year were unchanged at 2.6%, as were those for the next 5-10 years at 2.5%. The timing of the survey appeared to coincide with Hurricane Harvey, which could have played a role in the decline, particularly in the area of higher gasoline prices, which almost always tends to have a negative impact on consumer sentiment.

(+) The index of consumer confidence gained +2.9 points to 122.9 in August, beating expectations for a nearly flat reading of 120.4. Assessments of present economic conditions gained the most, up +6 points, while expectations gained just a point. The labor differential, which measures the ease of finding employment, rose almost +4 points to a multi-decade high. Interestingly, that level was only surpassed in the exceptionally strong job markets of the late 1960s and late 1990s.

(+) The ADP employment report of private job growth showed a gain of +237k for August, beating expectations calling for +185k. Additionally, the July number was revised up by +23k. Services led, as usual, gaining +204k, with trade/transports/utilities, leisure/hospitality and education/healthcare coming in with the strongest gains. Goods-production jobs rose +33k, both construction and manufacturing adding in roughly equivalent amounts.

(0) Initial jobless claims for the Aug. 26 ending week ticked up by +1k to 236k, which came in just below expectations of 238k. Continuing claims for the Aug. 19 week, on the other hand, fell by -12k to 1,942k, below the 1,951 expected. No unusual factors were reported, but summer plant shutdowns could be trickling off. In coming weeks, expect Hurricane Harvey effects to play a temporary role in boosting claims activity.

(-) The employment situation report for August was mixed, and generally weaker than economists expected beforehand, but it appear to move the needle dramatically in terms of Fed policy. Nonfarm payrolls came in at +156k, below the +180k expected. In addition, results from several prior months were revised lower by over -40k. For August, goods-producing jobs showed their best results since early in the year, gaining a total of +70k jobs in manufacturing and construction but also gains the mining group. Services declined to +95k, with growth in the education/health and professional services segments, but minimal gains in leisure/hospitality and retail, and a decline in information jobs. Government employment also declined, mostly in state/local as opposed to Federal.

The unemployment rate ticked upward a tenth to 4.4%, relative to expectations of no change. As the labor participation rate was flattish, the household jobs component falling (-74k) contributed to the higher jobless rate; however, the U-6 underemployment rate was unchanged at 8.6%. Average hourly earnings rose +0.1% for August, which was only half the gain expected, which kept the year-over-year rate at +2.5%—still a few ticks above the rate of broader inflation. Average weekly hours fell a tenth to 34.4.

Market Notes

Period ending 9/1/2017

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U.S. stocks gained, with small caps coming back to outperform large caps, in fact with the Russell 2000s weekly return accounting for more than half of its positive gain year-to-date. By sector, health care bounced back sharply earnings nearly +3%, with positive biotech M&A news, followed by solid returns in technology and materials. Telecom and utilities lagged with negative returns.

To buck recent trends, foreign stocks under-performed U.S., with mixed results from a stronger U.S. dollar for the week. Europe gained largely in line with the broader EAFE index, as were net returns in Japan, as a stronger local gain was pared away by a weaker yen. U.K. results had the opposite effect, due to a stronger pound. Recently in Europe, a stronger euro has raised a few concerns over earnings results going forward, especially for export-oriented companies. Emerging markets fared similarly, although country-to-country results were mixed. China ended the week as one of the leading performers due to several stronger manufacturing surveys. Mexican shares, among others, reacted negatively in light of U.S. negotiations about the future of NAFTA and legality of a U.S. pullout or restructuring.

U.S. bonds were relatively flat, with minor changes in the yield curve. However, credit outperformed governments, with gains in high yield. Emerging market bonds outperformed foreign developed markets, not helped by a minor recovery in the dollar. One interesting facet of the upcoming debt ceiling/federal budget deadlines is that yields for short-term treasury bills have 'spiked about 0.20% higher for maturities in early-to-mid October—just after the relevant calendar deadline dates, in a reflection of default probabilities. This has also happened in prior years under similar scenarios, so this phenomenon is nothing new.

Real estate equities gained in all regions, with Asia and Europe outperforming the U.S., in keeping with recent trend. Domestically, resorts/lodging experienced the strongest week, while retail and residential continued their respective weakness.

Commodities gained, with strength in energy and both industrial and precious metals. Oil prices were not generally affected by Hurricane Harvey initially, and actually fell later in the week as inventories were larger than anticipated and usage dropped off in the affected part of the country. West Texas crude dropped by over a dollar during the week but ended back up at $47.29, a net drop of just over 1%. By contrast, gasoline prices rose over +14% during the week in response—the difference between the two is based on the fact that almost 20% of U.S. refinery capacity is housed on the Gulf Coast. Gold spot prices are up +15% year-to-date, which coincides with dollar weakness and increased geopolitical uncertainty focused on Korea.

As September begins, as we've discussed, the twin issues of funding the government and raising the debt ceiling could dominate both political discussion and market concerns, depending on the severity of the rhetoric. Interestingly, though, the aftermath of Hurricane Harvey and need for emergency funding for the area may have softened the blow somewhat, according to several analysts, and could expedite legislation that ties disaster aid and FEMA funding to the broader legislation. At the same time, the Treasury Department and other agencies have reviewed contingency plans for payment delays, if legislation is not ironed out by then. While a politically-driven government shutdown is a higher probability case than a debt ceiling delay, sadly, a worst-case scenario could again threaten confidence of U.S. government debt holders for no good reason.

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 August 28, 2017.

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