Economic Notes – May 12, 2014


Written by: Jon McGraw

  • It was a slow week for economic news, but a few pieces came out positively. Janet Yellen’s congressional testimony was also benign and dovish—alluding to at least another year of easy monetary conditions.
  • Equity markets were generally flattish on the week, although a trend of large-cap outperforming small-cap names has continued, in line with valuation differences between the two.

(+) The ISM Nonmanufacturing index of service sector economic activity showed more improvement than expected for April, rising from 53.1 to 55.2 for the month (consensus called for a 54.0 reading). Business activity and new orders were several points higher, while the employment gauge lost a few points. The inventory change index was up strongly, but ‘inventory sentiment’ pointed to some opinions of too much inventory being in stock. Other anecdotes in the report appeared to be more positive than negative as spring activity picks up.

(0) The March trade balance came in similar to the expected -$40.0 bil., at -$40.4 bil. This was a narrowing from last month’s -$41.9 bil., mostly due to tighter petroleum balances, while everything other than petroleum widened a bit. Exports rose just over +2%, surpassing the +1% gain in imports (a large amount of the import dollar gain was from food/beverages, which is likely agricultural-price related).

(-) Nonfarm productivity for the first quarter fell -1.7%, lagging the consensus expected decline of -1.2%. The year-over-year increase was +1.4%. Unit labor costs rose +4.2% for the quarter (+0.9% year-over-year), which outgained expectations of a +2.8% increase—with productivity considered, that equates to a +2.4% gain in hourly compensation. These is naturally something we watch for inflation pressures, but they remain subdued for now.

(+) Wholesale inventories rose +1.1% in March, which was about double the forecasted increase and, as such, was a positive revision contributor to the first quarter’s GDP (it was needed). Both durable and nondurable inventories were higher, but the latter by a higher rate, mostly in groceries (related to recent food price spikes).

(0) The Fed’s quarterly Senior Loan Officer Opinion Survey showed a continued loosening of credit conditions in commercial & industrial as well as commercial real estate loans. A positive sign is that credit availability for smaller firms has lately outpaced that of larger firms, which is in line with better economic growth and what you’d expect to see as the cycle matures. Loan demand has also picked up, although at slower pace than last quarter. Demand on the real estate side has risen in all areas—construction/land development, multi-family residential, non-farm non-residential, etc. Consumer credit card and auto loan availability appeared positive, and demand a bit higher.

At the same time, mortgage loan demand has fallen somewhat, while credit standards tightened a bit for prime loans and at a much faster rate on non-standard and sub-prime. That component is related to the higher loan rates, which can play a role in weaker home sales figures, but isn’t a simple story just by itself. Per Freddie Mac, 30-year fixed rates have risen from 3.45% last April to 4.34% last month (the 10-year Treasury rates these roughly track, plus a spread, moved up from 1.7% to 2.7% over that same timeframe). What folks may be doing is locking in today’s low rates with the expectation of rates rising tomorrow, and the more that’s done, the less of it needs to be done as time goes on. There is also a tapering off of foreclosure and ‘investor’ demand that drove early recovery returns in housing as that effect looks to have become more saturated. Five years after the financial crisis, foreclosure inventory is far reduced from where it started out and opportunities for sharp home price recoveries appear lessened, so demand from that end has dropped.

(-) The government JOLTs report for March fell from 4,125k to 4,014k, but remained at a fairly high level from the perspective of readings seen during the recovery. The hiring and quit rates were revised upward a tenth each last month from the original figures, but for March, remained unchanged at 3.4% and 1.8%, respectively, and are depressed compared to what you’d expect to see at this stage. Everyone is watching the latter two more closely since Yellen has commented on them. The layoff rate, which has been at 1.2% all year so far, is the lowest in the series’ history (albeit just over a decade).

(+) Initial jobless claims for the May 3 ending week fell a bit from 345k to 319k—better than the 325k estimate. No special factors appeared to alter results, in contrast to the prior week. Continuing claims for the Apr. 26 week fell to 2,685k, lower than the 2,758k expected, and again reaching a low point in the post-recession cycle.

Speaking of Yellen, she spoke to the Joint Economic Committee to provide an update on conditions (yeah, this is the same May meeting where last year Bernanke hinted at the ‘taper,’ and spooked all interest-rate sensitive markets). Her comments were no doubt carefully orchestrated and were tinged with a dovish pro-stimulus tone. Despite acknowledging economic data improvement; other areas, such as housing and employment slack, she expressed less enthusiasm. Similarly, when asked about rate increases, it was ‘2015-2016,’ which leaves plenty of room for leeway.

Market Notes

Stocks experienced a generally uneventful week, with the S&P ending just slightly lower and the Dow reaching a new all-time high, with no major economic releases or high-profile earnings reports to excite or depress investors. From a sector standpoint, consumer staples and materials were strongest, while technology and consumer discretionary lagged. The biggest news seemed to be Apple in the market to buy a company that makes headphones. Small caps lost ground relative to large caps, continuing the trend of higher momentum and higher-valued issues falling off. Perhaps the overvaluation that we and many others (including some small-cap PMs we speak with and even Yellen during her Q&A last week) recognize the lessened opportunities there. From a sentiment standpoint, Lipper noted that last week was the 18th straight positive week for U.S. equities in terms of cash inflows ($1.6 billion for the week).

In foreign markets, the U.K. was up slightly, while Europe and Japan fell by a few basis points. Emerging market fared better, led by Russia, India and Turkey, while China dropped a few percent again, in line with estimates of private manufacturing activity there in April falling below 50 for the fourth month in a row. Political tension in Thailand also affected values in that part of the world.

Bonds were mixed, with Treasury rates sharply higher on the long-end, and lower in the 3-7 year belly of the curve, so most long bond indexes lost a percent or so on the week while other maturities weren’t as affected. The 10-year Treasury hit its lowest point in six months with continued Ukrainian stresses early in the week, lukewarm economic data and Yellen’s easing bias comments, but began to reverse later in the week. Rates remain low on a ‘real’ basis (considering year-over-year inflation levels of 1.5% and a Fed target of 2%) compared to history and this pressure continues.

Foreign bonds performed better than U.S. debt on the week, despite a stronger dollar. The ECB met this week, and the decision was no action. However, in the midst of very low growth and inflation pressures so low they border on deflation, Draghi suggested that policy may involve some easing in the next and forthcoming meetings and that caused sovereign rates to drop. Emerging market bonds rallied bit on eased Eastern European concerns and a few country upgrades.

Real estate was generally positive, led by European names and U.S. residential and retail. Asian REITs were negative, along with U.S. mortgage REITs as long interest rates moved higher.

Commodity markets were about a percent lower on the week. Nickel was the large gainer, almost up 10% the Indonesian government’s refusal to repeal an export limit of the unrefined metal—spooking global markets (the metal is up 15% in April, and over 40% year-to-date). Then again, it’s only 2% of the DJ-UBS index and less of the GSCI, so these idiosyncratic moves have more newsworthy impact than they do financial (at least in a direct sense). Wheat was also up a bit, as was crude oil slightly. Natural gas and coffee corrected by sizable amounts. However, the DJ-UBS remains up 8% year-to-date, making this one of the best places to be in 2014 so far.

Have a great week!

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