Economic Update 4-13-2015

• Economic data was light and results mixed last week with the ISM services report coming in a bit weaker, but jobs reports—JOLTs and claims—better than consensus.  The FOMC minutes generally read as expected, with differing views on the strength of the economy and timing of potential rate hikes.

• Equity markets gained on the week, led by emerging markets.  Government bonds lost ground upon higher rates, although corporates fared better.  Commodities generally gained—led by energy—even in spite of a stronger dollar.

Equities gained on a relatively quiet week, with earnings results just beginning to come in for the quarter.  (The traditional early entrant, Alcoa, outperformed, but this first report hasn’t been shown to have much correlation to the rest of the market’s reports.)  From a sector standpoint, energy fared best with some stabilization in oil prices, very low expectations and the Royal Dutch Shell buyout of BG Group, followed by health care and industrials, all gaining over a percent on the week.  Industrials were led by General Electric’s announcement of the sale of financial/non-industrial assets and upcoming share buyback, and subsequent +10% price gain.  Financials and utilities fared worst, with minimal gains, as the latter of which is usually tied in with rising rates. The volatile segment of the moment, biotech, continued this trend.

The bulk of the 1^st quarter earnings reports are expected out in coming weeks, and we all know they won’t look so great—as estimates have been pushed downward.  Expectations are for a drop in overall year-over-year growth, much of which has largely been reflected in guidance.  Several of the items saturating the financial news at this point, such as the strong dollar (affecting revenues translated in from abroad), drop in crude oil (reducing energy sector profitability), and West Coast port slowdowns are key stories from the quarter and offset some otherwise positive organic growth.  Another harsh winter compared to average didn’t help, either, and likely cast a shadow over consumer spending.  Of course, if guidance is adjusted too low (which it often is), and companies end up performing just a bit better than expected, we then end up with a positive ‘surprise.’  This is how that game is played every quarter, so if things turn out strangely better than expected, that’s the reason.

From a numbers standpoint, growth is expected to be negative for the quarter, on the order of -2% to -4% for the S&P.  These expectations improve into the positive if the impact of the energy sector is removed; in fact, several ‘growth’ sectors such as healthcare and technology are expected to deliver quarterly earnings gains in the double-digits.  For 2015 as a whole, expectations show some recovery potential, with +2% to +4% growth expected overall (when energy is included), and better outside of energy.

Foreign stocks were led by emerging markets, with strong gains in the BRIC countries, core Europe and Japan faring similarly to the United States, with peripheral Europe selling off somewhat. China was the big story on the week, as opened linkages between China and Hong Kong spurred additional speculation, fueled by a Chinese CPI number that came in better than expected.  Hopes continue that the Chinese government will do enough via stimulus to stem the growth slump by improving internal consumption.

U.S. bonds pulled back on the week with higher interest rates across the curve; consequently, longer-duration issues fared far worse than shorter-dated debt.  High yield and bank loans also performed positively, bucking the general trend.

The U.S. dollar index rose about +2% on the week which turned small local foreign bond returns into losses generally, so dollar-pay bonds outperformed, especially in emerging markets.  The foreign bond universe experienced an odd event this week, as Switzerland issued a new bond offering for the first time with a negative yield—a 10-year at -0.06%.  Of course secondary market negative yields have been increasingly common in several countries in Europe over the last few months, but this is the first primary issue event (perhaps ever).  To boot, the offering was over-subscribed by two times, implying no shortage of demand for the bonds.  We’ve discussed the circumstances before as to why buying a bond with a negative yield-to-maturity would make sense for some, examples being:  regulatory mandates (as in a pension fund or other domestic entity with a set need for Swiss bonds), needing to own ‘something’ (as opposed to just large bank deposits or holding cash), those hoping for a quick profitable trade to an even lower yield, or plays on a potential currency spike are other reasons.  Still, spurious and unusual territory.

Real estate gains were led by Asia (including Australia), while Europe and Japan fared decently.  Higher interest rates caused U.S. REITs to struggle, although health care and mortgage REITs fared better than residential and retail.

Commodities posted a decent week, up several percent, bucking the stronger dollar.  Negotiations with the Iranians over a nuclear deal appeared to be a driver of sentiment in the energy segment—in theory, this removal of one large element of geopolitical uncertainty should serve to depress oil prices further by reducing the ‘risk premium’ embedded in every barrel of oil (the range of this amount varies with circumstances but can be anywhere from several to several dozen dollars at any given time), and additional supplies through reduced export restrictions even more so.  Of course, a long road ahead remains for this agreement, but crude oil bounced around from a few dollars from under $50 last week to almost $52 by Friday, a +5% increase, which led index returns. Other groups hovered around zero, while agricultural commodities deteriorated the most, down -2% upon some improvement in perceived planting conditions in the Midwest; fewer worries in West Africa and Brazil appeared to push prices lower in the soft commodities group.

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.