Economic Notes – January 27, 2014


Written by: Jon McGraw

After a fairly busy week, the MLK holiday led off a quieter one in terms of economic data releases.

(-) The Markit manufacturing PMI fell from 55.0 in December to 53.7 in January (versus expectations for an unchanged reading). Within the index, new orders, output and employment all fell by up to a few points—with output disappointing the most. While not a radical shift, it does conflict with other stronger regional Fed surveys this month. At the same time, it is important to remember than any number over 50 signifies growth; in the case of this reading, a deceleration of growth for the month.

(-) The FHFA home price index, which covers properties financed with conforming mortgages, rose +0.1% for November, which underwhelmed expectations of a +0.4% gain. In fact, this was the worst month since the summer of 2012 from a performance standpoint. The main cause appeared to be a bit of tempered growth in the regions (such as the West Coast, Rocky Mountain states and Florida) that have performed so strongly post-bust, but other areas were weaker as well. To put it into perspective, the rate of increase for the year-over-year period was +7.6%, which remains impressive in real/after-inflation terms.

(0/+) Existing home sales, on the other hand, rose +1.0% in December, which surprised relative to the expected +0.6% gain, and represented the first gain in five months. However, some downward revisions for prior months caused this to be less impressive than at first glance. Single-family home sales rose +2%, while the smaller and more volatile condo/co-op group fell -5% on the month. For the more meaningful full 2013 year period, 4.5 million homes were sold—the best year since 2006. From the compilation of housing data, it appears the recovery gains could be tempering somewhat, although expectations for continued growth in 2014 remain intact. The nominal figures may just be a bit smaller than we’re used to.

(+) The Conference Board’s index of leading economic indicators for December rose +0.1%, which was weaker than the November gain of +1%. Positive contributions from the index’s financial components (interest rate and credit spreads, as well as stock prices), ISM and manufacturer new orders were responsible for the uptick; while unemployment claims, building permits and consumer expectations for business conditions were negative influences. Additionally, the coincident indicator index rose +0.2% and lagging indicator index rose +0.3%—both within the average range of the past several months. Over the last six months of 2013, the leading index rose at an equivalent annualized rate of +7%, which was almost double the rate seen for the first half of the year.

(0/+) Initial jobless claims for the Jan. 18 ending week rose just slightly to 326k, from 325k the prior week—and better than the 330k consensus expected. Continuing claims for the Jan. 11 week rose to 3,056k, compared to the anticipated 2,925k, and has been on a rising trend for the past few weeks. On the topic of the emergency unemployment benefit program expiring at the end of December without being renewed by Congress, about 1.35 million folks dropped off the rolls who receiving these benefits. This may lower the labor force participation rate in coming months, thereby effecting the unemployment rate calculation.

The debt limit is in the news again. Without rehashing this latest chapter of an ongoing series, current estimates from the Treasury Department pin mid- to late-February as the deadline before the coffers run dry. If legislators don’t act in advance (and there is no reason to expect that they will), expect additional volatility if optimistic sound bites don’t appear. From a fundamental basis, though, there appears to be much less support for playing around with this deadline as there seemed to be a year or two ago. One operational/timing problem is that February tends to be an especially bad month for treasury operations—there are quite a few more significant outflows, while inflows are delayed a few months (taxpayers expecting a refund generally file returns as soon as possible, while those forced to pay often delay writing checks as long as they can). This tendency is actually quite significant in budget planning.

Market Notes

U.S. stocks ended the week sharply negative (thanks especially to Thursday and Friday), as a myriad of continuing emerging market concerns pushed markets lower. We haven’t seen a negative week on that magnitude in some time. The defensive sectors of utilities and consumer staples rode conditions out the best, with minor losses, while financials, materials and industrials lost near or above -4%. Much of the Dow’s negative week compared to broader indexes were not due to earnings results per se, but those global/Emerging Markets concerns affecting sentiment for such behemoths as GE, Caterpillar and DuPont. From a financial release standpoint, revenues so far for S&P companies have been a modest surprise, while earnings per share has been generally in line with expected—results have been led by information technology and healthcare.

