Economic Update 11-01-2016

• Economic data for the week showed mixed results, with a decent GDP report for Q3, but weaker durable goods orders.  Real estate prices showed continued gains, as did pending home sales, while new home sales came in a bit weaker than expected.

• Global equity markets were generally lower, with mixed earnings and economic data.  Bonds lost ground as well, as interest rates rose along with expectations of a Fed hike in December.  Commodities declined in line with the price of oil falling by a few dollars a barrel.

U.S. stocks were down on net for the week, as third quarter earnings reports and various economic data points came through mixed.  On one hand, large index weights such as Apple and Amazon, some of which carrying high growth projections, disappointed; while firms with more tempered expectations, such as Procter & Gamble, surprised on the upside.  The good news, per FactSet, is that the S&P is slated to have positive year-over-year earnings growth for the first time in a year and a half.  This hope alone has likely buoyed stock valuations.  From a sector perspective, defensive consumer staples and utilities led the way with positive gains, while healthcare and consumer cyclicals lost the most ground.  Large caps outperformed small caps, which sold off sharply on the week.

M&A activity has continued to pick up as we near the end of the year, as top-line revenue growth has been very difficult to come by—resulting in a scramble for growth wherever firms can find it.  Sometimes deals get a bad rap, with few net efficiencies added, but well-designed and synergistic deals can actually work.  However, the bigger the potential deal, the larger the profile.  The proposed AT&T/Time Warner merger in the headlines last week, which would be the largest of the year, could face a good deal of regulatory scrutiny.  The FTC has been particularly tough (per the opinion of some experts) in ensuring deals are not compromising any industry’s competitive environment—particularly in oligopoly areas such as cable TV—where pricing has been under the microscope anyway from the consumer side.

In foreign markets, Japan ended with positive results, while Europe and the U.K. sold off in keeping with the magnitude of U.S. equities.  A slightly weaker dollar helped matters a bit.  In Japan, rising yields may have a played a role in improving sentiment, as it translates to a lessening of headwinds for financial firms.  Returns for the week were largely country-specific, as neither developed nor emerging markets outperformed the other by any meaningful degree overall.  It’s interesting to note, though, that European earnings have been surprisingly good so far (again, compared to very low expectations).

U.S. bonds experienced a poor week as interest rates rose, based on decent economic data and improved chances of FOMC action in December.  Shorter-maturity securities naturally outperformed longer, with long treasuries the worst performers.  Credit marginally underperformed governments, with high yield bond returns in a similar range to broader indexes, but bank loans ending up with a positive week.

Floating rate bank loans have experienced a resurgence as of late, which goes along with the recent spike in interest rates.  Due to the variable rate and faster-reset nature of the underlying loans, higher rates tend to help this asset class, which act counter in many ways to other fixed income, providing valuable diversification to portfolios in times like these.  The one knock on bank loans over the past few years (other than the fact that rates have fallen, as opposed to rising) is that, in addition to their rates being tied to LIBOR with a spread, newer loans had been issued with what are referred to as ‘LIBOR floors’—essentially, rates wouldn’t be reset higher until base rates reached 0.75% or 1.00% in many cases.  However, now that money market reform has caused a mass migration from prime commercial paper to government paper (along the lines of $1 tril.), the extra supply of corporate paper has pushed LIBOR higher, indirectly improving the yield picture for bank loans.  Based on interest rate movements, floating rate could potentially offer more durability over time, even after traditional high yield makes less sense at some point.

Foreign bonds also lagged, in both developed and emerging markets.  The German 10-year rose to nearly 0.2%, the highest yield seen since spring.  Much of the foreign bond concern surrounds the ability of central banks to provide any additional boost through stimulus programs, about which there is increasing skepticism.  If these programs pull off the gas pedal to any degree, this also removes a downward force on rates.

Real estate fared poorly on the week, which is typical when interest rates move higher.  Real estate in Asia, particularly Japan, fared better than in the U.S. and Europe.  Those in turn fared better than Canada and Australia, which tend to be driven by oil price movements.  Year-to-date in the U.S., REIT returns have been led by mortgage REITs (as rates are still lower than they were at the start of the year), healthcare and industrials; more challenged sectors include retail (due to a mixed environment for brick-and-mortar spending) and residential (where rental rates and begun to peak in some key markets).

Commodities declined on net for the week, with industrial metals gaining sharply, and positive returns from precious metals, offset by energy price declines.  The West Texas Intermediate crude oil spot price fell from nearly $51 to just under $49, as doubts surfaced about the planned OPEC production cuts actually coming to fruition.  This isn’t a surprise, as OPEC producers have incentives to ‘cheat’ by producing more than their agreed-upon quotes.  It’s no secret that many oil-reliant nations, including and especially the larger producers like Saudi Arabia and Russia, badly need the revenue either higher oil prices or more volume brings, in order to balance their fiscal budgets.

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.