Economic Notes – January 6, 2014


Written by: Jon McGraw

(+) The ISM Manufacturing survey came in stronger than expected for December, at 57.0 versus a forecasted 56.8, but was a bit lower than November’s 57.3 result. Underlying data was similarly strong, little changed from the prior month, with higher readings in new orders (actually, the best since spring 2010) and employment and a bit of contraction seen in production and inventories. Despite the lower reading by a few tenths compared to the prior month, which implies lower ‘acceleration’ of growth (that’s the sneaky background behind diffusion index readings—a ‘50’ implies no change over the preceding month, while a number over 50 implies growth to some degree), conditions continue to point to strengthening.

(0) The Chicago PMI fell from a 63.0 reading in November to 59.1 for December—worse than the anticipated down to 60.8. Underlying the core number, though, declines were a bit more widespread, with over 5-point drops in new orders, production and employment. While a negative from a nominal standpoint, anything near 60 signifies solid accelerating growth (per the diffusion index note above).

(+) The final December release of the Markit PMI rose to 54.7 from the initial 54.4, to match November’s figure. On par with similar metrics just noted above, underlying items were little changed, including output and new orders; however, employment gained a few points.

(+) The Case-Shiller home price index for October rose +1.05%, surpassing the forecast of +0.95%. Each of the 20 indexed cities posted a positive return—led by near-2% gains in Miami, Atlanta and Detroit (the latter being perhaps a ‘value’ play of sorts). The year-over-year gain came in at +13.6%, while the index continues to plod along below its peak level from the 2006 pre-bust period. From a variety of estimates we pay attention to, it appears home prices are still poised to move upward in 2014, albeit at a slower rate than in the last several years as a better balanced is reached between inventory levels and possibly higher mortgage rates.

(-) Pending home sales for November stabilized higher with a slight gain of +0.2% on the month, which underwhelmed relative to expectations of a +1.0% rise. However, at the same time, October’s sales number was revised lower by -0.6%. For the year-over-year period, the index is down -1.6%. Interestingly, all-cash home sales rose from 39% in October to 42% in November, with over-50% proportions in the deep South, Nevada and Michigan, where prices have been cheaper. This implies a continued trend of investor- and retiree-driven sales activity, which is better than no activity, but could end up being problematic for some markets if it falls off, which real estate investor behavior can tend to do.

(+) Construction spending rose +1.0% for November, which surpassed expectations calling for a +0.6% increase; the release was coupled with a small revision for October and sizable +1.7% revised Sept. figure. Private residential spending rose +1.9%, as seen in housing start figures, while non-residential gained +2.7%. However, these strong private market results were offset by government spending weakness weighed down by a -3.7% drop on the Federal side and -1.7% in state/local—both of which were largely expected and in keeping with trend. Year-over-year, spending is up +5.9%, with private sales gaining +8.6% and government falling a fraction of a percent.

(0) Even though auto sales had a mixed December—likely due to the timing of the Thanksgiving holiday and especially cold weather nationwide—the industry experienced its best annual performance since 2007, seeing 8% growth for the year and reaching 15.6 million vehicles sold. This disappointed analysts, however, who called for 16 million. Consumers appear to be feeling more confident in such large purchases; however, cars are also lasting longer, which is one reason purchasing behavior didn’t kick in as quickly after the recession.

(+) The Conference Board consumer confidence survey drifted higher from last month’s 72.0 to 78.1 for December—beating a forecasted 76.0 reading. Within the survey results, expectations for the future improved by a strong 8 points, and consumer assessments of present conditions ticked upward as well. Also positively for the survey, the ratio of respondents reporting that jobs are plentiful versus hard to find improved to the best level since late 2008 (although it remains sharply in the negative). While signs of confidence are coming back from lows seen during the autumn government shutdown, several weak areas such as employment, could still stand to see better days ahead.

(+) Initial jobless claims for the Dec. 28 ending week came in at 339k, which was little changed from the prior week, but came in below the consensus calling for 344k. Continuing claims for the Dec. 21 week fell to 2,833k, which was also below consensus estimates of 2,900k. As we’ve noted previously, the holiday period can sometimes make seasonal adjustments a bit difficult, which adds to the more volatile results—more consistent readings likely in coming weeks.

