Economic Update 11-10-2014

• The headline-worthy ISM manufacturing survey came in better than expected, while other releases were mixed. The employment situation report was also decent, but not overwhelming.  The mid-term election that resulted in a Republican takeover of the Senate was a moderate boost to sentiment mid-week.
• U.S. equity markets generally rose on the week, foreign markets were weaker. Bonds were generally flat as the yield curve flattened.  A continued strong dollar was a headwind for both foreign assets and commodities.

U.S. stocks gained on the week, as decent-to-good news trumped the neutral.  Large-cap stocks were all generally higher, while small-caps struggled early and never managed to end above zero.  From a sector standpoint, conservative consumer staples and utilities were the gainers on the week, while healthcare and consumer cyclicals lost about a percent each.  Healthcare stocks weakened partially due to the U.S. Supreme Court agreeing to hear a case that could threaten the government’s ability to provide Obamacare insurance tax credits.

The U.S. dollar, a comment for which has started to become a regular part of these reports, gained +2% on the week, causing another headwind for foreign and hard assets.  Foreign stocks were generally down, in line with the dollar strength.  Markets that bucked the trend were several in the European periphery, as the ECB announced that it’s seeking to expand its balance sheet by a trillion Euros while planning purchases of sovereign debt as well as equities.  India and Japan also gained—the latter on continued strong sentiment due to planned asset buying as well.  Stocks in Russia, Brazil and Turkey were down 5-10%, and were responsible for the bulk of negative index returns—the bulk of which was due to currency translation effects.  Russia announced the possibility of using gold to pay for imports, interest rate increases and other measures hopes of stemming the ruble’s depreciation, which has been dramatic this year.

Bonds were little changed on the week, with bellwether rates ticking downward a few basis points.  International bonds were negative in line with dollar strength.  The Treasury announced cuts in the auction sizes for certain maturities, noting that reductions in 2- and 3-year issues are intended to reduce anticipated project overfunding in fiscal year 2015.  The reduction is only by a few percent, but this type of trend may reduce supply over time and have an affect on yields for maturities involved.

Commodities were naturally affected by the rise in the dollar, and indexes fell by just less than the amount of its impact.  On the stronger side, natural gas contracts rallied 20-25% as a cold snap is expected to hit many of the Northern states in the coming week.  In other groups, base metals managed to get away with minimal losses, while West Texas crude fell from near $81 down to $78.50.  Interestingly, gold gained 3% on Friday to near $1,170 in its best day in some time, which closed the gap on a poor week up to that point.  Estimates from several commodities departments we review tend to peg the fair value to somewhere in the $1,000-1,200 range in coming years.

How did last week’s election impact the economy and market sentiment?

By the impact on Wednesday morning, equities were higher as were interest rates, but to a muted degree as the election results were largely in line with poll expectations—with the Republicans retaining their control of the House, as well as regaining control of the Senate for the first time in eight years.  However, both wins were by slightly wider margins than analysts had originally anticipated.  There are still a few closer races being tallied, and re-tallied, and possibly re-voted in run-offs in a few instances, but naturally, the wider the margin of seats won, the larger the buffer for party line politics as well as for seats up for grabs in 2016.

Republican victories are seen as being market-friendly, since GOP policies are generally in line with business interests, and in theory for lessened regulation, lower taxes, higher defense spending, pro-petroleum, and ‘smaller government’ in general, which is a tailwind for legislation affecting corporate America and investment market interests.  We say ‘in theory,’ as it’s rarely this cut-and-dried in practice, but hopes always start high after election day.

Another positive would be that a lack of gridlock also removes the risk of last-minute tensions surrounding government shutdowns, increases in the debt ceiling (another planned for early- to mid-2015) and the even more remote chance of a Treasury debt default—in fact, Senate Minority Leader Mitch McConnell reassured Americans during a post-election press conference that these concerns/hurdles are now off the table.  We would hope that’s the case, as the scare a few years ago rattled markets unnecessarily.  While it’s easy to make promises now, the chances certainly are lower now that the same party controls both chambers.  On the negative side, it may take significantly more time for any of Obama’s upcoming nominees for federal offices and judgeships to be filled, if they can be filled at all—this has been a recurrent problem in recent years due to party strife.  This includes two current vacancies on the Federal Reserve Board of Governors, which expire in a few years anyway, strangely enough.

There are a few industries that could be affected (some market impact may already be embedded since the election results weren’t a surprise), including energy infrastructure, which could benefit from fewer environmental roadblocks of the Keystone and other pipelines, as well as ‘tweaks’ to Obamacare, including possible removal of surcharge taxes on medical devices.  There are others, of course, such as immigration reform, which have a less direct impact on financial markets.  The broader tax reform issue is a daunting one, and progress on this remains to be determined, but a major roadblock (Democrats requiring a ‘revenue-neutral’ option, meaning retaining current levels of government tax receipts earmarked for spending) may have been partially removed.  Likely, corporate tax reform might be an easier hurdle to tackle first, as opposed to the entire income tax regime all at once.

The dollar also gained on the week on its continued trend, which appeared by be helped by the election results.  Why the boost?  Better chances for agreement between the chambers lowers uncertainty in policy—whether one is happy with policy or not by a given party in charge, markets at least know what to expect and we how much markets dislike uncertainty.  This again strengthens the U.S.’ role as the safe port in the storm, so to speak, relative to a struggling Europe and Japan which continue to be caught in the crosshairs of underlying fundamental challenges and need for additional stimulus.  From a historical standpoint (and certainly no scientific prediction for the future), stock market results for the months and full year after mid-term elections have generally been positive.

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.