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Weekly Review - September 6, 2016

Weekly Review - September 6, 2016

Guest Post - Tuesday, September 06, 2016


In a busy week for economic data, general results weren't as strong as expected, but neither were there any outright trouble spots. The ISM manufacturing index weakened by a few points, housing proved mixed but stable and the employment situation report disappointed a bit compared to expectations.

Equity markets generally ended up in the positive globally, as did domestic bonds, while foreign bonds were mixed due to a stronger dollar. Commodities, led by oil, were generally down on the week.

Economic Notes

(-) The ISM manufacturing survey for August declined more than expected, below expectations of a 52.0 reading to a contractionary 49.4. All key components were lower, including new orders, production and employment, which ended up with high-40's readings similar to the broader index, with little diffusion between the parts. This has been an area of interesting mixed results over the past year, with alternative periods of expansion (over-50) and contraction (under-50) readings. Due to the high-profile nature of this release, it may play a role in the Fed's determination of a September rate hike, although there is much more data than this to consider.

(-) Similarly, the Chicago PMI index fell several points from 55.8 in July to 51.5 in August, worse than an expected less dramatic decline to 54.0. A decline in both new orders and order backlogs were behind the drop, while employment actually improved slightly, keeping the overall index in expansionary territory.

(0) Personal income for July rose +0.4%, which was on target with expectations being the largest monthly gain so far in 2016; personal spending also met expectations, gaining +0.3% for the month. This moved the savings rate up a few tenths to 5.7%. The PCE price index (important due to it being the Fed's preferred inflation measure) was flat on a headline level while the core measure rose +0.1%. Year-over-year, headline and core PCE rose +0.8% and +1.6%, respectively, which are within the same ranges as other inflation measures—so no surprises. These will no doubt evolve as the extreme price declines in energy roll off, and the Fed will be watching closely as this is one of the key benchmarks for policy action.

(0) The S&P/Case-Shiller home price index fell -0.1% in June, which was on target with expectations; however, it appeared the monthly change may have been due to seasonal adjustment factors, which alter results from time to time in shorter periods. Portland gained +0.7%, leading the 20 cities in the index and has been one of the strongest cities in the nation as of late, while Chicago and Atlanta lost ground on the order of about a half-percent for the month. Year-over-year, the index rose +5.1%, which was the same pace as the prior month. For the 20-city index, trailing 12-month gains were led by Portland and Seattle, where home prices increased by over +10%, followed by Denver and Dallas at just under that mark. While all cities in that group gained ground for the year, the weakest performances came from Washington, D.C., New York and Cleveland, at around +2%.

(x) Pending home sales for July rose +1.3%, which outgained the +0.7% expected; however, some downward revisions to prior months took a bit away from the positivity. Regionally, pending sales were strongest in the West, which gained +7%, while the Midwest declined about -3%—other regions were little changed. Year-over-year, pending sales are down -2%, but what really matters are how these translate into existing home sales.

(0) Factory orders for July rose +1.9%, which fell just under the expected +2.0% gain, while core capital goods shipments were revised downward and durable inventories were revised higher. It appears oil industry dynamics are continuing to play a role in this series as machinery shipments in the mining/oil patch were down -4% over the month to the lowest levels in a decade.

(-) Construction spending for July came in flat, disappointing relative to an expected +0.5% increase; however, June numbers were revised upward sharply—mostly in non-residential—from a half-percent decline to nearly a +1% gain, offsetting some of the impact. Residential investment was barely above zero, while state/local government spending declined a few percent.

(+) The Conference Board's consumer confidence index for August rose to 101.1, a gain of +4.4 points over last month and better than the 97 level expected. Both current conditions and expectations of future conditions improved, as did the labor differential (a measure of the difficulty in finding a job), reaching a post-crisis high.

(0) The ADP employment survey for August showed a gain of +177k jobs, which was +2k better than expected, so relatively in line with consensus. Additionally, July jobs were revised up by +15k, which was positive. Service jobs gained by +183k, with a large impact from professional/business services, which rose by +53k, and trade/transports/utilities, which gained +26k. On the downside, goods-producing jobs fell by -6k, which it has for the bulk of this year, due to weakness in construction.

(0) Initial jobless claims for the Aug. 27 ending week ticked up by +2k to 263k, just -2k short of consensus expectations. Continuing claims for the Aug. 20 week came in at 2,159k—higher than the 2,145k median forecast. The bulk of claims activity occurred in the largest U.S. states, per usual, but Gulf Coast claims continued to run higher, perhaps due to recent flooding.

(-) The August employment situation report could have been worse, but remained a bit of a disappointment. Nonfarm payrolls came in at +151k, which was below the +180k expected. While private job growth was positive in a variety of areas, it was at a slower pace. Professional/business services jobs declined from +80k the prior month to +22k, and leisure/hospitality and government jobs also gained less ground than previously. Interestingly, August tends to be an odd month for payrolls, so these could still be revised up later (or not).

