Economic Update 7-05-2016

• Economic data for the week was highlighted by stronger manufacturing results in the ISM and Chicago PMI surveys and higher consumer confidence, while real estate activity was mixed—a combination of higher home prices but weaker building activity for the prior month.

• Investment markets recovered sharply following the ‘Brexit’ surprise last week, with equities higher globally.  Interestingly, bonds also fared well with bond yields falling on net for the week in both developed and emerging markets.  Commodity prices, including crude oil, generally showed continued strength during the week.

Global equities rose several percent on the week as ‘Brexit’ fears dissipated with investors moving back into ‘risk’ asset classes.  In addition, the Fed announced that most banks passed their most recent stress tests, which helped sentiment.  If this wasn’t enough, central banks (notably the Bank of England) alluded to additional monetary easing measures to help with the Brexit ‘transition’ period.  Markets often tend to respond well to central bank easing, especially when the promises are open-ended.  There are also new calls to cut Britain’s corporate tax rate, which could also help ease the pain, although the success of these types of ideas is dependent on Parliament.

In the U.S., defensive sectors continued to lead, however, with the largest gains coming from utilities, telecom and health care.  Materials lagged, while the other groups fell within a fairly tight range.

Foreign stocks outperformed domestic issues, with emerging markets leading the way, although U.K. and European shares were not far behind, with Japan as the laggard.  Peripheral Europe performed especially well, with hopes for interest rate easing.  Latin America also performed well, even though Mexico raised interest rates by a half-percent to 4.25% in order to combat inflation pressures brought on by a depreciated peso (an example of how currency fluctuations can impact inflation readings).

It was an interesting week where both risk assets and less risky ‘flight to quality’ assets each performed well.  U.S. bonds experienced a solid week, with the 30-year treasury hitting an all-time low yield and the rate on the 10-year note continued downward, back again under 1.5%.  Investment-grade bonds were surpassed, however, by high yield corporates, which earned several percent on the week.  Consequently, recent portfolio bond adjustments in government and corporate towards a broader universe of issues and slightly longer duration band has been effective in this type of environment.

The news in muni markets was the upcoming set default by Puerto Rico of almost $2 bil. in debt payments, about half of which are in the island’s general obligation bonds.  This result, although part of a much longer story, was due to the U.S. territory’s sorry financial position and political infighting—the drama was intensified as the governor declared the moratorium on G.O. debt payments minutes after President Obama signed the law regarding the territory’s restructuring process with all finances under a federal oversight board.  Long-story-short, the oversight board is a desired outcome for creditors (including a lot of muni mutual funds), but the price impact on Puerto Rican bonds has muted as bad conditions here, including default and partial restructuring, have been priced into bond quotes for quite some time.

Foreign bonds gained several percent as well, led by emerging market bonds, mostly due to EM currencies strengthening against the dollar.  Much of the developed market move was related to continued dovish language—this time by Bank of England governor Mark Carney mentioning that a rate decrease might be necessary this summer to assist with Brexit-related uncertainties.

Real estate continued to perform strongly, up several percent in keeping with general equity returns globally.  Regionally, the U.S., Japan and Europe all performed in line, while the U.K. lost ground, bringing year-to-date real estate returns in Britain to just under -20%.  Real estate activity depends on liquid lending conditions and free movement of capital from both domestic and foreign sources, so a Brexit could serve to hamper that.

Commodities were up several percent on the week, with strength in a variety of areas.  Crude oil gained a few percent with prices moving up again just above $49 towards the technically significant $50 level once again.  However, natural gas has been in the news much less frequently, but spot prices are up +50% over the last quarter as summer demand has strengthened relative to current supply levels.  Metals also gained, particularly silver and nickel, while agriculture was slightly down on net—despite higher volatility of various items within that basket as of late.  It may be a surprise to some, but commodities ended up as the best-performing asset class of the 2^nd quarter, with gains into the double-digits, in a continuation of the trend that began around mid-February with the bottoming of crude oil prices.

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.