Economic Update 3-09-2015

• Economic data last week was mixed, as ISM manufacturing and non-manufacturing reports showed expansion, albeit at a lessened rate than expected. Employment data was strong on Friday, in both payrolls and a lower unemployment rate, despite lower participation as a contributing element.

• Equity markets took a turn for the negative later in the week, as that same stronger employment data heightened fears of sooner Fed rate hike action. Interest rates responded by rising as well, which hurt bond prices.  Commodity prices fell upon a stronger dollar and larger crude oil inventories.

U.S. stocks ended the week on a weaker note on Friday, ironically, due to a strong jobs report, which raised fears that the Fed could raise rates sooner (June or even before) than later (later in the year).  All broad sectors were in the red, with financials and consumer discretionary faring best and losing under -1%, while utilities and energy were the hardest hit.

It was announced that Apple will be replacing AT&T in the Dow Jones Industrial Average, effective March 19.  AT&T had been a member of the Dow for 16 years.  As it’s the largest firm in the U.S. by market cap, the index committee has apparently been wanting to add Apple for quite some time, but it took so long because Apple’s high stock price (prior to last year’s stock split) would have created some problems for index calculations.  But now, DJIA member Visa’s upcoming 4-for-1 stock split will allow for an easier transition.  The last few sentences read oddly when you think about it, so we don’t blame you for scratching your heads.  It’s important to remember that the DJIA index is price-weighted, a relic from a bygone era when the easiest way to calculate an index value was by pencil-and-paper.  Most modern indexes are now market cap-weighted or configured some other way (equal-weighted, dividend-weighted, revenue-weighted, etc.).  So, the logic is outdated and infrequent changes in the index are even more arbitrary.  No professional managers we know of follow the Dow as anything more than a curiosity and its popularity is no doubt due to the fact that it’s well-known through the media, has been around for 100+ years, and companies within it are well-known blue chips that make familiar products in many cases.  If more ETF’s followed the Dow, it might spur demand for a newly added name, but academic research has tended to find that firms kicked out of indexes often outperform those newly included.

The U.S. dollar was up almost +3% on the week, per the U.S. dollar index against major traded currencies, which resulted in a -1.5% worse loss for the MSCI EAFE in USD terms than in local terms, in which it only experienced a slight decline.  Asian stocks led the way, in Japan, India and Thailand—with stronger sentiment from China’s choice to trim interest rates.  Turkey, Brazil and peripheral Europe were the big losers on the week although European stocks have been the recipient of strong inflows during the past few weeks.  Brazilian stocks suffered under their central bank decision to hike rates by a half-percent last week as their currency has also suffered and sentiment is mixed.  Chinese stocks also generally declined as their National People’s Congress lowered their 2015 growth target from ‘around 7.5%’ to ‘around 7%.’  This isn’t unexpected, as these higher targets are getting more difficult to reach as the economy matures, but public acknowledgement of this can sometimes be rattling to fans of Asia.

Bonds fared poorly last week, upon rising rates, with all domestic issues losing ground except for floating rate.  A heavier supply of corporate issuance also played a role in weaker pricing.  As expected, shorter-term debt fared best, with the lowest duration effect, while long bonds, such as 20-30 year Treasuries lost over -4% (so far, we’ve seen the opposite of last year’s trend).  Foreign bonds were affected a bit by rates and a bit by the stronger dollar, so largely ended up negative in the longer duration sovereign sectors.  Credit fared a bit better generally, with lower duration and higher coupons.

Real estate segments were generally negative on the week, in line with higher interest rates.  Developed Asian and Australian REITs fared a bit better, while U.S. health care and lodging were hit hardest on the negative end.  Health care REITs have lost some ground this year, perhaps due to valuations and uncertainty about a current Supreme Court case regarding federal Obamacare subsidies, set to be resolved by June.

Most commodities experienced a down week, largely in line with the corresponding strength in the U.S. dollar.  Crude oil prices spiked several percent early in the week, but reversed back to just under $50 by Friday as the U.S. Energy Information Administration reported that inventories were much higher than expected.  Natural gas prices jumped by an even higher amount with deeper inventory drawdowns than expected, while gasoline prices slipped several percent (albeit still +28% YTD), during refinery outage season.

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.