Economic Update 12-07-2015

• Economic data again showed some mixed results, with manufacturing (and some services results for that matter) coming in weaker than expected, while the monthly employment situation report for November came in strong.  The labor report was seen as raising the chances for a Fed interest rate hike in December.
• U.S. large cap stocks experienced a slightly positive week, while small caps and foreign equities lost ground—even despite a fall-off in the dollar which helped foreign returns.  Interest rates ticked upward as chances of Fed action in Dec. remained high, but not dramatically so.  Most commodity groups gained a few percent, except for crude oil, which saw declines yet again.

U.S. large cap stocks experienced a flattish week, at first turning negative on European monetary policy news and then climbing back higher by Friday due to a strong jobs report.  Mid- and small-caps, on the other hand, weren’t able to recover.  From a sector standpoint, growth segments technology and consumer staples led, while energy was the biggest loser, down over -4% upon further drops in oil prices.

Analysts have been looking at the results of the Black Friday and full kick-off weekend, but some trends are less apparent—especially as some deals were extended into the prior week and a greater proportion of shopping is being done online as opposed to in malls.  In fact, the growth of online sales has been growing significantly in recent years, to no one’s surprise, which has required a re-configuring of how holiday season sales are modeled (you can’t just stand at the mall entrance and count the number of shopping bags these days).

Janet Yellen also hinted in a presentation that a rate hike might be on the way sooner than later, alluding to the risks that could come with starting a hiking process too late and having to sustain sharper interest rate increases later to avoid an overshoot of policy—this came a day after another Fed voting member expressed fears about raising rates with inflation being so low currently.  Again, inconsistent communication has caused some market reaction in both directions.  Probabilities remain high for a December rate hike, but as we know, these can change quickly.

Foreign markets were mixed as the ECB left benchmark interest rates unchanged at a near-zero 0.05% but cut the deposit rate from -0.20% to -0.30%; also announcing that QE would be in place until March 2017.  However, many expected a deeper cut and expansion of QE which was hinted weeks ago, which caused global stocks to weaken while the euro strengthened against a variety of currencies (including the dollar, which explained the near -2% drop in the U.S. dollar index during the week).  Consequently, European stocks lost about -3% on the week in local terms, but the impact was far less severe for U.S. investors.  China was a big winner on the week, gaining several percent (per IMF action noted below), while commodity nations Russia, South Africa and Mexico came in with the sharpest weekly losses with more energy price negativity.

U.S. bonds lost a bit of ground on the week, although the flatness of the yield curve made the impact less severe than it first appeared.  Agency mortgages actually eked out some positive returns, while corporate high yield performed largely in line with other groups.  Foreign bond performance was mixed as usual, with the biggest impact being the effect of the weaker U.S. dollar—this helped USD-denominated indexes move into positive territory, while locally-denominated debt of all types languished with losses of up to a percent.  In Europe, the tempered monetary policy move was seen as insufficient, resulting in some bond sell-offs.

Speaking of foreign currencies, last week the International Monetary Fund decided to include the Chinese yuan in their Special Drawing Rights (SDR) currency basket, effective Oct. 1, 2016. The SDR is basically a special ‘high quality’ global currency basket that members can tap into during times of trouble, but doesn’t really serve any other purpose other than a symbolic one of global currency credibility.  This change had been under consideration for some time, with a sticking point being a lack of transparency, liquidity and ‘free-float’ independence of the yuan, which we’ve discussed at length several times.  The Chinese portion of the basket will be just under 11%, with the weightings taken from the euro, which will fall to just over 30%, and the British pound and Japanese yen, which will decrease to about 8% each.  The dollar’s allocation won’t be significantly affected, at just over 40% of that basket.

What does this all mean?  Now that the yuan has been ‘anointed’ as a legitimate key global currency (something Chinese officials had been hoping for), perhaps a continued slow adoption of the yuan in investment and trade transactions, and away from euros, yen, etc. could well occur.  There are still quite a few hurdles, though.  The capital controls in place by the Chinese don’t allow for as free a flow as in other ‘safe haven’ currency nations, not to mention political and other considerations, which are critical for liquidity and fair market pricing.  These types of issues are important with currency price stability and usage, so while this change does acknowledge the growing economic power and legitimacy of China on the global stage, it may take some time for the supremacy of the U.S. dollar as global reserve currency to be significantly challenged (some of these same concerns over the dollar’s supremacy were aired when the euro was rolled out in 1999—obviously sentiment can change a lot over time).

Real estate indexes lost some ground in the U.S., no doubt as the specter of rising interest rates looms.  Asian performance, however, was helped by positive Chinese sentiment related to the IMF currency decision, as symbolic as that is.  Real estate sentiment has become more segmented, as apartment/residential sub-indexes have continued to plug away with double-digit gains in 2015, while economically-sensitive lodging/resorts as well as very interest-rate sensitive mortgage REITs have experienced double-digit losses this year.

Commodities had a mixed week, led by a large drop in crude oil (by -4% to levels just above $40); however, most other groups rose by several percent, led by agriculture and precious/industrial metals.  No doubt the weaker dollar played a role in dynamics.  Despite lower rig counts, however, oil production continues at a surprisingly high rate as the most productive wells are those remaining in operation and Iraq/Iran supply is also assumed to be on the upswing rather than being reduced.  The OPEC meeting this last week was inconclusive, as no changes in quotas were announced—rather, decisions postponed until the next meeting—while members appear to be in disagreement as to next steps to handle the newly-emerged role of the U.S. as global swing producer.

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.