Economic Update 2-02-2015

• Economic data was highlighted by the conclusion of the FOMC meeting (status quo), GDP for Q4 was slightly weaker than expected, and housing numbers were mixed. Consumer confidence, however, on the heels of cheap gasoline, reached new highs.

• Equity markets lost ground last week, upon a variety of geopolitical concerns, optimistic Fed sentiment and mixed corporate earnings results. Bonds again shined, as yields fell to lows not seen since mid-2012.  Commodities actually rebounded a bit, as oil markets continued to search for a bottom to prices.

U.S. equities fell again this week, taking January as a whole into the negative.  The negativity last week originated from a variety of factors, including Greek elections, a FOMC that appeared more optimistic on economic growth than in previous meetings (ironically, bearish to many as it raises the chances and shortens the timeline for a rate increase) and a mixed bag of corporate earnings.  From a sector standpoint, all industries were in the red, with materials and consumer discretionary holding up best, while tech and consumer staples coming in worst.

Other than fears of slowing global growth, corporate earnings have been a primary story of the last several weeks, now that over half the S&P’s market cap has reported.  The results are all over the board, with investors focusing on currency impacts from a strong dollar, as well as carryover effects from cheaper oil.  The currency picture has affected revenues more than it has earnings, and may have accounted for up to a few percent of earnings growth (or non-growth).  The energy sector accounted for much of the earnings deterioration (energy company earnings down -20%), while, when energy is removed, other sectors came in generally in the higher-single to lower-double-digits in terms of growth.  All-in-all, positive surprises continue to outweigh the negative for earnings and revenue (when don’t they), albeit to a lesser degree than in prior quarters.  Overall, a net quarterly decline in earnings is expected, and this could carry into Q1 of 2015.

Foreign stocks were mixed, with Europe losing just marginally (worse with USD impact than in local terms), while Japan and developed Pacific markets gained.  Emerging market stocks were sharply lower, led by poor performances of the ‘BRICs,’ which make up 40% of the MSCI emerging markets index (more than half, if ‘edge of developing’ markets Taiwan and South Korea are excluded).  Russia also lost ground, with continued uncertainty and a surprise cut in rates from 17% to 15%—concerns continue to fester about the Russian central bank’s objectivity and freedom from Kremlin influence, which no doubt has contributed to poor market results (on top of oil and geopolitics).  Chinese stocks fell on top of weaker industrial profits, which has continued a multi-month trend.

Greek stocks were down almost -20% on the week, mostly early on, as the anti-austerity Syriza party ended up with the parliamentary majority.  This obviously raised concerns over potential policies not in the best interest of the euro, and more immediately, the willingness to handle debt repayments.  So far, in reality, the bark of Greek politics has been worse than the bite, as many Greeks (at least as noted through surveys) begrudgingly admit the positives of currency union membership outweigh the negatives, and most analysts believe this thinking will keep policymakers from veering too far to the extreme.

Bonds experienced another up week as risk-off sentiment pushed rates lower by 10-15 basis points.  Long duration treasuries fared well, keeping their year-over-year returns to equity-like levels, but most all fixed income ended up with positive absolute returns in one degree or another.  Despite frustration for those not invested in the longest-term treasuries over the past 12 months, it brings up questions about what type of assumptions are baked into a 1.7% yield on the 10-year and 2.25% on a 30-year bond.  For longer-term bonds, expected inflation is one of the larger inputs over time (other than term premium and ‘real’ return components)—do markets expect inflation rates this low for the next several decades, or are there merely shorter-term technical factors driving yields to these extremely low levels?  We were just reminded that current 10-year levels are below that seen at any time during the Great Depression.  Granted, one has to take into consideration different base starting points and modern market dynamics/liquidity, but it does provide an interesting perspective.

Outside of the U.S., most developed market debt fared well in local terms, with some deterioration when translated back to USD, while emerging market debt was generally flat on average.

Real estate lost ground on the week, in keeping with broader risk assets, with the exception of European REITs.  On the domestic side, mortgage REITs fared well upon lower rates, while lodging/resorts suffered likely due to concerns about marginal global growth prospects (with ‘leases’ as short as one night, hotels tend to be at the forefront of sentiment about future economic prospects, relative to real estate with longer-term locked-in lease periods).

Commodities experienced a rare positive week, with the GSCI index gaining close to +3%.  West Texas crude actually gained ground, ending near $48 after falling as low as $44.50 mid-week, taking crude indexes to a nice gain.  Charts for the last few weeks of trading sessions appear to show a bit of consolidation as oil appears to be looking for a bottom, and the choppiness of trading seems to this.  Nickel and cotton also gained ground on the week, while the losers were wheat, silver and natural gas (the latter almost always being weather expectations vs. inventory-dependent).

Interestingly, statistics have demonstrated that ‘oil-derivative’ assets (such as oil-levered equities and foreign exchange) have performed better than would be expected given the severe oil price decline.  While economists continue to debate the causes of oil’s plunge being caused by lower demand or a stockpile of supply, such tendencies may point to today’s situation looking more like the ‘oil glut’ experience of the mid-1980’s, but time will tell.

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.