Economic Update 1-16-2018

• Economic data for the week was led by growth in retail sales, tempered inflation results and mixed but continued strong labor market metrics.
• Equity markets gained ground again, with U.S. markets leading the way upon strong sentiment.  Foreign markets also gained, with a help from a weaker dollar.  Domestic bonds generally lost ground with interest rates ticking higher.  Commodities gained across the board, but particularly due to higher crude and natural gas prices last week.

U.S. stocks experienced another strong week, as continued good economic data and the first signs of the Q4 earnings season were reviewed.  Consumer discretionary, industrials and energy all gained—the latter in keeping with higher oil prices—while more defensive utilities, staples and telecom all sold off.  Expectations for Q4 earnings overall has risen to about 11-12%, a few points higher than in recent months.

Foreign stocks in developed markets were barely positive in local terms, with small increases in Europe but losses in Japan, but were helped by a -1% decline in the U.S. dollar.  Emerging markets also experienced positive returns, and were far less affected by dollar movement than they were the positive move in commodity prices and stronger economic data in China, such as export growth.

U.S. bonds generally lost ground, as yields rose across the curve—this affected treasuries a bit more than corporate credit, which ended the week flattish to slightly lower.  Interestingly, bonds were among the leaders in volatility earlier in the week as yields on the 10-year treasury touched 2.6%, the highest level in 10 months, under rumors that the Chinese were considering a pullback in their purchases of U.S. treasury bonds; however, they later denied the report.  As a significant buyer, keeping demand and prices high and yields contained, reduced activity could certainly pressure yields upward over time.  Underlying trends in inflation showing more normalization also has some investors raising their future inflation expectations.

Foreign government bonds fared similarly in local terms, with losses upon concerns over the ECB withdrawing stimulus support this year, but were saved by the weaker U.S. dollar, which turned these losses into gains.  This has been the trend for much of the past year, with zero-to very low-yielding developed market bonds in Europe, U.K. and Japan offering little to speak of in local currency terms, but benefitting from a -10% decline in the dollar, which directly added to their returns by a similar magnitude.  A common question involves the benefits or detriments of hedging currencies, particularly in a less volatile asset class like foreign fixed income.  The answer, of course, is more complicated, since over the long term, hedging out U.S. dollar risk provides roughly similar returns to not hedging; however, the unhedged form experiences greater volatility from currency fluctuations.  However, volatility moves in two directions—the last year has been the beneficial kind for certain unhedged foreign debt.

Real estate also weakened by a few percent along with more defensive equity groups upon rising interest rates, which tend to normally have a negative effect on real estate pricing in the short-term.  However, the dollar effect benefitted real estate returns for Asia, which ended in the positive.  Domestically, economically-sensitive lodging/resorts actually gained for the week, while apartments and health care lost the most ground.

Commodities gained a few percent, with help from a weaker dollar, which translated to gains in energy and industrial metals, and surprisingly in precious metals, but agriculture lost ground with weakness in several tropical soft commodity contracts.  West Texas crude rose almost +5% to end the week at $64.30, the highest weekly close since the declines of late 2014, when prices were in a freefall down from over $100 to $45.  Catalysts appeared to be concern over changes in Iranian sanctions, continued turmoil in Venezuela—both significant producers—and comments from Russia that supply/demand is not yet in balance.  Natural gas also rose around +10%, with a continued deep freeze in much of the U.S., particularly on the East coast, where milder temperatures had been predicted.

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.