Market Notes

On the holiday-divided week, stocks generally lost ground with a few poor days to open the year. Financial and consumer discretionary stocks led, with positive returns, while energy and telecom brought up the rear. Outside of the U.S., stocks followed the same pattern with flat returns from Japan, losses of a percent and a half in Europe along with weaker manufacturing data, and weak results in emerging markets with China, Russia and Brazil all sustaining large losses. In China, several factory output measures and a non-manufacturing/services index fell to a multi-month low to affect sentiment to the negative.

To close out the year, equities posted their best one-year performance number since 1997. (Conditions improved elsewhere as well—Japan’s 25% return was the best since 1973.) Interestingly, a year ago more than a few ‘experts’ predicted a ho-hum 8-12% ‘average’ year for 2013, based on the underlying metrics and overall lack of excitement for equities—certainly not a year of 30% gains. It’s another reminder that short-term results (even over one-year periods) don’t necessarily pay attention to metrics.

Does this bode well for 2014? Perhaps—momentum is on equities’ side and nothing is overly expensive. Great years have often been followed by at least good years, as that momentum effect (which tends to be more persistent than it should be, logically) kicks in and increasing numbers of retail investors become interested. Does it mean we won’t have a correction or two in the process? No. We know that’s bound to happen sooner or later, but we seem to forget that every time it happens. It is important for clients to realize the importance of corrections in digesting market prices and acting as the ‘pauses that refresh’ over the course of a full market cycle.

In the world of fixed income, interest rates ticked up a few basis points from Monday to New Year’s and then reset lower again, so that was about the limit of the excitement on the week. Long treasuries, TIPs, munis and corporates (both investment-grade and high yield) all gained a third to a half of one percent of total return. A stronger dollar punished international bonds, which ended up in a slight negative—with developed and emerging markets providing returns in roughly the same range.

For last year as a whole, it was an odd one for bonds, but a sequence that wasn’t entirely unexpected. The 10-year Treasury began 2013 at a 1.75% yield, plugged along range-bound for a good part of the first half, when summer gave us our first dose of rising rates after taper fears hit. But, strangely, the actual taper itself in December just tapped rates up a little (ending the year at 3%)—apparently, we’re used to the taper idea now. While difficult years in fixed income have historically been nowhere near the magnitude of bad stock market years, periods of rising rates can either sharply nip capital or slowly erode it over weeks and months—keeping the need for shorter durations intact. In fact, these may need to be kept intact for a while with such low yields—as there isn’t the usual buffer of higher coupons to help offset damage as we had in many prior periods.

Real estate inched higher by roughly a half-percent, so was non-correlated to equities on the week (albeit similar performing to financial stocks as a whole). Mortgage REITs were the best performers, followed by industrial/office, while Asian and European names lagged with negative returns—again in keeping with dollar weakness.

Commodities were roughly 2-4% lower on the week, depending on which index is being considered. The biggest culprit was a 5% drop in crude oil, presumably due to a stronger dollar and increased concerns about additional Fed tapering with stronger recent economic data, but also due to a Libyan oilfield coming back online. As we’ve noted previously, oil is a complex and finicky product. While (long) commodity traders and oil companies balk at sharply lower crude prices (the former for obvious reasons and the latter due to tighter ground-to-bottom line spreads), lower crude prices provide their own economic relief and a form of tax reduction to end consumers. On the more positive side on the week, gold prices rebounded a few percent on the week, following the media reminders of how ‘cheap’ the asset was after a terrible 2013 (down -30%).

Commodities have certainly been in the doghouse over the past few years, causing some to question their continued relevance in asset allocation portfolios. This often happens when an asset has underperformed for some time and sentiment plummets to a trough (measured by cash flows, and qualitatively, by the number of scathing articles). While expectations of a new commodity supercycle may be farfetched, there is an ‘insurance’ component to the commodities complex that plays an important role: as a hedge against inflation as well as geopolitical turmoil.

Have a great week – and Happy New Year!

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