Economic Update 7-11-2016

• Economic data for the week took a turn for the better, with strong results from non-manufacturing ISM as well as an improved employment situation report on Friday.

• Equity markets in the U.S. gained as Brexit returns were tempered by the stronger jobs report, but foreign stocks struggled.  Bonds rallied globally with interest rates falling to low if not record-low levels in many locations.  Crude oil prices fell backward with shorter-term supply disruption concerns fading and production rising again.

On a holiday-shortened week, stocks started slowly with a resurfacing of Brexit concerns but improved by Friday with the positive surprise of a decent June employment report with the S&P closing again near record highs.  Several M&A transactions also buoyed sentiment.

In the U.S., small-caps outperformed large-caps.  From a sector perspective, consumer cyclicals and healthcare led the way, gaining over +2%, while energy was the sole industry with negative returns on the week, reflecting a pullback in oil prices.  Earnings season for Q2 will be unfolding in coming weeks, and estimates are generally pointing to generally negative growth outright for the quarter and compared to a year ago, although better than last quarter, and much of this negativity is due to the energy sector.

In foreign equities, Japanese stocks ended up with positive gains in USD terms, while Europe and the U.K. lost another few percent in the aftermath of Brexit speculation, which appears to wax and wane as prognosticators analyze the potential impact of the vote and ultimate path of the separation process.  Accordingly, consumer confidence in the U.K. has reached at 20-year low, which naturally could have carryover effects into spending and business investment.  Too much of a pullback has the potential for driving the economy into recession, which is the biggest fear of policymakers at this point, and why the central bank is making liquidity more readily available.  This includes reducing banks’ required capital reserves as well as potentially lowering interest rates as needed.

The biggest victim so far, however, has been the British pound, which is down over -15% from a year ago.  Much of this decline was in the aftermath of the referendum, but had been eroding slowly prior as investors digested the possibility.  The good news, of course, is that this represents a boost to British exporters, which may offset the potentially negative impact of less-optimal trade agreements forged after the break from the EU.

U.S. bonds gained ground with rates falling again across the curve, and the 10-year treasury reaching new lows under 1.4%.  While investment-grade bonds gained, high yield fared well also as investors sought out income wherever it can be found.

Interestingly, the ‘shape’ of the yield curve has moved to its flattest point in about nine years, at least as measured by the 0.80% differential between the 10-year and 2-year treasury notes.  The short part of the curve is obviously not moving, so the flight to quality in the longer end has acted as the driver of this.

Despite a stronger dollar on the week, foreign bonds also rose as rates fell lower—deeper into negative territory for several developed markets.  In Japan, not only has the 10-year bond been pulled below zero, but now the 20-year has as well.

Real estate was mixed on the week, with positive returns in the U.S. accompanied by negative results from Asia and Europe, in keeping with trends in equity markets.  In recent weeks, residential/apartment REITs have continued their strong performance as buying homes has become increasingly expensive in certain parts of the country and rental units are taking up the slack.

Commodities generally lost ground due to a pullback in energy.  Crude oil fell from the cusp of $50/barrel by about -8% down to just above $45, as supply concerns again faded away with rig counts rising for the fifth straight week.  Precious metals rose a few percent, as low interest rates (and low real yields) make the competition for ‘safe’ capital less of a negative for non-interest paying items like gold.

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.