Economic Update 7-03-2017

• Economic data for the week was led by weaker durable goods orders, pending home sales and jobless claims, while several consumer sentiment measures strengthened.
• Equities were mixed for the week, with declines in the U.S. and foreign developed markets, while other groups were little changed.  Investment-grade bonds suffered due to interest rates creeping higher.  Commodities gained due to a rebound in the price of crude oil for the first time in weeks.

U.S. stocks lost ground on the week on the large cap side, while small caps eked out a small gain.  Financials led the way, gaining over +3% as U.S. banks completed their recent round of stress tests, essentially giving the firms the go-ahead to return more capital to shareholders.  This was coupled with stronger central bank language alluding to the need for continued tightening of conditions.  Tech, by contrast, lost nearly -3% on a continued round of apparent profit-taking for the sector (tech being up +17% year-to-date, beating all others) and Alphabet’s substantial EU fine of nearly $3 billion for anti-trust violations.

Foreign stocks were mixed, coupled with a -2% decline in the dollar for the week, which affected net returns.  The U.K. and Europe lost ground over the week in local terms, due to the hawkish central bank commentary which alluded to stronger growth; these losses were tempered by the weaker dollar.  The opposite occurred in Japan as the yen weakened, turning a flat local result into a loss for U.S. terms.  Emerging markets came in just slightly lower on net, with upward help from Brazil, China and Russia—several of which were aided by a sharp recovery in oil prices, being commodity-oriented nations.  Brazil also seemed to be aided by concerns about the current political corruption probe appearing to stall a bit and inflation levels declining.

U.S. bonds generally fared poorly, as interest rates increased across the yield curve in keeping with global central bank comments surrounding a shifting sentiment toward monetary tightening.  Investment-grade credit and government debt performed in similarly negative fashion; high yield experienced gains, however—no doubt helped by a recovery in energy prices.  Foreign bonds were flattish to lower on the week, hampered by the more hawkish central bank commentary which pushed key rates higher.  In EM, local currency bonds were helped by a weaker dollar, while USD-denominated debt lost ground in line with developed market debt.

In the world of munis, both Moody’s and S&P have downgraded Illinois general obligation debt to just a tick above below-investment grade status, as the state legislature has been unable to pass a new budget, not to mention a pattern of ongoing pension funding concerns.  A further downgrade to junk would be a first-time event for a U.S. state, and could create a host of carryover issues, including an inability for certain entities to hold the debt (as investment-grade ratings are required for certain institutional portfolios), in addition to higher borrowing costs for the state (as junk ratings imply higher required yields, just as with corporate high yield).  Even if this dramatic step isn’t reached, and odds of actual default don’t increase in practical terms, the move is a reflection of the difficult position many states and municipalities find themselves in.  Then again, these issues aren’t new.  While most muni defaults have been limited to higher-risk projects like hospitals, housing and other private/public partnership efforts, there have been nine G.O. technical defaults in the past 50 years, so it’s not unheard of.

Real estate declined in both the U.S. and abroad, by over a percent, in keeping with higher rates.  The year’s losers so far, retail and regional malls, were the sole gainers on the week, while health care and residential lost the most ground.

Commodity indexes gained sharply on the week, led by a recovery in energy.  Crude oil jumped each day of the week, netting +7% from $43 to just over $46/barrel, on reports of U.S. rig counts declining for the first time in 24 weeks.  Other commodity sub-groups also experienced gains, seemingly aided by a weaker U.S. dollar, except for precious metals which lost ground, as expected with higher real interest rates for the week.

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.