Economic Update 8-21-2017

• Economic data for the week was highlighted by mixed housing results but gains in retail sales, several strong readings from regional manufacturing surveys, and strong results for the index of leading economic indicators and jobless claims.
• Global equity markets were mixed last week with U.S. stocks losing ground, and foreign stocks gaining slightly on net.  Bonds were little changed along with minimal movement in interest rates, while emerging market bonds fared well.  Commodities lost ground slightly with losses more concentrated in agriculture than in energy.

U.S. stocks lost ground on net for the week, with volatility picking up somewhat, but large-caps again holding up better than small-caps (which have deteriorated to nearly flat on a year-to-date basis).  From a sector standpoint, utilities and materials experienced positive weeks, while energy and consumer cyclicals suffered the most.

Volatility was exemplified on Monday, with gains the highest in four months as tensions with North Korea waned.  However, on Thursday, markets experienced their biggest drop in three months (-1.5%) for the S&P.  To put this into perspective, this was an extremely long stretch of low volatility (defined as an under-1% move in either direction)—these types of moves are actually quite common.  The VIX, which has been floating around the 10-12 level for months, spiked back up to 15 for a bit by the end of the week.  Investors were unnerved mid-week by the terrorist attack in Spain and dismantling of several business councils in the aftermath of comments made (and not made) by the President following the Charlottesville, VA demonstrations.  This weakening of corporate executive confidence caused investors to question the ability of Trump to push through agenda items later in the year and next year—notably tax reform being the one that matters.  Tax reform matters far more for markets than most agenda items since any resulting tax relief or cuts would have a direct impact on corporate financials (e.g. a blue chip firm being subject to a 15% rate would create an immediate jump in profitability compared to paying a 30% rate).  Profitability, in turn, effects multiples and valuations.  This is why it matters.

Interestingly, despite knee-jerk market reactions, and based on opinions from political/financial market analysts, Republicans seem to be increasingly going their own way with legislation (particularly as Presidential opinion ratings continue to plummet).   Success in tax reform and possibly infrastructure could be dependent more on their efforts in Congress than the input of the President.  Time will tell, but this appears to be a more practical base case.  The announced exit of Steve Bannon, who was seen as a wildcard, appears to be soothing to markets.

European stocks outperformed U.S. stocks, showing slight gains, despite the tempering influence of a stronger U.S. dollar, while Japanese and British stocks ended with net losses in line with those of domestic equities.  Mostly, European growth in Q2 showing up stronger than first reported, particularly in smaller peripheral economies, continued to help sentiment.  Japanese GDP for the 2^nd quarter grew by 1%, which sharply beat consensus, but left economists wondering about revisions and sustainability.  In emerging markets, Chinese stocks fared well as the government issued instructions to restrict domestic firm investments in overseas property and certain entertainment ventures, in favor of being pushed to invest in internal infrastructure road projects.  Argentina was also a big winner as voters supported the reformist Macri administration even more than expected.

U.S. bonds were generally little changed, with minor movement across the yield curve on net.  Credit, on both the investment-grade and high yield sides, outperformed governments and bank loans.  Developed market government debt lost ground, hindered by a stronger dollar for the week, while emerging market bonds fared the best globally in both USD and local terms.

Real estate gained slightly in the U.S., which outperformed broader equities, but were outgained by Asian and European real estate.  Domestically, retail malls again lost significant ground, bringing year-to-date losses to around the -15% range, among the worst of any asset class other than energy.

Commodities lost ground slightly, with a lack of energy volatility being outshined by weakness in agriculture (primarily in soft commodities coffee and cocoa) and strength in industrial metals.  Crude oil declined by over a dollar a barrel mid-week before recovering to a few pennies from where it began at $48.66.

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.