Economic Update 9-29-2014

• Economic news was generally mixed on the week, with housing providing a slightly more optimistic tone. GDP for the 2^nd quarter was revised a bit higher as well, casting a more positive light on the prior period.
• Markets experienced a bit more volatility this week, ending in the negative, with U.S. blue chips the best of a bad bunch. Bonds eked out a small return on slightly lower yields, as the broader market news was strangely overshadowed late in the week by Bill Gross’ move from PIMCO to Janus.

U.S. stocks bounced around a bit this week, mostly determined by a bad Thursday.  While all sectors lost ground, materials and consumer staples held up the best, while telecom and industrials performed the worst, losing over -2%.  What appeared to spook markers?  A few things:  The Fed and interest rates increases, Apple’s operating system update troubles, which sent the stock down (it’s a big index member); Russia’s threats to confiscate foreign assets; and ongoing worries about Chinese growth vs. need for additional stimulus (the default fear du jour when there is need for something to worry about), although these worries tend to affect non-Chinese often more than they do Chinese shares directly.

There have been some downgrades in China’s expected GDP growth for 2014-2015, from the upper 7’s, down to a revised just over 7%, then into the high 6’s for the following few years.  In absolute terms, that’s still high growth, just not as high as it once was.  In more specific terms, their PMI is trailing that of the U.S. by about 10 points, about the widest it’s ever been—so there is a gap in momentum.  This deceleration of growth is a natural progression as an economy evolves, and the extreme improvements seen at the early stages are less possible at the margin as the quality of growth becomes a higher priority than the quantity.  Most economists agree that with generally slow growth in the developed (consuming) world, relying on exports won’t do the trick, nor will indefinitely large infrastructure projects.  It has to come from internal consumption; this is the careful and difficult balance the Chinese government is hoping to accomplish.  (Part of the Alibaba story is based on hopes for that latter theme.)  Perhaps more on this in another weekly review at some point.

In other markets, Japanese shares actually gained almost a percent, following a poor CPI result (only 1% versus the Abenomics target of 2%+), which raises probabilities of additional central bank stimulus action.  Currency effects and USD strength appeared to add additional weakness to foreign markets, which generally lost ground across the board—emerging markets performing a bit worse than developed.

Bond prices experienced a positive week, as yields fell.  Although things came to halt later as fears over the impact of Bill Gross (specifics below) leaving PIMCO and potential for significant outflows of bond assets.  Markets don’t like disruption, and being of the size PIMCO is, this is a management shift affecting a $2 trillion firm, mostly in bond money.  Long treasuries performed best, high yield and bank loans lost some ground, while most other segments were flat.  The 1% gain in the dollar proved to be an equivalent headwind for the bulk of foreign bonds on the week; emerging market bond spreads widened a bit.

The investment industry news of the week was certainly Bill Gross’ departure from PIMCO, a firm he helped create and certainly put on the map as the long-time face of the firm, and relocation to Janus, a firm that has been working for some time to beef up their fixed income footprint to supplement an already well-regarded equity group.  The move was surprising, especially as it is obviously rare to see a firm founder depart to a competitor; but rumors of dissent and recent management reshuffling around PIMCO haven’t exactly been quiet.  We don’t know if the move was voluntary or involuntary exactly, but these things don’t happen overnight.  PIMCO remains a sizable force in the fixed income world, and employs a deep bench featuring a world-class staff of economic and fixed income specialists, so the impact to the firm is yet to be determined (but it may not be as severe as feared).  As we have inferred through our own due diligence and discussions with personnel there in recent years, a larger size can offer pros and cons.  On the positive side, being a behemoth can put a firm in the position for better access and leverage for upcoming deals, and, in fact, provide enough power to mold and customize new issues to their benefit, to some extent.  The negatives, though, are that the impact of individual security selection is more diluted, and the use of derivatives and other exposures are required to express views.

Real estate sector returns were all negative, in line with equities, but with a little better result from residential (in keeping with housing stats on the week) and Europe bringing up the rear.

Commodities were generally flat on the week as a whole.  Continued strength in coffee, sugar and cocoa were the primary positive drivers (for the first two, production cuts in Brazil, while the latter continued to be impacted by fears over Ebola in West Africa, that could affect normal harvest and production operations).  Precious metals and industrial metals suffered the largest losses on the week, while crude oil ticked up a bit above $93, off its lows.

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.