Economic Update 10-23-2017
- Economic data for the week included solid regional manufacturing results and production numbers, while housing statistics reflected the large impact of recent multiple hurricanes, which depressed activity. Labor strength remained robust, with jobless claims again reaching multi-decade lows.
- Equity markets gained in the U.S., outperforming foreign stocks that were held back by dollar movements higher. Bonds on the investment-grade side lost ground due to higher rates, while lower quality bonds fared better; foreign bonds were held back by currency movements. Commodity prices were mixed as crude oil prices moved slightly higher, ending in the low 50’s.
U.S. stocks gained strongly during the week, helped by Friday’s relief rally caused by the suspension of the federal debt ceiling until early December, as well as a variety of large-cap earnings surprises. However, the trend of lower expected growth for Q3 due to a variety of weather effects is expected to persist, so hopes appear to be focused on 2018—common at this time of year. From a sector standpoint, health care and utilities led the week with the strongest gains, interestingly, while consumer staples and energy lagged with negative returns.
Foreign developed market returns in Europe and the U.K. which were slightly negative in local terms, but were hampered by a stronger dollar, that was led higher by lessened geopolitical pressures in the U.S. and higher interest rates, leading to sharper losses. European earnings have been slightly less robust than those in the U.S. for the quarter, while U.K. inflation has picked up a bit to +3%—making rate hikes more likely. A similar pattern occurred in Japan as well, as sharply positive returns in local terms were reduced when translated to USD. Interestingly, Japanese stocks have experienced daily gains for almost three straight weeks, the longest stretch of positivity in several decades as pre-election polls looked more status-quo than expected (the incumbent prime minister Abe did end up winning), which implied a continuation of current accommodative financial policies, and economic conditions continue to improve. Emerging markets fared a bit worse, with losses worst in Latin America, Russia and South Africa.
Discussions on the future of NAFTA, after the fourth round, resulted in an agreement to extend talks to 2018. This removes more immediate uncertainty about the future of the treaty, but could cast a shadow on Mexican elections early next year, since Mexico is heavily invested in the outcome (their exports to the U.S. greatly outweigh our exports to them). It appears that a President does have the authority to unilaterally withdraw from treaty agreements without the need for congressional approval, however, there would be other repercussions—notably, a reversion to existing WTO-default tariff agreements and/or retaliation from other parties. While economists tend to agree on the undesirableness of hampering free trade, it’s also been conjectured that these ‘stunts’ are designed simply to improve the bargaining position of the U.S. and negotiate more favorable terms.
U.S. bonds lost ground as interest rates increased, in keeping with the passage of the congressional budget resolution, which could pave the way to quicker discussions about tax reform. As tax reform could boost growth, higher rates reflect this assumption. High yield, with higher correlation to equities, fared better than other bonds, with positive returns as spreads continue to grind tighter. Due to the stronger dollar effect and miniature yield, developed market bonds declined nearly a percent, while emerging market debt suffered, albeit not to the same degree. Interestingly, high yield and emerging market bonds continue to attract investor inflows due to very strong trailing returns this year, due to a lack of other alternatives providing any type of yield, as well as more extended valuations for U.S. equities. At the same time, spreads have been grinding tighter in these assets (meaning they’re more expensive), and could imply more tempered opportunities looking forward. However, price momentum can often continue to take precedence over valuations in the near term—that is, until they don’t.
Real estate suffered somewhat with interest rates ticking higher during the week in the U.S., while European and Asian real estate was hampered by a stronger dollar as well.
Commodity indexes were mixed on the week, as sharp declines in agricultural contracts and precious metals were offset by the energy sector gaining ground. Soft commodities, such as sugar and cotton, were responsible for the bulk of ag declines. Crude oil rose just under +1% on the week on net with prices ending at $51.84/barrel. Higher pricing in recent weeks appears to be due to several unique factors, such as stronger compliance (less ‘cheating’ via sneaking extra output) by OPEC, uncertainty around the future of the Iran nuclear deal as well as Kurdistan’s independence referendum appear to be several catalysts for the upward move. This is in addition to oil demand beginning to grow once again, resulting the supply glut looking less extreme. Interestingly, despite calls for higher pricing a few years ago, estimates have fallen to the mid-50’s for the next few years, reflecting a balance between demand pick-up and larger shale output.
Thirty years ago this week, October 19, 1987, or ‘Black Monday’, saw a -22.6% decline in the Dow Jones Industrial Average. This event is still referred to as a benchmark to some extent for modern single-day declines and has been reviewed extensively since that time. While a variety of Middle East-related geopolitical factors seemed to play a role in the early negative sentiment, automated selling related to new ‘portfolio insurance’ systems exacerbated the damage. While there have been corrections and bear markets since the 1987 drop, due to the use of ‘circuit breaker’ systems designed to halt trading and create a time-out of sorts when these panics begin, we haven’t experienced a single day episode of that magnitude. What is less-often reported is that, following that day, the Dow earned a total return of +12.4% for the rest of 1987, to generate a low positive return for the year—most of which were provided by dividend yield, which tended to be much higher at that time than today. Additionally, since that infamous day, the Dow gained a cumulative total return of +2779% (+11.9% average annualized) through last Friday. Those were the days when the Dow 30 was more widely used by many as ‘the market’, prior to the S&P 500 gaining wider acceptance. By contrast, although the VIX wasn’t available until 1990, one would have to assume the number for that week would have been quite high, compared to historical average of 19.4 and levels around 10 last week, matching all-time lows yet again.
|Period ending 10/20/2017||1 Week (%)||YTD (%)|
|BlmbgBarcl U.S. Aggregate||-0.45||3.01|
|U.S. Treasury Yields||3 Mo.||2 Yr.||5 Yr.||10 Yr.||30 Yr.|
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.