Economic Update 7-18-2016

• Economic data for the week was fairly positive, with improvements in retail sales, industrial production and jobless claims.  Inflation ticked a bit higher due to housing costs and energy, while manufacturing remained mixed.

• Global equity markets gained ground on the week, with foreign stocks outperforming those in the U.S., particular in emerging markets.  Bond prices fell back on the week as interest rates rose.  Commodity prices were slightly higher as oil and industrial metals ticked upward.

U.S. stocks fared positively with economic reports that were better than expected as well as decent showing in early earnings releases.  In fact, the S&P hit all-time highs for five days in row, something which last happened in 1998.  From a sector standpoint, cyclical materials and financials led the way, while defensive utilities and consumer staples lagged the broader market by the greatest degree.

Foreign stocks outperformed U.S. names in almost all regions.  Japan was one of the bigger winners, gaining almost 10% in local terms (4% in USD), as investor absorbed the idea that the Japanese Central Bank may embark on deeper monetary stimulus—in the form of ‘helicopter money’.  This is, a concept of more direct infusions of cash to the public in order to stimulate spending.  Accordingly, with the prospect of more easing, the strong yen finally fell last week (largest weekly drop in 17 years in fact).  The odd strength of the yen, despite very low interest rates, a weak economy and prospect for even more intensive easing, has been one of the most baffling mysteries for economists and portfolio managers (especially in fixed income) during the past several quarters.

Despite expectations for a cut of 0.25% or even 0.50%, the Bank of England decided to leave interest rates unchanged in the aftermath of Brexit.  They’ve noted their intentions to review and likely lower rate policy during the summer, so August is still on the table.  Markets have remained largely stable in the weeks following the vote, which provides a signal to central banks at times regarding sentiment and liquidity in financial markets (that things aren’t as bad as first feared).  This is a long, drawn-out process, however, so no doubt much more to come on the timing and implementation of this.  The British pound did strengthen on the news, which helped the currency retrace back some of its decline following the vote.

The attempted military coup in Turkey occurred largely after markets closed, but the Turkish lira fell just over -5% on the news (recovering somewhat since), and risk markets are lower.  Turkey had become an increasingly stable location for emerging market investors, in terms of better financial market credibility and regime stability compared to perceptions of decades past.  However, in recent years, disagreements in policy among central bakers and the administration have given some investors pause, and the regime appears to have strayed a bit away from its traditional secular underpinnings (the supposed cause of the coup attempt in the first place).  Events like this don’t help the cause for such nations, although the impact here appears to be contained.  In a worst-case scenario for nations in these situations, currencies decline, which creates higher price inflation for imported goods, and often corresponds with monetary challenges—as higher rates would help the inflation problem and stabilize the currency, in theory, but lower rates could enhance liquidity and stimulate economic growth if conditions became less certain.  Neither may be needed here, but the Turkish central bank has declared their support for the lira, which has helped market sentiment.

U.S. bonds lost ground on the week as interest rates reverted higher.  Longer duration treasuries lost the most ground, while high yield corporates and bank loans earned positive returns.  Foreign bonds were mixed, with strong gains in locally-denominated emerging market debt.  Developed market debt lost significant ground as interest rates ticked upward, in keeping with U.S. government markets.

Real estate gained ground in all areas, albeit to a lesser degree in the U.S. as results lagged broader equity markets and interest rates increased.  Sharper gains, on the other hand, were experienced in Asia and Europe, where pricing has been more challenged; the U.K. was a particular outperformer, gaining +6%, as fears over post-Brexit illiquidity abated somewhat.

Commodities gained slightly, as oil ticked up from $45 the prior week by just over a dollar a barrel.  Differing reports indicated both an increase and decrease in inventories, which largely offset each other.  Gold fell back by a few percent in line with other safe haven assets, as flows continued into equity and risk markets.  Natural gas also fell back after a recent strong run of gains, due to a rise in inventories.  Industrial metals also experienced gains, particularly in copper due to storm in South America that are delaying shipments to major consumers such as China.  These are the types of ‘random’ events that are often used as examples of commodities’ value in a portfolio.

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.