Economic Notes – July 15, 2013


Written by: Jon McGraw

(-) Wholesale inventories came in weaker than expected for May, falling -0.5% versus an anticipated gain of +0.3%. Auto inventories were flat (in contrast to making positive contributions in recent months), while machinery and nondurable goods fell nearly a percent each. The inventory-to-sales ratio declined to its lowest level in the last year, which is not necessarily a bad thing—and represents either sales rising (which they have been) and inventory build-up remaining tempered and not overshooting demand.

(0) Producer price inflation (PPI) for June rose +0.8%, compared to a forecast of +0.5% (taking the year-over-year headline number to +2.5%). The core component of the index sans energy and food rose +0.16%, which just surpassed the expected +0.1% (+1.7% year-over year). The headline number was dictated by a +7% rise in seasonally-adjusted retail gasoline prices, while auto prices rising +1% underpinned core inflation results. While a bit higher than in previous months as of late, these price measures remain contained.

(0) Import prices fell -0.2% for June, relative to a forecast of no change, making this the fourth straight month of declines. The key areas of consumer and capital goods both declined slightly in keeping with the broader number; the primary factor appeared to be a substantial drop in prices from Japanese imports due to a weaker yen.

(-) The University of Michigan consumer sentiment survey fell from the final June number of 84.1 to 83.9 in July (compared to consensus expectations of 84.7), but remained near post-recession highs. Consumer assessments of current conditions improved quite a bit; however, future expectations deteriorated. Underlying these thoughts, three-quarters of consumers now believe interest rates will rise over the next year (previously, only half thought so), which may play a factor in consumer home buying before rates are expected to rise—according to anecdotal comments from the survey, as well as what makes logical sense from an economic standpoint. Inflation expectations for the coming year ticked up to 3.3%, which is just above the long-term 3% baseline, but expectations for the longer-term beyond one year stayed around that median. We look at this because ‘inflation expectations’ can be an important, yet sporadic, predictor of consumer behavior.

(-) The NFIB small business optimism survey ticked down from 94.4 in May to 93.5 in June, compared to a forecasted 94.9 result. Declines were seen across the board, through decreased plans to increase inventories and lower expectations for sales; however, expectations for increasing employment rose. While the survey level is back to where it was before the drop late last year, it still remains below the high of the last business cycle recovery. Business owners noted an increase in loan interest rates over recent months, while credit availability was little changed.

(+) The government JOLTs report rose to 3,828k in May, which surpassed the forecasted 3,800k figure by a bit. In the report’s detail, job openings remain high relative to the overall level of employment. The hiring rate edged up slightly, but continues to hover at a low level. The quit and layoff/discharge rates were unchanged, and near normal.

(-/0) Initial jobless claims for the July 6 week jumped to 360k—higher than the consensus call for 340k. However, much of this looks to be due to July seasonal adjustment factors related to summer auto plant retoolings that are especially difficult for Labor Department to model. Continuing claims for the June 29 week came in at 2,977k, which was a bit higher than the 2,955k expected, and were little changed from the prior week. These are now consistently coming in at below the 3,000k range.

(0) Despite the controversial ‘taper talk’ after the meeting, the June FOMC minutes were not of much help in providing any additional information about the Fed’s intentions. These days, in an era of increased Fed transparency, changes to a single descriptive word in the post-meeting Fed statement can move markets.

During the meeting, it seemed participants were torn about how much communication to share regarding the idea of ‘tapering’ (clearly, in hindsight, concerns about market reactions were valid), in order to preserve Fed flexibility in tapering purchase up or down as needed to react to economic and employment conditions. Roughly half of participants (not all voting members) felt that ending purchases this year made sense, while the other portion (including Bernanke and other leading members, most likely) felt 2014 was a more appropriate ending point based on current data. So, the membership itself is split about how much QE continues to be needed. That question is regarding the QE tapering issue only.

When we look at potential outcomes for actual Fed Funds rate increases, the timeline is significantly further out (as in several years) unless conditions strengthen much more quickly and significantly than seen in recent quarters. To do so implies putting the ‘brakes’ on a fast-heating economy—something we seem to be far from needing at this point, anyway. In a separate speech to the NBER last week, Bernanke reiterated the same message, in that accommodation will be needed for some time yet and that the 6.5% unemployment rate itself (communicated previously as a target) may not be the sole measure of labor market improvement. Bottom line: despite the need for an end to QE at some point, the Fed is balancing a need for transparency with flexibility. In doing so, expect its communication program to be adjusted accordingly.

