Economic Update 10-12-2015

• In a lighter week for economic data, the ISM non-manufacturing survey release disappointed while remaining quite positive, the trade balance deteriorated due to a stronger dollar and the FOMC minutes were a bit more benign than expected although didn’t clarify any interest rate policy uncertainty.
• Equity markets gained in the U.S., upon stronger sentiment from higher energy prices, while bonds sold off a bit as interest rates inched higher.  Commodities naturally had a strong week due to the oil impact, a rare event recently.

U.S. stocks were generally higher on the week, with positive returns across the board with positive sentiment related to oil and continued accommodative sentiment from the Fed, including the Sept. meeting minutes discussed above—this continued to lower expectations for a rate increase in 2015.  The longer lower interest rates continue, the higher the implied fair values for equities.

Small- and mid-cap stocks outperformed large, due to a beta effect on the week.  From a sector standpoint, energy ended up sharply higher, unsurprisingly, followed by materials; more defensive health care and utilities ended positively but at the bottom of the group.  Earnings season is beginning in earnest, which should contribute to possibly higher volatility as lowered expectations compete with reality.  Expect weakness in Chinese exposure and a stronger dollar to be key words expressed often.  As we’ve mentioned before, steel company Alcoa is traditional bell-ringer for the earnings season, which being a materials company, unsurprisingly disappointed, but the firm’s results have tended to have little correlation to broader market earnings reports/sentiment in recent years.

Emerging market equities had an exceptional week, which due to the recent correlations to energy and commodities and index composition, wasn’t a complete surprise.  Double-digit gains were the rule in commodity-heavy nations such as Indonesia, Malaysia and Russia.

U.S. bonds pulled back a bit in a fairly conventional risk-on week where asset flows moved into equities and away from fixed income.  Longer-duration treasuries suffered the most damage, as usual, while many other investment-grade areas ended flattish.  To the contrary, high yield corporates broke a string of recent weakness with strong gains.  Managers in the high yield space (in private conversations) have recently been quite bullish on the asset class, believing energy sector-related volatility is perhaps overdone and dollar pricing appearing cheap compared to current fundamentals that look quite decent and limited default prospects; there is opportunistic bond-picking to be had in the space, it appears, with these wider spread conditions.

One interesting item last week was that the Treasury auction for new 3-month T-bills ended with a 0.00% yield for the first time (it’s happened several times in the 1-month T-bill market). Essentially, instead of paying a normal discount to get back 100 cents on the dollar in a few months, investors paid 100 cents on the dollar—so no discount, and no yield.  This can be explained by technicals, where there were more interested buyers than there was supply for these safe-haven bills, which drove prices back up to par.  This is the same dynamic that caused European bond yields to fall into the negative not that long ago, in an even more dramatic example.

Foreign bonds generally performed well, gaining several percent in total return, with the dollar falling back about a percent on the week, with emerging market local bonds and commodity-exporting countries leading the way, per what also occurred in equity markets.  Traditional safe havens, such as the U.K. and Eurozone fell back.

Real estate, in keeping with broader equity results, experienced a strong week, led by ‘risk-on’ sectors such as lodging and office/industrial.  Naturally, any prospect of lower rates for longer boosts near-term sentiment for the REIT market.

Commodity indexes rose in the low single-digits on the week, with crude oil rising almost +9%.  Market participants have been attempting to get better clarity on energy inventory supply levels, which has been the unusual independent variable in the energy equation as of late (usually it’s global demand)—supply appears to finally be slowing down, including from Iran, which was an initial ‘feared’ supply source.  Russia also expressed in meeting with other oil producers, which was seen as a positive earlier in the week.  Industrial metals, such as copper and zinc, also gained sharply on the week as economically-sensitive assets were favored.

 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.