Economic Update 10-26-2015

• Economic data on the week was focused on several housing reports, which came in better than expected; however, the much broader index of leading economic indicators fell backward a bit.

• Global equity markets responded positively to news of possible (European Central Bank) and actual (China) additional quantitative easing measures designed to spur sluggish economic growth.  U.S. bonds lagged upon slightly higher interest rates, while foreign results were mixed due to a stronger dollar.  Crude oil declined dramatically again upon reports of higher inventories and higher-than-expected upcoming supply.

U.S. stocks gained on the week, despite the presence of a key catalyst. To some extent, contained inflation numbers perhaps lowered the possibility of Fed action in December and the talk of biotech/pharma pricing as a campaign issue died down a bit (as expected).  Stanley Fischer, the FOMC Vice Chair, made a comment at the annual IMF/World Bank meeting in Peru, that Fed is looking to raise rates this year, but is not completely committed to it.

From a sector standpoint, more defensive utilities and healthcare led with gains of nearly 2% while industrials brought up the rear, losing nearly that amount.  In notable earnings news, mega-cap Wal-Mart fell -10% with disappointing guidance.  Overall earnings results through Friday (just over 10% of S&P companies reporting, so granted a limited sample) show roughly two-thirds of reports coming in positively on a cap-weighted basis, which is close to the ratio of recent quarters.

Internationally, Chinese stocks gained over +5% on the week due to several anecdotal items.  A quote from a central banker implied that the equity correction there is nearly over (due to the level of control the government attempts to take in market activity, this is taken with a bit more seriousness here than in other nations as it implies additional stimulus), as well as strong retail sales during their holiday week and reports of higher bank lending.  However, this was somewhat offset by weakness in both Chinese exports and imports, as well as inflation that came in below expectations at 1.6%.  This led emerging market indexes higher in general, which surpassed developed regions on the week.  A slightly weaker dollar played a minor role.

On the negative side, commodity-exporter nations such as Brazil (which has other internal political problems), Russia and Indonesia all lost a few percent.  As we’ve discussed previously, the emerging market group is getting more complicated to classify than simply ‘risk on’ or ‘risk off’.  At the very least, the recent environment has created a clear delineation between commodity exporting nations, where lower oil prices have made a big dent in national revenues (think Russia and Brazil) and those that benefit from cheaper commodity imports (such as India and China).  This is true of several developed market nations as well, which explains uncertainty over prospects in places like Canada, Australia and Norway.

U.S. bonds gained a bit on the week as interest rates fell, to a lesser degree than equities.  As expected, long treasuries experienced the largest gains.  With no significant currency impact, emerging market bonds also gained strongly in both USD and local currency terms.  On the lagging side, high yield corporates rose minimally as energy price declines likely drove sentiment in the sector.  As we discussed in last week’s monthly advisor meeting, the U.S. high yield is currently bifurcated into a majority of issues with relatively strong fundamentals and low and below-historical-average current default probabilities, whereas the energy/materials/mining complex is where the majority of pricing pressure has been focused.  Then again, there do appear to be some opportunities here for names where fears have been overdone—as there usually is.

Real estate experienced another solid week with interest rates falling and fundamentals continuing to appear solid.  U.S. retail, malls and apartments led the way, gaining nearly +2%, while more cyclically sensitive areas, such as lodging/resorts suffered, as did certain Japanese REITs.

Commodity prices declined on the week in general, as oil gave up last week’s gains to fall a few dollars from near $50/barrel back into the upper 40’s.  Lower forecasts for 2016 demand appeared to be partially responsible as well as uncertainty about future Iranian demand.  Precious metals, especially gold, experienced a gain of several percent on the week as bond yields fell and sentiment towards Fed action dissipated somewhat.

U.S. bond indexes lost some ground on the week as interest rates ticked upward, with longer duration issues being more affected than shorter.  In a week where risk assets performed better than ‘risk-off’, high yield corporates ended up as one of the week’s better performers, despite additional pricing pressures (again) in the energy sector.

The treasury has decided to cancel an auction for 2-year notes on Oct. 27 due to uncertainty surrounding the Federal debt limit and operational settlement concerns.  However, other maturities don’t appear to be affected and it’s not clear whether any additional postponements or delays will be put in place.  This isn’t entirely unusual, as similar delays have occurred due to debt limit constraints before—typically affecting short-maturity bill auctions.  Usually, auctions have been rescheduled to resume within a week or so of the original date, assuming the debt ceiling issues are ironed out.

Outside of the U.S., European debt fared with, especially in the periphery areas like Spain and Italy, that are expected to benefit most from stimulus and feature the largest spreads; however, higher-quality debt performed positively as well.  In translation terms, the weakness in the USD was significant as well for a one-week basis, and explained as much as anything else (where absolute returns in fixed income are generally minor week-to-week relative to other asset classes).

Real estate experienced a strong week, in keeping with or slightly better than equities.  European REITs also showed strength, with the ECB quant easing expectations.  U.S. lodging/hotels continued to show some weakness, however, along the lines of continued slow economic growth domestically.

Commodities experienced a weak showing, losing several percent on the week.  Crude oil prices fell over -6% to under $45 once again, as reports showed inventory levels rose dramatically higher than expected and Iran’s oil minister predicted a boost of 500k barrels/day in coming months.  Supply concerns continue to be the issue.  Agriculture and precious metals experienced the smallest losses.

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.