Economic Update 7-30-2018

• Economic data for the week was highlighted by the 2^ndquarter GDP report, with the best results in five years.  Durable goods were mixed, as were jobless claims, while housing data generally came in below expectations.
• U.S. equity markets rose last week, as trade tensions eased somewhat, although were outperformed by foreign, and especially emerging market equities.    Bond returns were mixed as interest rates rose across the curve, with higher-risk outperforming lower-risk globally.  Commodities gained on the week, led by a rise in prices of a variety of sectors.

U.S. stocks ended in the positive, with gains all earned during the first half of the week, with hopes that talks between the U.S. and European Union would ease tariff and trade tensions—particularly in metals, agriculture (soybeans), natural gas and auto parts.  Small cap did not fare as well, losing ground, in contrast to their strength through most of this year.

From a sector standpoint, energy, industrial and materials—all related to global trade most directly—experienced the strongest gains, up over +2%.  Technology was the sole losing segment, down over -1%.  A nearly -20% decline in the price Facebook, a glamour stock and large index component, was a key story, as revenue and user results underwhelmed and negativity spiraled.  Naturally, the $120 billion loss in value was dramatized as the largest one-day loss of stock value in history—this is not surprising as market caps are a lot higher than they used to be.  When expectations reach this level, naturally this type of outcome can happen.  While the drop pulled down related companies, the broader market was less affected.  However, so far in 2018, over 60% of the S&P’s return has originated from the top 10 contributing stocks, and of that short list, 9 are tech or internet-related companies (Facebook not being on that list).  Typically, such narrow breadth has been cause for concern; however, earnings growth appears broader-based more recently, which may buy some time for this current cycle.  Interestingly, the market has moved along in a less dramatic few steps forward, one step back fashion in recent months, which is a relatively healthier pattern than a straight up parabolic chart.

Per FactSet, more than half of the S&P member companies have reported for Q2 so far, with over three-quarters beating analyst estimates for both revenue and earnings.  The year-over-year earnings growth rate remains at about 21% (which would be the second-highest in the last eight years), with revenue growth just over 9%.  The forward P/E ratio stands at 16.7, which is just above its long-term average.  Anecdotally, in a search of earnings call transcript keywords, ‘tariff’ appeared in just under half of all earnings calls, with over half of companies expecting little to no impact, and another quarter expecting an impact described as ‘modest’—notably in industrials.  Expectations for 2019 are more tempered, with expected revenue and earnings growth moderating to 5% and 10%, respectively.

Despite a slightly stronger dollar, international stocks outpaced U.S. names, particularly in emerging markets.  Results globally appeared driven by improved sentiment surrounding tariffs—with potential agreements between the U.S. and Europe, and Europe and Japan.  Unsurprisingly, all key BRIC nation stocks gained over 2%, led by Brazil, Mexico and China.  In China and neighboring Asia, news of a more proactive fiscal policy helped sentiment, while Chinese stocks have been affected in recent weeks by a sharp decline in the yuan.  Whether sparked by government action or purely through global markets, a currency decline is a natural response to partially neutralize the impact of any imposed tariffs, but equalizing the net price of exported goods.

U.S. bond returns were weak as interest rates moved higher in response to solid economic data.  Treasury performance ended negative on the week, while investment-grade corporate credit, high yield and floating rate bank loans fared better as spreads narrowed.

Foreign bonds in developed markets lost ground as well, while emerging market debt earned among the best gains for the week.  Yields abroad ticked up on building speculation about various global central banks—notably Europe and Japan—increasing preparations to pull back on their easy monetary policies of the past decade.  In the case of Europe, the pullback in bond buying and reversal of QE (as happened in the U.S. over the last several years) is the key issue, with the assumed impact being higher interest rates across the continent.  If this happens in an orderly way, and if accompanied by growth, no doubt the ECB would hope for an outcome similar to the tempered (and even sometimes cheered) reactions in the U.S.  The situation in Japan is a bit different, with the Bank of Japan having attempted to spur a reversal of a long-standing slow growth trend by keeping rates near zero.  While some economists argue that this can be an effective tactical technique for shorter-term periods, the effects are untested, and it’s thought by many to be an unsustainable policy over time.  Thus far, while growth is up a bit, inflation remains low and the low rates are punishing to financial institutions, who rely on rate differentials to earn a profit.  The BOJ responded to rumors by announcing their intention to buy an unlimited amount of bonds in order to keep 10-year rates targeted at 0.11%.

Commodities gained ground during the week, with the S&P GSCI approaching +2%.  Returns were led by roughly equal gains for energy, industrial metals and agriculture, due to an improvement in sentiment about free trade winning out over tariffs, while precious metals suffered due to a rise in interest rates.  Crude oil prices rose, as tensions with Iran flared up, with the U.S. threatening to block the latter’s oil exports through the Strait of Hormuz, and Iran threatening to retaliate by antagonizing other vessels proceeding through the waterway—through which a large amount of global oil passes through on a consistent basis.  West Texas crude ended the week higher by under a percent, to just under $69/barrel.  Although they represent a tiny component in most commodity indexes (several of which, including the GSCI, are weighted by trade volumes), the livestock sector has suffered with tariff talk.  Lean hogs, in particular, have been pummeled in price (over -30% over the past month) due to tariffs on exports to China and Mexico, as well as general oversupply.  Effects on goods such as hogs, and the much larger soybean complex, are what spurred the administration to announce $12 bil. in farm subsidies to stem any potential tariff damage.

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.