Economic Update 10-20-2014
- The important economic releases of the week were largely lackluster, with retail sales, and several regional fed surveys underwhelming, but not terrible. Perhaps more importantly, input from Europe and the Far East was more of a concern to world markets.
- Equity markets experienced several of the most volatile days in several years, with +/- 1%-2% swings and reversals common. On net, the U.S. large cap market was among the worst performing globally, while smaller caps and emerging market equities held up much better. Bonds gained on interest rates dipping to multi-year lows before recovering a bit.
U.S. stock markets experienced their most volatile week in some time, with extreme day-to-day volatility—most of which was on the downside. The October trend continues. Markets started the week lower on Monday, which at first seemed largely the result of global growth concerns which are now a persistent backdrop in recent weeks, but also due to rumors of a quarantined flight into Boston with sick passengers sent things downhill. The uncertainty of Ebola and apparent vulnerability are certainly a headline wildcard—the sentiment changes from such headlines are sometimes difficult to quantify, but don’t appear to be panicky at this point. But, it appeared to be a combination of several other factors other than global growth and pandemic, including an upcoming ECB review of bank asset quality at the end of this month, a minor flash crash in Treasuries Wed. morning, as well as self-fulfilling formulaic trading that can cause a downturn to feed on itself (echoes of October 1987, although to a far less severe degree).
From a sector standpoint, industrials and materials outperformed, while healthcare and staples lagged most dramatically—perhaps due to a reversal of oversold conditions. Interestingly, small caps experienced a positive week, as some bottomfishers looked for bargains after the asset class reached a technical -10% correction territory. From an earnings standpoint, ¾ of S&P firms have topped their reduced earnings estimates, but revisions for future quarters have been moving lower.
Considering this week’s effects, U.S. large caps have moved from around fair value down to a bit inexpensive again, while small caps have moved from more richly price to moderately rich. International equities were not as impacted this week, and values moved slightly lower, with emerging markets remaining very inexpensive (in light of poor sentiment and risks abundant).
In foreign equities, some of the non-BRIC emerging market nations led on the week, with strong showings from equity markets in Indonesia, Turkey and South Africa. Interestingly, Germany, Scandinavia and Russia also ended up with positive weeks, mostly due to Friday and aided by a weaker dollar. Perhaps this could be a sign of things to come—as economic results and central bank policies around the world begin to diverge from each other, we would expect cross-country correlations to decrease also. Peripheral Europe, Brazil and India generally lost in line with U.S. equities (among the worst nations of the week).
Bonds gained sharply on the flight to quality away from risky assets, demonstrated by the yield on the bellwether 10-Year Treasury falling from 2.3% to just under 2.0%—its lowest level since May 2013—before rebounding a bit higher on Friday. St. Louis Fed president Bullard’s comments about delaying the phase-out of QE if lackluster conditions continue (albeit unlikely), implied an extension in stimulus and raised hopes, and also may have acted in a downward way on rates. The best performing bonds were U.S. high yield (now priced a bit lower), and all types of foreign debt gained strongly as the dollar index dropped by a percent and ECB purchase programs were set to begin, but most all segments of fixed income were in the positive.
Real estate overall was positive, but led by the U.S. industrial/office group, although residential and health care REITs also gained. Europe was positive to a slightly lesser degree, while Asia lost ground.
Commodities were helped by a decline of about a percent in the dollar, and were led by a reversal in grains, including corn, wheat and soybeans. Precious metals also gained a percent, no doubt aided by general volatility and risk-avoidance on the week. Crude oil fell as much as -5% again on the week, to just over $80/barrel, but regained some ground towards the end of the week.
Low oil prices, while a positive for U.S. consumers, have naturally been a negative for energy companies as well as for oil exporting countries. While the per-barrel breakeven price needed to balance fiscal budgets in these nations varies, it tends to be around $100 for several key nations (Saudi Arabia and Russia). It’s lower for those with stronger resources to absorb these types of shocks (Kuwait and UAE) and higher for countries with little buffer (such as Venezuela and Nigeria). Interestingly, recent research by Deutsche Bank shows that crude prices would need to fall to the $50-60 level in order to become re-aligned with long-term trend ‘fair value,’ in real terms and relative to incomes. Of course, as budgets hang in the balance, it is unlikely OPEC nations would stand for such decline without action. In the meantime, at least in the U.S., a rule of thumb demonstrates that a $10/barrel fall in prices translates to a corresponding 0.2% gain in GDP growth in the following year.
|Period ending 10/17/2014||1 Week (%)||YTD (%)|
|BarCap U.S. Aggregate||0.45||5.61|
|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.