The unemployment rate was unchanged at 4.9%, despite expectations for a decline of a tenth of a percent. The accompanying household survey showed a +97k gain in jobs, while the U-6 'underemployment' measure also came in flat at 9.7%. Average hourly earnings rose +0.1%, despite consensus expectations of a gain twice that much, bringing the 12-month change to +2.4%—however, this has backed off from the stronger 2.7% year-over-year trend previously. Average weekly hours also ticked down a bit to 34.3, a 2-year low.

In a release earlier in the week, the final tally for unit labor costs showed a rise of +4.3% in the 2nd quarter, which was almost twice the expected +2.1% gain. This was primarily due to increases in employee compensation, and, in this revision, bumped the year-over-year increase in labor costs from +2.1% to +2.6%. The underlying story shows that wage growth is starting to rise in certain segments, an area that has been stubbornly slow, with compensation per hour being revised up to a +3.7% Q2 pace, and +2.2% year-over-year. Nonfarm productivity, however, remained stalled, with the final Q2 number coming in unchanged at a -0.6% decline, as expected. There remain many unanswered questions about the weakness in productivity, as evidenced by the multitude of academic papers recently on the topic, with one possible answer being that 'old school' measurement methods aren't capturing its affect properly.

Overall, the employment report wasn't up to expectations, but it remained in the 'ok' category, which may or may not be good enough for the Fed to take action in September (where odds of a rate move around about 50/50); a December move appears to remain a consensus higher-probability bet. Signs continue to appear that strength in labor markets could be peaking.

Read the "Question of the Week" for September 6, 2016:

What should we make of the lack of volatility lately?

Market Notes

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U.S. stocks marked gains, ending another low-volatility end-of-summer period. This was helped on Friday with the less-than-stellar jobs report providing some hope of a delay in the Fed hiking interest rates, and keeping the extraordinarily accommodative policy alive for a bit longer. This market reaction effect of lower for longer rates is broader than it might seem and trickles down to several areas—including upward pressure on U.S. stock prices, a less-strong dollar (not necessarily weak but tempered gains at least as those could require higher relative interest rates), and stronger commodity prices absent other short-term dynamics (affecting gold mostly).

From a sector standpoint, financials led by gaining a few percent on the week, followed by materials, while energy and health care lost slightly. Retail earnings continue to be an area of investor focus with divergent results and comments from the auto industry that sales may have already peaked and begun to level off. Probably the most interesting piece of stock news for the week was a European Commission court decision to fine Apple 13 bil. euros ($14.5 billion) based on Ireland's providing the firm 'selective tax treatment.' Due to several other large companies using Ireland as a domicile/tax haven, there could be more to come, subject to any appeals from the Irish government and firms themselves.

Developed foreign stock indexes overall gained a few percent in local terms, in Europe and Japan, but much of this was eroded by a stronger dollar. European economic news was mixed, with investor outflows away from equities in that region continuing, while stocks in Japan were buoyed by further confidence words from the BOJ that more easing could be coming. This brings up an interesting situation, as we've mentioned, with the Japanese government (Bank of Japan and national pension fund) on its way to owning almost the entire domestic bond market and now, indirectly, is the leading shareholder in nearly 500 domestic companies. This is not only unique due to the size of the ownership stakes, but especially from the fact that pension assets there traditionally have been risk-averse and stock-avoidant (but government pressure seems to have altered this worldview). Now the purchases have moved to ETFs, in an effort to stimulate pricing upward. In the U.K., a stronger pound had the opposite effect as stocks outperformed due to a stronger-than-expected manufacturing report. Following strong year-to-date performance, flows have continued into emerging markets for a record ninth consecutive week, which is the strongest stretch in half a decade.

U.S. bonds were little changed to slightly positive during the week as rates dipped and rose again by week's end, just a touch lower than where they began. High yield corporates led, with the strongest performance in the group, and credit overall outperformed government bonds slightly. With a headwind of a stronger dollar, locally-denominated foreign bonds in developed markets performed negatively, while USD-denominated emerging market debt showed small gains.

Real estate gained ground on the week in the U.S. and Europe, while Asian REITs lost ground due to losses in Japan and Australia.

Commodities fell, led by a decline in the energy and agriculture sectors, while precious metals gained. Crude oil fell by –7% to the $44.50 range, upon news of rising U.S. inventories over the past week which offset continued talk of an OPEC cut in output; mediocre jobs news that kept the dollar contained also acted as a boost on Friday. To no surprise, there continues to be a difficulty in formulating a broad agreement among oil-producing countries about shared goals (other than wanting prices to rise in order to help their own income statements), although meetings between Russia and Saudi Arabia have raised hopes for some type of production freeze to achieve higher prices.

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 29, 2016.

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