Economic Update 6-25-2018

• Economic data last week saw manufacturing experience a bit of a decline, housing was mixed, although housing starts and prices were higher, jobless claims were mixed but remained strong, while the index of leading economic indicators continued to run at a high level.
• U.S. stock markets fell back on the week, as did equity markets abroad in developed and emerging markets, with concern again over trade tensions.  Bonds were mixed domestically, with governments outperforming, while foreign bonds shined due to a weaker dollar.  Commodities gained solely due to the price of oil re-advancing following uncertainty over OPEC production changes.

U.S. stocks declined on net for the week, with smaller cap stocks again outperforming by ending the week flat.  From a sector standpoint, defensive utilities gained the most ground, followed by energy, while industrials declined by the greatest degree, notably several blue firms that were more exposed to global trade.  Year-to-date, consumer cyclicals and technology lead the pack dramatically, with gains over +13%, while performance for other sectors is far less dramatic.  The 35 largest U.S. banks all passed the first round of their annual stress test, which has become increasingly more rigorous, including sharply higher employment and extreme yield curve changes, but the sector did not seem to be affected.

Trade and tariff talk continued to be a catalyst for market sentiment, with continued talk of escalation and larger amounts (up to $200 billion worth) of U.S. and Chinese goods being potentially affected.  Europe’s annoyances are also apparent, with targeted tariffs being discussed for specific American cultural items, such as Kentucky bourbon, jeans and motorcycles.  Despite the back and forth in recent weeks, a variety of commentators continue to see this situation as a game of ‘chicken’, with a lot to lose on both sides (and for other nations) if a full-scale trade war is implemented.  The base case is that cooler heads prevail, with an acknowledgement of and additional analysis being conducted to measure potential impacts should this full gamut of tariffs be put into place.

One newsworthy event of the week was a change in the composition of the ‘venerable’ Dow Jones Industrial Average.  General Electric is being removed after a 111-year run and is being replaced by Walgreens Boots Alliance on June 26.  GE was part of the initial Dow group in 1896, and was kicked out and re-added a few times in the early 1900’s prior to its current run.  GE’s poor performance during an internal restructuring as of late may have played a role, but, officially, it appears the Dow is adjusted based on its intention to be a bellwether for a group of leading stocks that best represent the U.S. economy at the time.  The addition reflects a larger contribution from consumer and health care, while the impact of industrials has declined.  Some were wondering why Amazon wasn’t the new name added, due to its size, scale and clout, but maybe that’ll be next.  The Dow folks have generally been a bit late to add technology, perhaps due to their over-representation on the Nasdaq.  Another factor in the change could be related to the historical quirk of its ‘price-weighted’ construction scheme—the chairman of the index committee last year noted that they prefer the ratio of the highest priced to lowest priced stock in the index to be less than 10 to 1.  Again, the antiquated format of the index’s construction render this an issue where it shouldn’t be—other indexes are market cap-weighted or use another easily calculated scheme.  While the price-weighted construction no doubt assisted in the process of calculations done by pencil 1900, it makes very little sense today.

Foreign stocks fell back overall, with most developed areas losing ground, as did emerging markets.  The Bank of England kept rates steady, although the vote was closer, with thoughts of a rate hike being appropriate later in the year—which boosted equities.  Chinese markets fell dramatically again, with the A shares now down -15% year-to-date, with tariff concerns trickling through; other large Asian nations followed suit with weakness, as they would also be affected quite negatively by a trade war.  A variety of emerging market central banks met last week with most keeping policy unchanged, but a handful, including Mexico, hiked rates in order to help stabilize currencies (a consideration for central banks of developing nations).  Argentina was interestingly promoted from frontier to back to emerging market status by MSCI, despite strong weakness in markets and their currency this year.

U.S. bonds ticked higher as interest rates fell back slightly.  Government bonds gained the most, while wider credit spreads pushed returns into the negative for both investment-grade and high yield corporates.  A slightly weaker dollar pushed dollar-denominated developed and emerging market bonds into a positive direction, leading all others, while EM local debt declined.  Governments in the eurozone have put together a debt relief deal for Greece, which includes extending loan maturities and deferring interest payments by 10 years, including billions of additional funds and allows the nation to issue new debt in a variety of maturities.

Real estate moved higher by over a percent in the U.S., helped by tempered interest rates.  Despite a weaker dollar, foreign REITs declined a bit on the week.  U.S. REITs were led by a resurgence in malls/retail, which have been seen as a value play by real estate managers, as well as subject to merger and acquisition chatter, despite the wide dispersion in quality between REITs and properties within the sector.

Commodity indexes gained last week due to the influence of the energy sector outweighed losses in all other groups, including agriculture and metals.  OPEC talks last week ended with an agreement to modestly increase output to compensate for production losses, as global demand continued to increase—however, this was a weaker and vaguer statement than the market had expected.  Accordingly, crude oil prices moved over +5% higher to end at just over $68.50 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.