Economic Update 9-15-2014

• In a slower week for economic data, results came in tempered to positive (retail sales being a more important release), but included no major surprises. Geopolitically, the highlight originated from a developed market this time, as polls showed a stronger possibility of Scotland’s secession from the United Kingdom before this coming week’s vote.
• Equity and fixed income markets were both lower, with little extreme news to move the needle in either direction, but an upcoming Fed meeting and concerns over when rates may be increased have taken the forefront again.

U.S. stocks suffered a down albeit quiet week, with a variety of mixed messages and lack of any strong positive catalysts to take indexes higher.  Smaller-caps suffered on par with large-caps, but foreign equities overall lagged domestic names.  From an industry standpoint in the U.S.,  technology was the only positive-performing group on the week (seemingly helped by Apple’s iPhone 6 release and introduction of their wristwatch), while energy and utilities suffered the worst—not surprising due to  weaker crude prices and fears of higher interest rates.

A 1% gain in the U.S. dollar served as a headwind for the bulk of foreign markets.  In developed nations, Japanese equities were only down a half-percent, while Europe and the U.K suffered declines of 1-2%.  Emerging markets experienced the worst week, led by weakness in Brazil (-10%) as Moody’s downgraded their outlook from stable to negative due to ‘sustained low growth and worsening debt metrics.’  Support for the current president appeared to solidify—lowering chances for change during upcoming elections in a few weeks there.  Hopes for change through leadership reshuffling often add an element of bullish optimism to EM equities, especially in the wake of a new reformer (as we’ve witnessed in India this year), although the change has to occur within a certain time limit.  If chances for reform (i.e. getting conditions/policies more inline with what developed markets deep appropriate) dissipate, often, so do the returns.  Russia and China were also down last week, but by only half as much as Brazil.

Speaking of the U.S. dollar, over last 2 months, the USD Index (dollar versus basket of major world currencies) is up +6%.  The threat of accommodation and monetary stimulus tends to depress currency values, which explains the weakness in the Yen and Euro as of late (notably the latter, after potential QE commentary).  There are a few reasons for this, one of which is the more immediate ‘carry’ effect, in that the correspondingly lower interest rates are less attractive to long-only fixed income investors, so they gravitate their money flows somewhere else (this is a key component in how currency ‘values’ are monitored).  Another is the economic reason, incorporating the fact that monetary stimulus is potentially inflationary, and that erodes the value of a currency over time.  So, currency reactions are often a combination of both.

Bond markets experienced a negative week as well, with long bond yields moving higher on the order of 10-15 bps (quite a bit for a single week these days—for context’s sake, this corresponds to at least a -1% move on a bond with a duration of 10 years; obviously worse the longer you go out the curve).  Accordingly, long bonds were the worst performing domestic area, with short debt and floating rate faring a bit better.  Foreign bonds were the worst performing, declining about a percent beyond the rest of the group, explainable by the dollar’s strength.

With a week free of geopolitical/military drama for the most part, it appeared central bank policies and the risk of higher interest rates at some point in the coming year took center stage.  The current obsession is about when the FOMC will eventually raise the Fed Funds rate, and a white paper put out by the San Francisco Fed seemed to fan the flames a bit, implying investors may be underestimating potential increases in rates from currently low levels of rate volatility.  More to come mid-week in a special note after the Fed meeting, but the guesses for this occurring remain centered around mid-2015 (more or less).  It’s almost irrelevant, as markets are sure to move well before then, rendering the actual hike itself a formality.  The Fed rate increase is more symbolic of a regime shift than it is meaningful from a mathematical perspective, as the difference between 0.00-0.25% and 0.25% is quite small from the standpoint of most bond buyers and model inputs that are driven from such risk-free rates.  Bigger shifts of 0.25% or 0.50%, though, will start to matter, but that will also be dependent on the reasons behind them (stronger growth or inflation fears).

Real estate was negative across the group, with weakness in risk assets and interest rate timing fears.  Europe was down the least, while U.S. retail and residential suffered the most.

Commodities prices generally came in a few percent weaker, influenced as of late by strength in the U.S. dollar, which has the inverse effect on commodity prices overall (which are priced in dollars).  On the week, cotton gained several percent, but came back to earth after Chinese buyers balked at the high prices by cancelling orders.  The weakest areas were nickel/industrial metals as well as coffee and sugar in the softs group.  Year-to-date, agricultural commodities are down 10-15%, on record harvest results, while industrial metals remain in the lead (nickel several times higher than others).  Gold has earned just a few percent this year, as real yields in bonds have tightened once again.  Crude oil is now just under where it began the year, in the low $90’s, after getting as high as $107 mid-summer.

Sources:  LSA Portfolio Analytics, 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.