Economic Update 8-01-2016

• Economic data for the week was highlighted by no policy action at the FOMC meeting, while GDP for Q2 underwhelmed compared to expectations.  Housing numbers were relatively good with home sales reaching pre-recession levels.

• U.S. equity markets were mixed, and were outperformed by foreign developed stock indexes which benefitted from a weaker dollar for the week.  Bonds generally gained some ground with lower interest rates.  Commodities fell as the price of crude oil fell to 3-month lows based on stronger inventories.

U.S. stocks were mixed with large-caps down slightly, but small caps ended higher.  Technology stocks rose +1.5% on the week, with positive earnings reactions from Alphabet/Google, Apple, Amazon and Facebook (the latter of which was told it owed billions in back taxes); health care also earned positive returns.  Laggards included energy, with falling oil prices, and consumer staples.  Earnings results haven’t been outstanding, but have beaten expectations, which has helped stock prices retain their momentum.  Revenues are also weak, but may actually end up positive year-over-year, which has been a bit of a surprise on the upside and hasn’t happened since Q4 of 2014.

Foreign developed market returns in Europe and Japan were slightly positive, but a weaker dollar translated these returns to several percent higher for U.S. investors.  Interestingly, U.K. GDP growth for Q2 improved to +0.6%, a few tenths better the prior period, and calmed some fears about slowing post-Brexit momentum which could affect the timing and magnitude of any central bank policy response.

Results of the 51-bank European stress test came out after the close Friday, with some banks performing better than others.  All banks but one ‘passed’; the exception being the world’s oldest bank, Banca Monte dei Paschi di Siena, which showed a loss of tier 1 capital under a simulated adverse economic scenario.  As we’ve discussed, Italian banks have been pressured with high debt levels and worsening loan performance metrics, which will likely require a bailout at some level.  (For Banca Monte, this wouldn’t be the first time help was needed, as losses from over-expansion just a few years ago required a bailout package from the Bank of Italy, and it’s also failed prior stress tests—so the outcome was in line with expectations.)

The Bank of Japan announced further stimulus.  This was largely expected, but base monetary policy through interest rates was left unchanged, with rates already being at negative levels.  Instead, the BOJ will be ramping up purchases of exchange-traded fund assets from ¥3.3 tril. to ¥6 tril. (about $60 bil.) a year.  This appears a bit unconventional, but further BOJ statements alluded to the need to remain flexible due to a worsening growth situation, and analysts have noted that further buying of traditional government bonds could be limited due a lack of available supply, hence, the focus on ETFs and other financial instruments, like equities and REITs.  Debate continues about the effectiveness of these measures, due to the sole focus on inflation.  A few other metrics in Japan, such as employment, are in decent shape, but like the U.S. in a more extreme sense, there is a large demographic headwind impeding growth.  A persistently strong yen, which has acted in opposite fashion to what many would expect with Japan’s low growth and low rate situation, has also challenged the economy as a headwind to exporters.

U.S. bonds fared well on the week as interest rates declined again, back under 1.5% for the bellwether 10-year treasury note.  Markets were no doubt reassured by the lack of Fed action, but likely more so by the weak GDP report, which cast doubt upon the probability of near-term rate increases.  Although all bond segments generally experienced gains to one degree or another, long duration debt outperformed short.  Foreign bonds gained similarly to U.S. issues in local terms, but a -2% decline in the dollar boosted USD-denominated returns, although this was more pronounced in developed markets than in emerging markets.

Real estate earned positive returns globally, with half-percent gains or so in the U.S. and better abroad, with the impact of a weaker dollar.  European REITs and U.K. REITs outperformed Japan, although all ended the week strongly.

Commodities lost ground on the week, led by a -6% decline in crude oil back to the $41-42/barrel range (a 3-month low) as oversupply concerns have again come to the forefront.  Interestingly, this represents close to a -20% ‘re-correction’ in oil prices back from recent highs in the $50 range.  Natural gas, on the other hand, gained +8% in one day during the week, with stockpiles coming in lower than expected—the opposite of the situation with oil.  Precious metals, mostly in silver, saw gains on the week due to falling rates and a weaker economic outlook.

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.