Economic Update 7-22-2019

• Economic data for the week included positive surprises in retail sales as well as several regional manufacturing surveys, mixed results in industrial production and housing, while the index of leading economic indicators pointed to weakening conditions.
• U.S. equity markets declined as earnings season kicked off for the most recent quarter.  Foreign stocks fared slightly better, despite a stronger dollar.  Bonds gained as investors moved away from risk during the week, and the Fed continued to hint at lower interest rates.  Commodities declined as prices for crude oil and natural gas declined sharply.

U.S. stocks lost ground last week, with small caps faring worse than large, as earnings for the second quarter began to command investors’ attention. By sector, only consumer staples and materials gained slightly, while all other segments fell into the negative for the week, led by declines in communications services and energy. Executives from the technology & communications sectors, including leaders from Apple, Amazon, Facebook and Alphabet/Google, were grilled by Congress on anti-trust concerns, although tech recovered to minimal losses on the week.

Earnings for Q2 have just begun to trickle in, with results mixed and overall expectations looking flattish overall from a year ago. In the communications sector, among the popular FANG group, Netflix fell sharply as domestic subscribers declined for the first quarter in eight years. This was not overly surprising, with sales expectations sky-high and valuations among the highest of any stock in the S&P by traditional cash flow-based metrics.

Recent commentary from the Fed continues to lay the groundwork for a possible rate cut by the end of this month—this appears to be well baked into expectations. The question now is: will a 0.25% cut be enough, or will markets be disappointed if it isn’t 0.50% (believe it or not). The Governor of the New York Fed, John Williams, made an interest speech last week implying that ‘preventative measures’ were preferred to waiting for a disaster to happen first, which was later echoed in similar language from Fed Vice Chair Clarida. However, the New York Fed later officially clarified/walked back on these remarks a bit, which created even more uncertainty about next week’s FOMC outcomes. While recent data don’t point to a sharply deteriorating economy, some quantitative metrics, which include more soft data from weaker business confidence surveys and lack of capital spending, do point to rising recession probabilities. This appears to be due to a tightening up of business activity due to the increasingly uncertain environment. Unfortunately, if such conditions perpetuate, this is how recessions have unfolded from a negative sentiment feedback loop.

In foreign markets, European and U.K. stocks were flat on the week, although a stronger dollar pulled these returns negative when translated back. Little news dominated, other than difficulties with the Italian government coming together, which could force new elections. Japan was negative in local and USD terms, as exports continued their streak of declines. There were also rising concerns in the U.K. over the chances of Boris Johnson taking over as prime minister and a harder line towards a no-deal Brexit.

Emerging markets, on the other hand, gained about a half-percent, with currency strength, which enhanced their returns. As expected historically, a dovish tilt to U.S. monetary policy and increased chances of lower rates elevated sentiment for the group, which has tended to behave favorably under such conditions. Additionally, several emerging market central banks cut key interest rates by a quarter-percent last week, including Indonesia, South Korea, and South Africa, to stem growing concerns over global economic slowing. The most surprising foreign news earlier in the week was the Chinese GDP reading for the 2^nd quarter, which came in at 6.2%—the lowest growth rate in several decades. While global growth overall has been decelerating, economists have naturally been questioning the degree of negative impact on this growth from U.S.-imposed tariffs, although Chinese retail sales remains robust, so the story is mixed.

U.S. bonds fared decently on the week, gaining ground as investor cash flows moved away from equities. Investment-grade corporates outperformed governments slightly, although high yield debt ended with a negative return for the week, in keeping with their traditional correlation with stocks. A stronger dollar seemed to have minimal impact on foreign bonds, which gained in keeping with U.S. indexes, although emerging market local debt again outperformed.

Commodities fell by several percent overall, along with the headwind of a stronger dollar. Gains in industrial metals and precious metals were held back by weakness in agriculture and energy—both in crude oil and natural gas. The price of crude oil fell over -7% to just over $55/barrel, as crude inventories declined to a lesser degree than the market expected. This is in addition to rumors of Iran’s interest in a deal to help restart oil exports to revive their battered economy, offsetting the negative influence of a British tanker being seized.

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.