Economic Update 10-10-2016

• Economic news last week was highlighted by strong reports in ISM manufacturing and non-manufacturing, and a decent but not outstanding September employment situation report.  The combination of data led to increased expectations for a Fed rate hike in December.

• Equity markets were generally negative for the week, as was most fixed income, due to a rise in interest rates.  Commodities, however, were surprisingly resilient, led by continued gains in the price of crude oil.

U.S. stocks ended up with a down week, with a number of cross-currents continuing, such as the highly-anticipated September employment report, continued election speculation and comments from Fed members about rate-hike prospects.  Rising interest rates as a result of several of these factors helped financial stocks (which need higher rates to some degree, and a steeper yield curve for sure, to operate normally) and higher oil prices boosted the energy sector; conversely, utility stocks, seen as a high-dividend bond proxy of sorts, were hit hard due to the rate moves.

Twitter was in the news more than usual, as it courted a myriad of rumored suitors, including Salesforce, Alphabet/Google, Apple and Walt Disney—however, towards the end of the week, hopes had dissipated with one CEO’s comment about the company’s severe challenges.  This is the conundrum with new media firms like Twitter—while a widely-used technology, with envied customer counts, can these counts be adequately monetized into actual sustainable profits?

Foreign stocks were mixed, with all areas positive in local terms.  However, after taking account the stronger dollar, only emerging markets ended up with positive returns for the week, while developed Europe, U.K. and Japan ended negative and lagged the U.S.

U.K. results were accentuated by a drop in the British pound, which has fallen to a new 30-year low.  This began as being related to concerns over Britain proceeding with Brexit as early as March 2017, but, specifically, a ‘hard Brexit’, where they would retain more autonomous control over items like borders (e.g. a Switzerland-like model), as opposed to a ‘soft Brexit’, where a type of EU-lite arrangement would remain in place (e.g. Norway).  Naturally, a harder Brexit could create a tougher transition, but provide U.K. citizens a bit more of what they originally wanted, which largely focused on labor and immigration control.  On the positive side, a weaker pound helps their cause as it benefits exporters during this time of transition.  Also, the pound wasn’t helped by a nearly -10% ‘flash crash’ in the course of just a few minutes on Friday—the cause of which is still currently a mystery.  It could have been due to a ‘fat finger’ trade error, a ‘rogue’ algorithm that takes advantage of certain market conditions, a series of currency option expirations, bank hedging, or something else entirely that could remain unexplainable.

European results were harmed by concerns over a possible ‘tapering-off’ of ECB stimulus, despite denials from officials.  There has been an increasing groundswell of skepticism that continued QE, and the resulting ballooning fiscal debt load as a result of it, fails to be as effective over long-term periods as initially hoped—with the byproduct of a high national debt burden creating more problems down the road than it’s helping.  But this is really nothing new.

The International Monetary Fund’s most recent World Economic Outlook, released last week, featured a lower global growth forecast than expected that could also have soured the mood.  Global economic projections remained at 3% for 2016 and 3.4% next year, as U.S. growth was downgraded and offset by upgrades for India and Russia (as well as a slight upgrade for the U.K., interestingly).  However, the global economy at large was described as ‘moving sideways’ and a victim of its own poor momentum.  Oddly, the IMF has been criticized for being too optimistic on such projections in recent reports.

U.S. investment-grade bonds lagged across the board, unsurprisingly, due to the sizable rise in interest rates during the week.  This was naturally more pronounced at the longer end of the yield curve.  U.S. high yield and floating rate bank loans, however, bucked the trend with positive gains—no doubt helped by stronger pricing in energy.  Foreign bonds in developed markets were especially hit hard with higher rates in other key markets, such as the German bund moving back from negative to positive, coupled with a stronger dollar.  Emerging markets tended to fare better than developed by comparison.

Real estate has taken it on the chin in recent days, as rising interest rates have prompted some investors to head for the exits and capture some strong gains earned this year.  U.S. REITs ended the week about -5% lower, with returns slightly worse in developed Europe and slightly better in developed Asia.  This is not a big surprise, as the asset class has historically been prone to volatility in the wake of short-term interest rate moves; however, it’s also important to remember that the environment that results in higher interest rates has also been largely beneficial for real estate fundamentals—an improving economy, tenant demand and cash flows.

Commodities moved a few percent higher for the week, despite the headwind of a stronger U.S. dollar.  West Texas crude oil moved up over +3% to just under $50/barrel—its highest level since June.  Livestock also gained for the week, agriculture was flat, while both industrial and precious metals declined.  In the latter group, gold fell by -5% and silver by nearly -10% as higher rates and correspondingly stronger dollar rendered their ownership less compelling.

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.