In developed foreign markets, performance was similarly poor, with the U.K. down -2.5% and the Eurozone and Japan down -3%. The big news in the U.K. was a drop in the unemployment rate to 7.1%, the lowest since February 2009. This will certainly cast additional questions about the longevity of interest rate guidance (as in the U.S.). The Japanese central bank announced that it would continue its expansion of the nation’s monetary base by 10 trillion yen to 70 trillion in ongoing efforts to combat deflation, generate economic growth and offset the impact of new consumer sales taxes. Eurozone PMI also gained a point to near 54, which is moving more into stronger recovery territory. Bottom line: conditions in Europe are continuing to get a bit better.

Emerging markets were the primary negative catalysts last week. China’s PMI came in far weaker than expected, although GDP was robust and within target range (exact figures there are sometimes hard to pin down). China injected over $40 billion in liquidity into their financial system to maintain money market stability as the Chinese New Year approaches, which is often characterized by higher-than-normal seasonal cash demand and rate volatility. Many markets didn’t react well to this boost of cautionary liquidity, but the second jolt of the week from this part of the world was due to Chinese PMI results falling short of expectations by a few points and, more importantly, falling under 50, which indicates a degree of contraction—albeit small and perhaps a one-off. To put this into perspective, these levels were also breached several times during 2013 with no negative carryover effects into the developed markets.

In other areas, continued currency crises in Argentina, South Africa and Turkey affected stock market performance to the worse in those areas—for several names in this genre, we shouldn’t be overly surprised. In the latter case, Turkey has frequently been mentioned during the last several years as a ‘rising star’ in the emerging markets (meaning they’ve moved from almost frontier-like status into a higher tier of investibility), with improved stability and governmental credibility coupled with solid growth. However, recent scandals have rocked this perception (and its currency), and internal interventions to provide support have been reacted to unfavorably. Such is the tale of shorter-term bumps in the longer-term road of emerging market development. Macro concerns aside, in emerging markets as a whole, many individual company fundamentals appear strong while corporate leverage remains low overall as well.

Emerging market equities have now returned to levels last seen in the mid-2000’s, which reflects the current uncertainty, but piques the interest of contrarians. We will likely continue to hear a lot of bad news, potential volatility and pessimistic/catastrophic forecasts about several (but not all) emerging market nations. It’s important to remember we heard a lot of terrible things about U.S. equities in March of 2009 too…

As ‘leaked’ a few weeks back, the International Monetary Fund raised its growth forecast for 2014 by a tick to 3.7%. The expected U.S. growth prediction was raised from 2.6% to 2.8%, the Eurozone’s pegged at 1% overall and China’s raised two ticks to 7.5%. Nominal growth for America is obviously looking a bit better, while Europe continues to struggle (albeit better than zero) and, despite the volatility, emerging markets continue to be the primary source of world growth.

Bonds had a great week in relative terms, with yields on the 10- and 30-year Treasury falling by nearly 10 basis points (a big deal in bondland). Consequently, long treasury debt was the best performer, gaining 1-2% in total return on the week, while MBS and TIPs came in with decent returns. High yield, floating rate bank loans and credit of any type lagged.

Foreign developed market bonds experienced a strong week as well, with a 1% decline in the dollar (in this case, better news leading to strengthening currencies in the U.K., Eurozone and Japan as opposed to any negative U.S. news). Emerging markets had the opposite experience, with currency weakness leading to wider spreads and a generally bad week.

Real estate suffered along with equities during the week, with the exception of mortgage REITs, which gained along with bond prices and industrial/office, which bucked the trend. Asian REITs fared the worst, in keeping with the China comments above, losing over -4%.

A sagging dollar can often help commodities in the short term, and indeed, indexes were generally up on the week. Individually, natural gas contracts gained +20% (!) due to another bout of freezing weather over good parts of the nation—necessitating higher energy usage and challenges in getting gas out of the ground and transported. While shale oil/gas exploration and production have certainly increased the availability of and pressured prices downward for domestically-produced energy in recent years, the properties of natural gas create a unique environment for storage, and contracts can still be subject to extreme supply/demand imbalances. Crude oil also rose several percent on the week, as did several ‘softs’ including sugar, cotton and cocoa, with potential for lower production from several key foreign nations. On the other side, copper and aluminum lost ground—both of reacted to potential hiccups in Chinese growth and concerning emerging market conditions.

Have a great week!

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