Economic Update 5-12-2015

• Economic reports last week were led by a decent ISM non-manufacturing report, low levels of jobless claims and a decent but unexceptional employment situation release—uninspiring enough to keep markets hoping for continued easy Fed policy beyond June.

• Stocks generally gained in developed markets last week, and many emerging markets as well, although a sharply negative week in China weighed on overall index numbers.  Bonds were flat in the U.S. but sold off sharply in Europe upon better economic data and accompanying rising interest rates.  Commodities were generally flat as well, as oil prices were stable on the week.

U.S. stocks experienced some weaker days earlier last week, due in no small part to Janet Yellen’s comments regarding equity valuations looking somewhat extended.  She’s made these comments before, about other asset classes, so the uproar usually passes.  By Friday, however, the mixed employment report helped investors feel better about a slower pace for Fed action.  There has been a bit of profit-taking lately, and that’s also weighed on market returns in risk assets.  From a sector standpoint, financials experienced the strongest week, followed by health care; energy, telecom and utilities were the worst performers.

Developed market foreign equities gained on the week, while emerging market lost ground.  A weaker dollar helped Europe and Japan slightly, while emerging markets were little affected.  Europe overall performed well, as inflation figures released showed progress (and alleviated fears of deflation, with a 0% reading as opposed to negative as per the prior four months).  In a bit of a surprise, the U.K. election resulted in the re-election of PM David Cameron and a solidification of a conservative/tory majority in parliament.  Voters appear happy with the improvement in the British economy, with stronger employment and GDP growth at a rate in the mid-2’s, dramatically outpacing the rest of Europe.

Chinese trade data looked weak, with volumes falling by 10% year-over-year—although part of the change was currency-related.  Regardless, fears from this and other examples of lukewarm economic data ended the two-month run in Chinese equity indexes, as well as those of Australia and South Africa, which tend to be export dependent.  This points to additional likely stimulus to keep economic growth afloat.  Due to China’s large profile in total global GDP, the possibility of such action had generally been bullish for equity investors worldwide.  Alas, by late Sunday, the Chinese cut interest rates again, for the third time in six months, by a quarter percent down to 5.1% on the benchmark one-year loan rate and to 2.25% on the one-year deposit rate.  The rapid expansion of credit over the last several years has created a significant debt load, and officials are cognizant in keeping the interest service on these debts manageable.

U.S. bonds experienced their least volatile week in several, with minimal yield changes across the curve, resulting in flattish to slightly negative results for most domestic bond indexes.  Floating rate loans and high yield corporate debt fared a bit better than governments.

While emerging market bonds rallied decently in line with other risk assets, European bond rates shot higher, causing prices to weaken as investors continued to unload European debt.  Technical factors appear to be at play somewhat, and, in last week’s case, were prompted by higher inflation data that helped to alleviate fears of a continued deflationary spiral and, therefore, remove part of the rationale for the one scenario that negative yields actually make sense.  Although there is a natural base of owners for practically every sovereign bond (that we’ve discussed before, such as governments, pensions, etc.), a negative yield doesn’t offer a lot of upside—especially if economic prospects look to improve.  The deflation ‘trade’ may have come to an end for those with that worldview.

Real estate returned positively in the U.S. in line with equities, but was outshined by stronger results in Europe and the U.K., fed by better anecdotal economic data and the British election outcome.

Commodities were generally flat on average, but at a more tempered pace than recent weeks—a weaker dollar likely also contributed.  After a bump in price mid-week, crude oil settled back down just under $60 by Friday.  Although still very high, crude oil inventories appear to have fallen a bit for the first time in several months, which has spurred a rebuilding in long positions from traders.  Precious metals and agriculture were the winners, gaining a few percent, while industrial metals experienced the sharpest declines, led by copper, which tends to be news-sensitive to Chinese economic data.

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.