Market Notes

The S&P 500 and Russell 2000 hit new all-time highs in the week, as Ben Bernanke’s soothing follow-up words to the short ‘taper talk’ correction helped sentiment. All S&P sectors were up 2-4% generally on the week; more defensive utilities and consumer staples outperformed, while technology and energy lagged by the most significant amounts. In recent weeks, small caps have performed better with domestic economic data looking stronger more consistently.

What does earnings season hold for the second quarter? Consensus forecasted earnings growth for the quarter is 2%, which could take the full-year growth number to over 10% if the third and fourth quarters gain the traction they are expected to. Revenues are again forecasted to disappoint. Several leading indicators such as architectural billings, box orders, truck tonnage and light vehicle sales results bode positively for potential upward revisions on the quarter. However, multi-nationals have been hit by a strong dollar and weakness from foreign markets (especially emerging markets) has added to negative pressures.

Last week in foreign markets, Germany gained 6%, followed by strong results among the Scandinavian nations, but almost all foreign stocks were higher with stronger sentiment from the U.S. and Japan. While still positive, Italian and Spanish stocks lagged as the former was downgraded from BBB+ to BBB by S&P and the latter was plagued by continued political turmoil (now over alleged texts from the Spanish PM about an illegal slush fund). The U.K. and ECB elected to keep rates as they are and Japan declined to add further fuel to their already-large monetary stimulus. The ECB did decide to provide an additional €3 billion in additional aid to Greece, despite questions about how quickly desired reforms there are taking shape.

In emerging markets, Brazil’s central bank raised its benchmark interest rate from 8.0% to 8.5%. The decline in the Real has led to higher inflation, and this is the tool to combat that—although economic growth has also slowed, making a more restrictive monetary policy a difficult choice. The combination has been a catalyst for poor market performance in that leading member of the Latin American market segment. In China, exports dropped by 3% last month compared to a year ago, which was attributed to both weak global demand and rising labor and foreign exchange costs. Chinese GDP has also fallen to ‘only’ 7.5% for the second quarter after 7.7% in the first.

These and other headwinds have resulted in difficulty in emerging markets; however, valuations reflect this (EM stocks are arguably the cheapest asset in the world from an asset allocation standpoint). The blog from the manager of Oppenheimer Developing Markets Fund captures the situation briefly but well, and is worth a read. –>

Bonds have been through a lot lately, but experienced a respite last week as rates declined. High yield, international developed market bonds (in spite of Italy’s downgrade) and munis experienced the strongest returns, at over 2%. Investment-grade corporates and other long Treasuries also gained ground, based on the duration effect. Short bonds and floating rate lagged, unsurprisingly.

In real estate, European REITs led, followed by a bounceback in mortgage REIT shares (which were pummeled during the recent spike in rates). U.S. industrial/office and retail also gained over 3%. Asian real estate were positive also, but only up over a percentage point.

Commodities were generally higher on the week, led by sharp rises in precious metals, unleaded gasoline and crude oil (with a decline in inventories and worries over Middle East supply disruptions), as well as a bit of a recovery in the grains area (wheat and corn). Softs like sugar and coffee were generally lower by a percent or two. The commodity asset class has struggled in recent quarters, no doubt about that. It’s been hit by several negative factors at one time, which has created the perfect negative storm. For one, we’ve seen an extreme pullback in precious metals prices this year as the usual factors that drive demand in gold and silver have been running in the opposite direction this year (like declining versus rising inflation fears, a stronger versus weaker dollar and fewer rather than more major geopolitical crises). Slow global growth prospects (led by emerging markets) have resulted in lower demand prospects for industrial metals and energy to some degree. And, to add insult to injury, better weather prospects (at least compared to recent years) have resulted in better crop supply estimates, which have caused the prices of some key agricultural commodities to plummet. Good for food costs, not so great for futures prices. As a final negative, actively managed collateral in the form of fixed income (any type other than T-bills) lost ground over the past few months with a broader sell-off in bonds.

As we do continually, we track our own performance versus competitors versus other options. Commodities remain one of the better long-term diversifiers in a general asset allocation portfolio, and correlations have generally been low to other more conventional asset classes. These correlations are certainly low now—stocks have been working while commodities haven’t. However, these types of events run in cycles. Should we see better global growth prospects, which often lead to higher inflation expectations, we may see better results from commodities, so, now, they perhaps fall in the ‘cheap’ camp.

In other unique news, the SEC voted to eliminate an 80-year old prohibition on advertising for public offerings (including hedge funds and like entities), which now allows much more leeway to such firms seeking investor capital although the accredited investor requirement remains in place. At the same time, felons and other ‘bad actors’ have been banned from involvement such offerings. It will be interesting to see how this changes the playing field and marketplace, if at all.

Have a great week!