By Nottingham Advisors
One of the few economic highlights of August can usually be found at the Kansas City Fed’s annual symposium held in Jackson Hole, WY.
Central bankers from around the world gather for a few days to discuss monetary policy, economics, politics and fishing. Beautiful scenery aside, this idyllic mountain retreat has on occasion been the source of a fair amount of market volatility, as Fed officials make pronouncements amidst half-empty trading desks and decidedly junior staff.
This year, however, proved tame as the fireworks were few and bankers did their best to stay on script. The good news is that there was more positive than negative news to discuss.
Nonfarm payrolls in the US rose 209k in July (estimates were for an increase of 180k) as the unemployment rate dropped from 4.4% to 4.3%. Average Hourly Earnings rose a robust 0.3% MoM and are up 2.5% YoY, slightly ahead of expectations. The Underemployment Rate held steady at 8.6% while the JOLTS Job Openings survey for June showed the highest reading since the BLS began collecting data in 2000.
GDP estimates for the second quarter were revised up from a prior reading of 2.7% to 3.0%, with personal consumption leading the way with a 3.3% increase. Personal Income for July rose 0.4% MoM, beating estimates and strongly above June’s reading of 0.0%. Personal Spending surged 0.3% after ticking up just 0.1% in June.
Certainly the Fed’s reluctance to pursue interest rate hikes too agressively stems from the profound absence of consumer price inflation in today’s economy. The PCE Deflator in July rose 1.4% YoY while the Core PCE measure rose just 0.1% MoM (1.4% YoY). Top line CPI rose just 0.1% MoM while Producer Prices actually declined -0.1% last month. Core CPI edged up 0.1% while core PPI fell -0.1%. As we’ve suggested in these pages before, outside of asset price inflation, prices for goods and services remain well within reason and give the Fed ample cover to delay, or continue their measured approach to raising short term interest rates.
It would seem to us that the global economy is experiencing something of a synchronized economic upswing. Low interest rates around the globe, soft commodity prices and rising equity markets have triggered animal spirits which it would appear are driving a sustainable increase in consumerism.
Domestic Equity Investing Update
U.S. equities stumbled a bit in August as the so-called “Trump-trade” continued to unwind.
Small-caps, which had surged following Trump’s election on the belief that they would be the greatest beneficiaries of tax-reform, infrastructure spending and deregulation, have given back
nearly 5% versus their large-cap brethren over the past few weeks. The S&P 600 Small Cap Index declined -2.56% in August while the S&P 500 gained 0.31%. Mid-caps roughly split the
difference with the S&P 400 Midcap Index falling -1.53% on the month. Year-to-date, large-caps continue to lead the way, up 11.9% thru 8/31, while mid-caps have gained 5.3% and small-caps
Growth-stocks continued to distance themselves from their value counterparts as the S&P 500 Growth Index gained 1.48% in August while the S&P 500 Value Index fell -1.16%. Year-to-date in
2017 Growth is up 18.0% while Value has gained just 5.0%. Given that the top 5 holdings in the cap-weighted Growth index are Apple (up 42% YTD), Microsoft (up 19%), Facebook (up 50%),
Amazon (up 30%) and Google (up 21%), it’s clear the outperformance is being driven by a select few mega-cap stocks, rather than the broader growth space.
At the sector level, Information Technology led the way again, climbing 3.47% on the month and is now up 26.6% YTD. Utilities posted a solid 3.25% gain in August, benefitting from a drop in
interest rates, which also aided the Real Estate sector which rose 1.14% for the month. The biggest decliner in August was the volatile Energy space, which dipped -5.18%, and is now down
-15.0% YTD. Telecom, Financials, Consumer Discretionary and Staples all saw declines in August as the continued market advance gets more and more narrow.
International Equity Investing Update
International equities posted mixed results in August, hardly surprising given little news flow and the extended vacation time many foreign countries avail themselves of in the summer months.
As ECB head Mario Draghi sets the stage for the eventual end to quantitative easing efforts in Europe, the Bank of Japan appears to remain fully committed to highly accommodative monetary policy, with no end in sight.
The broad MSCI All-country World Index gained 0.44% in August and is up 15.49% YTD in US Dollar terms.
The MSCI EAFE index remained flat in August while the MSCI EM index gained 2.3% on the month. With the US Dollar having fallen nearly -10% year to date versus a basket of international currencies, exposures to foreign markets have been amply rewarded. Whereas London’s FTSE 100 is down -3.0% YTD for a Eurobased investor, it has returned 9.3% to a US Dollar based holder. Likewise, whereas an investor in continental Europe has seen a 4.8% return thus far in 2017 on the Euro Stoxx 50 Index, a US Dollar based investor has gained over 18.0%!
