Economic Update 8-07-2017

• Economic data for the week was dominated by the employment situation report, which surprised on the upside.  The ISM manufacturing and non-manufacturing indexes both declined, but remained solidly expansionary.
• Equity markets gained globally, as did bonds to a certain degree with lower interest rates on the longer part of the yield curve.  Commodities declined slightly, despite little net change in oil prices during the week.  Overall, low volatility conditions in stock and bond markets continue.

U.S. stocks rose, with continued decent Q2 revenue and earnings reports.  The mega-cap Dow Jones Industrial Average was the best performing stock index, reaching another round number milestone at 22,000, with good reports from several individual members such as Apple (it’s only a 30-stock index, as opposed to 500).  Overall, decent stock earnings were the primary driver, with a lack of other geopolitical or other events during the week to move the needle.  From a sector standpoint, financials and utilities led the way, while energy and materials lost the most ground for the week.

Volatility continues to trail along at low levels, especially so, even for light summer trading sessions.  Interestingly, year-to-date, investors have pulled $11 bil. out of U.S. equity funds (with some of this going towards foreign equities, granted), while adding $210 bil. to taxable fixed income.  Skepticism continues surrounding the durability of equity markets, which higher valuations likely have a role in; however, sentiment has never reached the ‘exuberant’ stage at any time during this recovery.

Foreign stocks generally outperformed the broader U.S. market, with developed areas outperformed emerging.  European stocks were similarly helped by earnings growth improvement, which have come in over +10%, which slightly better than that of U.S. stocks.

U.S. bonds gained a fraction of a percent overall, as rates ticked down at the longer end of the yield curve.  As a result, longer treasuries outperformed credit slightly, while high yield returns were just above zero.  A slightly stronger dollar was a headwind to foreign bonds, which still ended with minor gains in line with U.S. bonds—developed outperforming emerging for the week.  The Bank of England left interest rates unchanged, as expected.

The most recent emerging market crisis is unfolding in Venezuela, with difficult economic conditions and attempts at consolidating political power are resulting in violent anti-government protests.  The nation earns over half its annual revenue from petroleum, so economic conditions there are even more closely tied to energy market prices than Russia or similar commodity-dependent nations.  When times were good, the fatter coffers were spent at an unsustainable rate, including social programs to keep the government in the public’s good graces; of course, as oil prices collapsed, this put the nation into a cash crunch and persistent depression characterized by high inflation and essential food/consumer good shortages.  Cash reserves have been dwindling for some time, which has called into question the possibility of foreign debt default.  It’s also been a strong performer this year, and a hedge fund favorite.  However, many active managers have been anticipating a negative scenario, and have avoided the nation’s debt despite its cheap price and high yield (as default risks have been steadily rising in keeping with these falling reserves).  Nevertheless, Venezuelan debt remains at about 2-4% of emerging market bond indexes (weighting dependent on the index used), so is a component of many ETFs tracking that asset class.  There is certainly more to come, as default doesn’t mean the end of the road for bondholders—recoveries would offset any losses, but are also dependent on the political environment.  It’s important to remember that foreign governments, despite self-serving rhetoric and obstinate behavior, consider foreign debt repayments among their highest priorities (along with staying in office).  If a country violates one or several of the big ‘C’s’, it can be locked out of bond markets for some time and/or be forced to pay an exorbitant interest rate on new debt, so there is incentive for positive outcomes.  On the positive side, there is far less concern over carryover of this crisis to other Latin American nations, which have stronger fundamentals than they did decades ago during similar scenarios.

Real estate lost a fraction of a percent overall in the U.S., but returns were positive in Europe and Asia, in keeping with recent trend.  Domestically, malls and retail gained sharply in a bit of a recovery, as did mortgage REITs, while apartments and health care struggled.

Commodity indexes lost about a half-percent, with slight declines in energy (due to natural gas more than crude last week), coupled with drops in wheat, soybeans and silver, while industrial metals and softs fared well—in one of the more divergent weeks recently.  Oil was generally flattish on the week, for a change, with West Texas crude ending at $49.58, near where it started.

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.