Economic Update 6-13-2016

• In a quiet week for economic data, inventories rose, which was a positive for forward-looking GDP, jobs data was decent but consumer sentiment dropped a bit.

• Equity markets in the U.S. ended generally flat, while foreign markets lost ground, with global growth and Brexit fears.  Bonds ended higher with interest rates falling around the world.  Commodities gained with strength outside of crude oil, which was little changed on the week.

U.S. stocks were flat last week on net, on both the large and small cap side, due to weaker results on Thursday and Friday.  Energy and consumer staples were the leading sectors for the week, while financials and health care (namely biotech) suffered the most significant losses.

Overseas, a stronger dollar on the order of two-thirds of a percent affected non-U.S. returns negatively somewhat, but returns were generally poor in Europe and the U.K. in local terms anyway, with stocks down close to -4%, with Brexit fears outweighing stronger industrial numbers.  Emerging market stocks were the leaders on the week, with recovery performances from South Korea, which cut interest rates by a quarter-percent to a record low of 1.25% (in a still-emerging market no less) in an effort to stimulate growth; this effect carried over to several Asian neighbors.

Brexit fears have been an overhang for markets, especially in Europe and the U.K., as a recent poll showed a stronger-than-expected chance of a British exit.  Recent polls have been split on the issue, making this a closer call than many would prefer.  The Bank of England announced that it has prepared emergency liquidity for banks, just in case, as it did prior to the Scottish referendum in Sept. 2014 that also appeared close but failed.  Generally, should the initiative pass, analysts expect some short-term disruptions, volatility and general uncertainty as trade linkages and agreements are re-negotiated, but don’t foresee longer-term hurdles that can’t be overcome.   While the U.K. has always retained a degree of separation from the rest of Europe (retaining its own currency is a big one), a remaining concern surrounds other nations who might opt for the same path within the eurozone, with messier results due to a shared currency.  This is essentially another chapter of the same story:  will the EU survive?  This and slower growth have certainly led to continued tempered sentiment in this part of the world.

Speaking of developing and emerging markets, index maintainer MSCI will make its annual announcement this week about index compositions, namely, where nations fall in the respective developed vs. emerging vs. frontier status, and what weightings should be.  Some of this is quantitative (based on market cap sizes in various nations) but some is also qualitative, and relies on investment industry input.  Current areas of evaluation include how to treat China’s large but generally domestically-focused ‘A share’ market, and how to handle transitions of certain upcoming nations (like Pakistan) and deteriorating ones (like Peru).  Some of these market weights are so small that they don’t seem to matter, but as emerging market active managers and index funds alike frequent benchmark strategies to MSCI’s decisions, tweaks can mean larger inflow or outflows for less liquid nations.  Often, a year is dedicated to making large transitions, which could matter significantly in the case of Chinese A shares—on a market cap basis, it would be an immediate 20% weight, with a total of 40% considering the already-included H-shares—but such a radical addition would never be undertaken.  Instead, these would be scaled up over time.  So, while passive investors don’t often think of using index ETFs as being ‘managed’ in any way, the actual management of the index includes some very human subjective elements.

U.S. bonds rose on the week, as rates fell across the yield curve.  Investment-grade treasury and corporate debt both gained, as did high yield, with continued higher and moderating energy prices.  Developed market foreign bonds fell, with the dollar impact, although in local terms, German 10-year bonds fell to their lowest yields yet—at 0.02%.  The ECB began their corporate bond-buying effort last week, and caused a decline in the euro, which is not surprising considering the 3 tril. euro size of the central bank’s balance sheet.

Commodities rose with strength in agriculture, gold and natural gas, the latter of which enhanced returns in the energy sub-group, resulting from lower-than expected supplies as summer demand season is about to begin.  Crude oil inventories fell, but this was offset later in the week with a rise in the Baker Hughes rig count, which led to the West Texas price rising above $50 briefly than back below it—for a net minimal change.  Saudi Arabia has also announced price cuts for European customers on the order of 10-35 cents or so a barrel, similar to what the Russians have done, as competition for production exports has intensified.

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.