Economic Update 1-12-2015

• The economic news of the week was led by a somewhat disappointing ISM non-manufacturing report early, Fed minutes that were largely as expected and a mixed employment report with stronger payrolls but weaker wage growth.

• Equity markets lost ground globally, while bonds of all types earned positive returns, as did real estate. Oil prices slipped again and closed under $50/barrel—one of the most closely watched items in recent months.

U.S. stocks ended up down on the week as concerns filtered through about the weakness in energy prices affecting domestic industry and infrastructure, based on anecdotal company comments.  Interestingly, the S&P is off to its fourth worst start in history.  From a sector standpoint, defensive health care and staples outperformed while energy lost ground again by -4% or so with lower oil prices.

Eurozone inflation turned negative, and that stoked headlines from that part of the world.  Adding fuel to the fire, last weekend Angela Merkel made comments indicating that a Greek exit from the Eurozone would be acceptable, so this pressured Greek names, as well as Italy, which is often put in a similar category.  However, despite the election rhetoric from Greek politicians and parties, neither a complete write-off of Greek debt nor exit from the broader Eurozone appear to be in the base case of analysts.  With such news, Europe (especially the periphery) was the worst-performing region of the week.  On the positive side, problem children of Turkey, Russia and Mexico were among the best-performing areas of the week in a bit of a rebound.

Domestic bonds rallied as 10-year treasury rates fell under 2.0% again, before recovering back towards that mark by the end of the week.  The ‘risk-off’ response of bonds relative to higher stock volatility so far in 2015 isn’t entirely surprising, but rates this low, with economic data improving, is somewhat.  Foreign bonds in developed countries came in positive on the risk-off sentiment, with German Bund yields coming in at under 0.50%, but were held back by a 1% stronger US Dollar Index—the exception was wider spreads in the European periphery, which weighed on price returns there.  Emerging market bonds generally gained all around, in both terms, as the dollar didn’t have the same impact in EM.

Real estate trusts led the way with +5% gains on the week, at least in the U.S.  Sectors were all in general alignment, with malls, retail and residential all performing strongly, a bit better than industrial and lodging.  European and Asian REITs also gained, but to a much lesser degree.  Falling interest rates and improving fundamentals have certainly helped the REIT space over the past year, especially with volatility in other equities.

Commodities experienced another painful week—more so for energy-heavy indexes and contracts than for the more diversified mixes, and the dollar strengthened by another 2%, adding fuel to the fire.  Just when it was thought that conditions for oil couldn’t get any cheaper, West Texas crude prices declined from $53 to $48, before.  On the positive side, coffee, sugar, nickel and gold all gained a few percent, bucking the trend of broader category.  Gold has benefitted from lower interest rates, which has served to shrink ‘real’ yields and lower the opportunity costs for owning precious metals over other financial assets.

In many markets, including commodities, ‘round’ numbers tend to have importance from a trading/sentiment side, although the straight downward move has bucked that trend this time.  Perhaps $50 will be that rough support point for oil, or maybe it won’t.  Without beating this to death, many economists/analysts still seem to agree that the lower price environment of petroleum (being now a smaller component of consumer budgets, leading to other spending) is more of a benefit than the pain because of it (headwinds for energy firms, such as drillers and infrastructure operations).  The tricky part is that the U.S. oil market is forecast to provide 75% of non-OPEC supply growth this coming year, so while great for factors favoring oil independence, there are some difficult decisions to be made at the margin while this adjustment happens.

Per stats provided by Deutsche Bank, this recent correction in crude has been one of the most powerful in its history, surpassed only by the collapse in 1986 (-67%) and 2009 (-74%), is close to the -58% crop from Jan. 1997-Dec. 1998.  While markets have been startled by the magnitude of the correction, and are still undecided about its implications, these movements don’t continue indefinitely and, eventually, momentum runs its course.  Where the fair value of crude ‘should’ be remains to be determined, but such volatility may ultimately create other investment opportunities.

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.