Japan’s Nikkei 225 Index remains relatively cheap versus it’s 10-year average on a Price-to-earnings ratio basis. So far in 2017, it has returned just 3.0% in local currency terms; however for a US Dollar-based investor, the Nikkei has gained 9.2%. A continued commitment to the principles of Abenomics, including robust quantitative easing, should provide a long lasting tailwind to the Japanese economy. Recent inflation reports in Japan showed consumer prices rising 0.4% YoY in July, a seemingly underwhelming number but after years of battling deflation, this 4th consecutive reading of rising prices is promising.
Emerging markets continue to win back investors after years of lagging developed markets. The MSCI EM Index has gained 28.5% thru 8/31, as continued low interest rates in the US along with a weakening US Dollar have improved the outlook for many EM economies. China, as usual, remains the key to the region; however, YTD the Shanghai Composite is up 10.4% and fears over bad debts and a housing bubble have yet proven unfounded.
Fixed Income Investing Update
Bond investors were better buyers in August as softening US economic data, an increasingly benign Fed, and little to no consumer price inflation combined to spur the latest chase for yield. The broad ML US Treasury/Agency Master Index gained 1.11% in August as the yield on the 10-year US Treasury fell from 2.25% to 2.12%. Fears over the potential for a hawkish speech by Janet Yellen at the annual August Jackson Hole Symposium went unrealized as she spent most of her prepared remarks defending the work of the Federal Reserve and policymakers following the collapse of the credit bubble.
Risk-on in debt markets took divergent paths in August with bond investors actively seeking returns in the EM space while at the same time cooling on US high yield. The ML USD Emerging Market Sovereign & Credit Index surged 1.7% on the month, and is now up 8.9% YTD. The ML US High Yield Master II Index fell -0.03%, yet remains up a solid 6.09% for the year. US high yield spreads over Treasuries did widen out almost 25 bps in August after touching a 3-year low of +368 in late July. Along with tighter spreads, we have seen the continued deterioration in investor protections with the vast majority of high yield debt now being issued along cov-lite lines. As taxable high-yield investors have pulled back, we’ve seen increased interest in tax-exempt high-yield, with the ML Municipal High Yield Index rising 1.4% in August, for a 5.31% YTD gain.
Despite a 13 bps pullback in the spread over Treasuries on investment-grade debt, the ML US Corporate Master Index gained 0.85% on the month and is up over 5.5% YTD. Demand for investment-grade bonds remains robust across the board and despite the continuation of heavy issuance (Amazon floated $16 billion in August to help fund the Whole Foods acquisition and the deal was met with $47 billion in investor interest), the relative attractiveness of US yields versus those available in the eurozone and Japan has spurred investor demand.
The odds for a December rate hike currently stand at 34% according to the futures market. Todays somewhat underwhelming employment report for August, along with meager inflation data, has reduced the likelihood that the Fed will feel any sense of urgency around the timing of its next rate hike.
Alternative Investments Update
Trepidation around the devastating impact Hurricane Harvey is having on the Texas Gulf Coast has roiled energy markets and injected a fair amount of uncertainty into the forward curve. The immediate impact of Harvey, beyond the human toll, has been a drop in oil prices as crude stockpiles increase, unable to find their way to the massive refineries currently closed by the storm. At the same time, gasoline prices are surging as shortfalls are anticipated until production can come back online.
At the end of the day, however, prices will adjust sooner rather than later while the unfortunate human impact of Harvey will likely linger for some time.
Oil prices fell nearly -9% in August with much of that decline coming pre-hurricane. The US continues to be buffeted (blessed?) with an abundance of oil and gas, and the net impact of increased exports is only starting to be felt. Brent crude declined only -3.7% on the month as global demand for petroleum products remains robust.
NYMEX Gasoline prices surged nearly 14% in August, mostly on the heels of Hurricane Harvey. At the distribution level, MLP’s suffered broad declines with MLPA, the Global X MLP ETF falling -7.2% in August.
The price of gold rose 4.3% in August, as interest rates declined and geopolitical risk heightened. North Korea’s provocative missile launches have global investors seeking some sort of hedge against a scaling up of tensions on the Korean peninsula. Metals in general rose in August as solid demand around the globe has driven prices of everything including copper (+6.5% in Aug), aluminum (+10.3%), palladium (+8.9%) and platinum (+7.05%) higher.
Hedge funds stabilized a bit in August despite mixed results. Year to date, Event-driven and Convertible Arbitrage have “outperformed”, returning 5.4% and 5.1% respectively, versus the 11.9% return for the S&P 500. Most of the other hedge fund strategies have realized returns more consistent with the fixed income markets, perhaps offering investors risk diversification away from traditional long equity portfolios. A glance at the 5-yr number column, however, should cause most rational investors to scratch their heads and at least contemplate whether there’s a cheaper way to earn returns in the low single digits.
This article was written by Nottingham Advisors, a participant in the ETF Strategist Channel.