Economic Update 12-19-2016

• Economic news for the week was highlighted by the Federal Reserve raising short-term interest rates by another quarter-percent, as expected.  Retail sales disappointed, while several regional manufacturing surveys and homebuilder sentiment showed far stronger results and inflation ticked slightly higher.

• U.S. stock markets were mixed, with large-caps outperforming small-caps.  In foreign markets, developed markets experienced stronger gains but were held back by a stronger dollar.  Bonds suffered again as interest rates rose in keeping with more anticipated Fed moves next year.  Commodities gained a bit as oil finished higher along with expected production declines.

U.S. stocks were mixed on the week, with mega-caps, represented by the Dow especially, gaining ground, while small caps fell back by the greatest degree.  From a sector standpoint, defensive telecom, utilities and healthcare experienced the strongest gains, while industrials and materials, strong in the post-election rally, reverted backward and lagged.  While the FOMC rate hike was largely anticipated, the tone and estimates for hikes in the coming year was slightly more aggressive than expected by the market, which tempered some of the recent optimism.

Foreign stocks fared decently in Europe in local terms, as a stronger dollar is being viewed as a positive for exporters there, and could trickle in as needed economic growth.  However, that same dollar strength held back foreign stock returns for U.S. investors in major indexes.  Italian shares gained sharply after the conclusion of the prior week’s constitutional vote, which cleared up some uncertainty and potential further anti-European sentiment, but left ongoing problems.  Winning emerging market nations, such as Russia, tended to be those benefitting from higher oil prices, while China and Brazil declined—the latter due to news of a new corruption probe.  Mexico also lost ground after again raising rates by 0.50% to combat weakness in the peso (raising interest rates is one technique nations can use to defend their currency, as it’s intended to attract investors enticed by the higher rate).

U.S. bonds declined almost across the board, due to rates moving higher in intermediate- to longer-term segments of the yield curve.  However, corporate credit outperformed government bonds, and high yield debt losses were minimal; bank loans, as expected, continued to gain ground and have attracted an increasing amount of investor attention.  Foreign debt in developed markets gained just slightly in local terms, while this was converted to a sharply negative number as a result of dollar strength.  Emerging market debt continued to perform negatively.

Real estate equities declined a few percent in keeping with higher rates and expectations for rates in 2017—behavior which is not surprising.  However, Asia and Europe fared worse, due to currency effects.  More cyclically-sensitive parts of the real estate space have outperformed as of late, which include hotels/lodging and self-storage, as well as apartments last week.  While attractiveness varies from sector to sector, per usual, the broader real estate market in the U.S. continues to benefit from a lack of supply, which could perpetuate and elongate this particular cycle.

Commodities gained ground slightly on average, led by strength in oil, and weakness in natural gas as well as precious and industrial metals.  Oil bounced around within a range before ending higher, just under $53, a gain of just under +3%, after signing of OPEC production agreement.  At this more ‘normal’ level, there is less room for error, meaning that weekly inventory numbers and rig counts are being watched more closely.  The reason for the OPEC deal in the first place was to limit output, which would push prices higher, thereby raising oil revenue for affected developing nations and lessen the strain on government fiscal budgets.  (Unsurprisingly, their budgets don’t look pretty when oil prices decline dramatically and, if this goes on long enough, can end up causing a whole host of economic and societal problems, such as unrest, regime stability issues, etc.).  On the other end, if oil prices get too high, U.S. shale producers are more than happy to ramp up output to fill the gap, as long as their costs are covered.  The resulting extra supply can have a dampening effect in keeping prices contained within a range.

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.