Economic Update 3-14-2016

• In a slow week for meaningful economic data, the few reports that did surface showed a bit of small business pessimism, some inventory build-up, perhaps some benefit of a flattening U.S. dollar and strength in consumer mortgage demand.

• Equity markets experienced gains on the week, mostly due to positive sentiment as a result of the European Central Bank’s decision to lower interest rates further and add to monetary easing efforts.  Bonds were mixed as interest rates ticked higher in the U.S., although credit saw gains with additional price recovery in crude oil markets.

U.S. stocks gained generally across the board, with rebounds in utilities, as well as energy and materials coming in line with stronger pricing for crude oil.  Industrials and consumer cyclicals lagged, with lower positive returns.

The European Central Bank (ECB), in an ongoing fight to keep deflationary forces at bay and stimulate at least some growth, again lowered interest rates and added to their already-robust quantitative easing program, not to mention strong forward guidance language hinting at more of the ‘whatever it takes’ theme to get the economy back on track.  The ECB deposit rate was cut by -0.10% to -0.40%—so further into the negative, QE amounts raised by +20 bil. euros/month to 80 bil. euros, and two new Long-Term Refinancing Operations that allow banks to borrow nearly up to a third of their books of loans at a zero rate (with an option of that rate to go into the negative—meaning the ECB would pay banks to borrow…yes, an odd thing).  A big concern now, as it is in Japan (facing a similar but likely even more severe environment), is about how effective further stimulus and negative rates will be in moving inflation and economic growth to the positive.  Interestingly, Europe remains more heavily levered than does the United States, so pushes to take on more borrowing appear to be a bit counterproductive considering other fiscal and labor reforms that appear to be more pressing needs.  From an investment standpoint, however, earnings do seem to be taking shape to a stronger degree in Europe, which is encouraging for forward-looking returns.

European stocks were just barely positive on the week in local terms, but a weaker dollar transformed these into gains slightly better than U.S. equities.  The periphery nations, such as Italy and Spain led, with larger expected benefits from additional easing.  Emerging markets also fared well with stronger commodities prices and eased global financial conditions, helping Brazil, Turkey and Russia.  Brazil has been on a tear year-to-date, with fundamentals largely still very challenged, but better sentiment with sentiment towards presidential impeachment gaining traction again.

China was the worst-performing market on the week, falling a few percent, as trade performance for February came in worse than expected (exports down -25% from a year ago, while imports were down as well.  The investments segment have grown to almost half of GDP, much of which credit expansion in the banking sector.  Chinese inflation also rose to +2.3% year-over-year, about a half-percent higher than expected, and led by dramatic increases in food inflation (+7%), notably fresh vegetables that tend to be in demand for Chinese New Year activities.  A few of these numbers look especially volatile at face value, although some analysts blame the timing of the new year in creating some seasonal distortions.  For perspective’s sake, economists often view U.S. results in context with the timing of certain long weekends or one-day holidays, but the closure of almost an entire economy of that size for a solid week is bound to have some dramatic impacts.

While risk assets fared well, rising interest rates in the U.S. created a poor week for domestic bonds.  The worst performers were long treasuries, due to duration effect, and most government bonds suffered mildly negative returns.  On the other hand, credit and notably high yield, performed positively with eased credit spreads as oil prices ticked upward, helping the lowest quality debt.

Foreign bonds were most affected by the U.S. dollar falling by just over a percent (mostly versus the euro), pushing dollar-denominated bonds into positive territory, while locally-denominated issues came in flat or negative.  European debt was largely unfazed by the ECB easing announcement, which appeared to have been largely price in to expectations.  One of the better performing asset classes this year, in fact, are USD-denominated foreign developed market bond indexes—led by the dual factors U.S. dollar strength tapering off and interest rates moving from very low into even lower/negative yield territory.  As we’ve discussed previously, such low-yielding developed market debt doesn’t not offer a high degree of longer-term strategic appeal considering such conditions.

REITs generally experienced gains surpassing equities, particularly in the U.S. and in Europe, where sentiment was boosted by central bank stimulus and hopes for additional lending activity. Asian REITs saw positive returns, but lagged the other broad groups with negative results from Japan.

Commodities were aided by stronger sentiment towards energy, which led the group with close to +10% gains.  Agriculture also ended in the positive and metals of all types lagged with negative returns.  Crude oil experienced a less volatile week than we’ve seen in recent weeks, moving higher from $36.30 to $38.50—a gain of just over +6%.  While it’s early and difficult to make such calls about longer-term trends, the short-term stabilization is a positive sign and has been obviously welcomed by affected equity and fixed income sectors.

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.