Economic Update 9-03-2019

• Economic news for the week included a slight revision downward in U.S. GDP for the prior quarter, stronger than expected results for durable goods orders and personal spending, while jobless claims and consumer confidence weakened.
• Equity markets in the U.S. and overseas rose on stronger sentiment and hopes about trade talks making progress. Bonds also gained, although interest rate changes were less dramatic than in recent weeks. Commodities rose generally, although the performance of the sub-groups was mixed.

U.S. stocks rebounded last week, with optimism over U.S.-China trade winning out over pessimism for the time being, highlighted by a Presidential tweet claiming China wanted to make a deal ‘very badly.’ Mid-week, optimism increased due to the likelihood of a near-term meeting between the two, as well as a decision by China to ‘remain calm’ and not further escalate tariffs beyond current levels. (Overall, sentiment has been driven by the U.S.-China trade spat for months, with little substantive news to report, other than markets reacting to shorter-term rumors, hopes and tweets.) Industrials, materials, and communications fared best with 3%+ returns last week, while defensives consumer staples and utilities brought up the rear, although they nearly achieved 2% gains each, which was a minimal lag.

By some metrics, such as a dividend discount model approach, equities have moved from ‘fairly valued’ to ‘attractive’—based solely on movements lower for the pegged risk-free rate, the 10-year treasury note. Absent substantial changes in other inputs, such as earnings expectations or earnings growth rates for future years, discount rates represent an overwhelmingly important contribution to valuations. This phenomenon explains higher multiples which can surface during periods of lower rates and compressed multiples during high-rate periods (such as the early 1980s).

A more unusual piece of news from the corporate world was the most recent meeting of the Business Roundtable, a collection of CEO’s who discuss symbolic issues of common interest. Last month, the group signed a statement claiming that shareholder interests (in contrast to long-standing practice) would no longer be considered paramount. Instead, all ‘stakeholders’—which also includes customers, employees, suppliers, and communities, in addition to shareholders—would be given top priority. While this is in keeping with a trend of deeper interest in ESG topics and desired improvements in corporate behavior, it runs in contrast to traditional thinking as to the purpose of corporations in the first place (to earn a reasonable profit for owners/shareholders). In fact, it’s a repudiation of the long-accepted Friedman Doctrine (espoused by the late economist Milton Friedman), which states the only goal of a corporation should be acting on the behalf of shareholders for profit. While serving this proposed new variety of masters is not always in conflict, there are fears of the threat of pushback and/or unintended consequences if this trend continues to gain traction.

Foreign stocks earned gains, in similar magnitude to those in the U.S., with emerging markets leading the way and the U.K. lagging a bit. U.K. performed surprisingly well considering threats over a suspension of the U.K. Parliament for over a month, the longest shutdown since World War II, in order to ensure anti-Brexit sentiment and any ‘no confidence’ votes on the prime minister himself are kept at bay. Elsewhere in Europe, Italian asset rose with a new political coalition being agreed upon, while the removal of multi-year capital controls in Greece lifted equity sentiment. China experienced gains as sentiment about a trade deal improved again, but Latin America led most other groups.

U.S. bonds ticked a bit higher with little change in the yield curve last week. Due to the rally in risk assets, both investment-grade and high yield corporate credit outperformed governments in the U.S. The U.S. dollar rising over a percent on the week was a negative influence on foreign developed market bonds, which lost ground, and emerging market debt was mixed, based with USD-denominated gaining and local currency bonds declining as one would expect. Year-to-date, bonds continue their pace of an exceptional year, with the Bloomberg BarCap U.S. Aggregate up around 9%, due to the sharp decline in interest rates, but also credit tightening, which has helped performance of corporate debt.

In recent weeks, the U.S. Treasury has been discussing the possibility of issuing an ultra-long-term bond, as in one with a 50- or 100-year maturity. In fact, bonds known as ‘perpetuities’ (as in perpetual, with no maturity date) were issued in the U.K. Bonds of this length have been looked again by a variety of governments in recent years, with some adopting them, but the idea of a very long bond is centuries old. Whether such bonds take root again remains to be seen, but there does seem to be a market for safe assets, which such products would satisfy, along with allowing governments to lock in a historically-low funding rate. One of the downsides, however, is that a bond paying a 2% coupon for 100 years would have a duration of nearly 45 years, although this falls to just over 30 years if issued with a 3% coupon.

Argentina is also seeking to ‘reprofile’ (extend payment maturities) of $100 bil. in debt, the bulk of which is foreign currency-denominated, and largely payable to the IMF. The net size of the debt has exploded due to the recent sharp devaluation of the peso following the surprise election results that pummeled stock and bond markets there. While this is a shade below a full default, and only affects a portion of bonds outstanding, it does get close to the edge, bordering on a restructuring. To put in context, Argentina has defaulted eight times in the past century, although emerging market bond investors always appear to be interested in giving the country another chance (assuming the yield is high enough).

Real estate in the U.S. gained nearly 2%, nearly on par with broader equities, although foreign REITs also experienced positive returns.

Commodities generally fared well for the week, despite the normally-negative influence of the stronger dollar. While agricultural prices declined, with stronger crop yields, and lower prices for precious metals as optimism outweighed pessimism on the week, energy and industrial metals gained. The price of crude oil rose by almost 2% to end at near $55/barrel, although natural gas prices rose 6% in anticipation for the Hurricane Dorian expected to reach Florida in coming days.

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. 

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