Economic Update 10-5-2014
- Economic reports were mixed in terms of improvement, but continue to show strength. The highest-profile report of the week, the government employment situation, came in much stronger than expected and featured an unemployment rate under 6%.
- Equity markets experienced more volatility as investors worried about global growth and geopolitics, such as the demonstrations in Hong Kong. Bonds rose a bit on lower yields and ‘risk-off’ tendencies.
U.S. stocks lost some ground on the week, on net, as economic data disappointed and pro-democracy demonstrations in Hong Kong raised a bit of geopolitical tension, as a Chinese response remains uncertain, yet would send a sentiment signal as to the regime’s true stance toward such activity (the world hopes for a more diplomatic response than what the regime has displayed in the past). Domestic large-cap stocks again outperformed small-caps, as the latter moved into -10% correction territory before recovering. From a sector standpoint, defensive utilities and consumer staples outperformed, while energy and materials lagged—energy stocks due to continued lower oil pricing.
Foreign equities were affected partially by a 1% increase in the trade-weighted U.S. dollar index, but even more so by weaker economic data. European stocks were hit as German manufacturing PMI for last month fell just below 50, which indicates a bit of contraction, and Eurozone inflation slipped another tick to a barely-positive 0.3%. The ECB meeting decision announcing purchases of covered bonds and later, asset-backed securities, may have struck markets as not extreme enough for the recessionary/almost deflationary situation Europe finds itself in.
Bonds experienced a positive week, with yields falling about 10 basis points in line with general risk-off sentiment. Long treasuries benefitted by over a percentage point in price gain, as did high yield in a reversal of cash outflows in prior weeks. Despite strong fundamentals and very low default conditions, it appears technicals in the high yield market, such as larger seasonal supply and increasing proportions of ETF activity, have been affecting shorter-term performance. Spreads now are a bit wider and a bit further away from all-time tight levels.
Outside the U.S., the stronger dollar provided another headwind for foreign fixed income, however, European debt gained strongly on hopes for continued Euro stimulus and accompanying lower rates. Emerging market debt, particularly in Asia, lost ground, primarily due to the currency impact.
Broader real estate indexes were roughly flat on the week, with a bit more strength in residential/apartments and retail, and sharply negative returns in Europe and Asia—no doubt impacted by the dollar.
Commodities were hit with a continuing headwind of dollar strength, which affected the majority of contracts adversely. Coffee prices bucked the trend, rising 10%, on fears that current drought conditions in Brazil will adversely affect next year’s crop. You tend to see soft commodities like this act together in some instances, as many are grown in bulk in the same tropical areas (Brazil is a big one). Cocoa bucked this trend, falling nearly -10% as top producer Ivory Coast raised the price paid to farmers. In less obscure segments, gold fell as economic concerns abated a bit in light of stronger U.S. employment figures. West Texas crude oil fell to under $91/barrel, its lowest price since April 2013 when prices fell into the 80’s—technical trends are certainly working against oil prices presently for those who follow the charts. Interestingly, the Saudi’s, not known for being especially willing to cut deals in oil markets have lowered prices to Asian customers (if even only by $1/barrel or so) in order to remain relevant and competitive with increased competition from neighbors like Iran/Iraq and indirectly from North American supplies. One might argue some commodities are more important to watch than others, but oil prices are usually only newsworthy while they’re spiking—which can be a dramatic increase in budget overhead to corporations, governments and households; however, lower prices can free up additional resources for better uses.
If you’re looking for a one-word summary for how the 3rd quarter ended up, it would be ‘currencies.’ The U.S. dollar index rose over 7% in the quarter versus a developed market basket of currencies, and roughly half that amount when compared to a basket of broader emerging market currencies. This is substantial, as strength in one’s domestic currency translates into corresponding weakness for foreign currencies translated back into dollars—so consider it a major headwind for returns last quarter. It’s worth putting out a reminder of how volatile and fickle currency trends can be (central banks themselves have historically experienced a hard time managing currency expectations, let alone bucking market trends). Just a year or two ago, we remember responding to inquiries from clients wanting to ‘sell all their dollars’ and move into whatever foreign exposure or hard asset (real estate, gold…or firearms and canned goods) they could get their hands on. Naturally, this was poorly timed, and the opposite condition ensued, albeit through some patches of volatility. We aren’t in the habit of making currency predictions, but extreme moves in any assets should give an investor pause as to their continuity.
The expected dollar collapse was based on the rationale of QE exploding beyond expectations, resulting in rampant inflation, which has a currency-depressing effect. Inflation by conventional measures hasn’t taken off as of yet, but, even more importantly, ambitious stimulus measures in Japan and Europe have sunk the Yen and Euro, respectively (it’s easy to forget that any two currency pairs are priced in relative terms only to each other). So, coupled with a U.S. economy gaining more solid footing and lessened need for our own stimulus (QE ending in October), we’ve perhaps been the best-looking currency option out there for now. This explains some of the recent technical strength.
Other than that overriding component, returns for domestic stocks and bonds ended up fairly tame in the 3rd quarter, in the range of 0-1% for both the S&P 500 and BarCap Aggregate. Foreign equities, with the above-noted currency effect embedded in returns and working against them, were notably lackluster, and brought returns for most portfolios into the negative. On the positive side, our portfolios generally held their ground better than did our set of blended benchmarks during the period. Ironically, foreign bonds were a very large positive contributor, but the bulk of asset classes added some degree of value over the period, while domestic corporate bonds lagged a bit due to the influence of high yield.
During our recent monthly advisor meeting, we demonstrated that over the last almost-90 years of market history, certain patterns have surfaced on a seasonal basis. In large-cap U.S. equities, the most notable is the differential between ‘winter’ months (Nov. through Apr.), which have gained an equivalent annualized return of 13.5%, while ‘summer’ months (May through Oct.) earned a less robust 6.8% (the overall market earned an annualized 10.1% over the entire period). Over the last twenty years, this pattern has become even more dramatic, with ‘winter’ periods improving to a 15.4% annualized rate, while ‘summer’ has deteriorated to 3.3%, with the overall market falling at a leaner 9.2% rate.
From a monthly standpoint, we just finished the seasonally worst month on a historical basis—September—which is the only calendar month with a losing record. While more volatile than average, October returns have been slightly positive, with November and December among the most productive months to be an equity investor. No forecasts for this year, but history has tended to look favorably on the holiday season.
|Period ending 10/3/2014||1 Week (%)||YTD (%)|
|BarCap U.S. Aggregate||0.41||4.48|
|U.S. Treasury Yields||3 Mo.||2 Yr.||5 Yr.||10 Yr.||30 Yr.|
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.