Economic Update 6-26-2017

• In a slow week for economic data to open the summer, several housing metrics showed strength, as did the Index of Leading Economic Indicators, while jobless claims ticked upward slightly.
• Equities gained a bit for the week in the U.S., Japan and emerging markets, while Europe and the U.K. declined.  Bonds were up slightly with mixed interest rate changes across the yield curve.  Commodities lost ground as high oil supplies continued to push down prices.

U.S. stocks generally fared positively for the week, with small-caps recovering to outperform large-caps.  Health care led the way with significant gains, as Senate versions of the updated healthcare legislation appeared to favor hospital, insurance and pharma firms more than prior versions (such as phased reductions to Medicaid), followed by gains in technology.  The energy sector declined by nearly -3% on the week, on the back of continued weakness in crude oil prices.

Trading volume picked up later in the week mostly as a result of the annual rebalancing of the Russell equity market cap and style-based indexes.  Apparently over $8 trillion is either benchmarked to or passively-managed based on Russell indexes, making the changes in composition of these indexes (even if slight) relatively meaningful.

Foreign stocks ended mixed with positive returns in Japan and the emerging markets, with the former being helped by dovish central bank meeting minutes, and the latter by sharp gains in China.  Europe and the U.K. lost ground during the week, with mixed economic results and the beginning of formal Brexit negotiations.

Chinese stocks rose upon confirmation of the local ‘A share’ market entry into the MSCI Emerging Markets index and MSCI ACWI (all-world) index in June 2018.  This will be a gradual process, starting with about 220 of the most liquid Chinese stocks, for a starting weight of about 0.75% of the total EM index basket.  This slow start is due to liquidity issues and restricted access to foreign buyers, but serves as a validation of that market’s place in the world market basket and likely growing importance.  In the same annual review, MSCI decided to remand Argentina to its current status as a ‘frontier’ markets, as opposed to promoting it to ‘emerging’, based on the newness of the political reforms taking place there.  Regardless, many foreign fixed income managers have been eagerly snapping up Argentinian debt over the last several years due the high yields and reform progress made so far; the equity market there retains a significantly lower profile.

U.S. bonds were mixed as the yield curve ‘twisted,’ with shorter-term and longer-term rates falling, while the belly of the curve in the 5-10 year area was little changed.  Governments and investment-grade corporate credits performed generally in line with each other for the week, outperforming high yield, which ended flat.  Weakness in inflation expectations has caused the yield curve to flatten somewhat, as well as lower the market probability of further Fed hikes this year (although the balance sheet normalization is assumed to be on track due to the Fed’s more formal communication about the procedure).  International bonds generally ended the week with negative returns, with emerging markets underperforming developed.

There often isn’t an abundance of exciting short-term bond news, but it appears LIBOR (the London Interbank Offered Rate) will be eventually going away.  LIBOR represents an important and widely-used short-term corporate lending rate, mostly for 1-month and 3-month periods, but has been derided for the seemingly arbitrary and non-transparent way rates are set, as well as claims of inside manipulation by bankers.  This affects a variety of markets, including floating rate bank loans (for which LIBOR is the ‘floating’ component), as well as a variety of other corporate debt and mortgages.  A committee studying the issue decided on a Treasury-backed repurchase agreement rate (also commonly used) as the new alternative.  These things can’t change overnight, due to systems, convention and the fact that debt contracts are tied to LIBOR, but expect this to slowly evolve.

Commodity indexes declined several percent on an overall basis, led by further weakness in the energy sector.  Agriculture also declined, while precious metals were flat and industrial metals gained several percent.  Crude oil officially moved into a bear market (down -20 % year-to-date), as prices fell by over -4% to just a tick above $43/barrel by the end of the week, a 10-month low.  A continued gut of inventory has prompted a variety of strategists to lower forward-looking oil forecasts, which tends to perpetuate an already-weak slide for pricing.  Many consumers aren’t complaining, as long as the decline translates to lower gasoline prices (which are closely tied to short-term consumer sentiment), while energy firms are negatively affected from an earnings standpoint, which affects both equity and debt.

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.