Market Noise: Lowering the Volume for Summer

Observations on the Capital Markets – Week Ended June 27, 2014

Summer, summer, summertime – time to sit back and unwind. The Fresh Prince and DJ Jazzy Jeff might have been talking about the quiet tone last week in the capital markets.

  • Can you spell Goldilocks? Stocks, bonds, and commodities all rallied in the first half of 2014…for the first time since 1993.
  • Currencies: The Euro and Yen each rose 0.5%-1% against the dollar, extending their gains for the month.
  • Bonds: The 10-year Treasury yield fell 9 basis points (bps) to 2.54%; the 10-year TIP yield fell 8 bps to 0.27%.The Bank of America Merrill Lynch High Yield Index (BoAML HY) widened 1 bp to 3.48%. The Japanese 10-year bond fell to 0.55%, a 2014 low. Eurozone bond markets were generally quiet.
  • Equities: The S&P 500 Index declined almost imperceptibly last week. Within the index, Utilities and Consumer Discretionary (each up 1.0%) led; media companies rallied when the Supreme Court effectively shut down Aereo. Industrials (-1.7%) lagged; Consumer Staples (-1.3%) and Energy (-0.9%) were also weak. MSCI Europe and Japan were each down 1.5-2%. The MSCI Emerging Markets Index was down a bit.
  • Commodities: WTI Oil was down about $1 (1%)…still not really reacting to Iraq. Gold, up 3% last week, gained another $5 (0.5%).

Q1 GDP shocks were likely transitory.

  • 1.2 percentage points of the 1.9 point reduction (from -1.0 to -2.9) is attributable to actual health-care spending declining 1.4%, instead of rising 9.1% as earlier estimated.
  • Inventory shrinkage contributed -1.7% of the -2.9. Inventories are mean-reverting.
  • Consumer spending contributed only 0.7%, more than a full point below its normal contribution. With incomes and employment fine, the most likely explanation is higher savings (perhaps because weather kept them from the mall?). In time, spending follows incomes, so I expect spending to recover.
  • Lower exports (a possible symptom of a weaker global economy and thus genuinely worrying) contributed -1.3%. The downward revision in exports adds to the concern about global demand.

Most other economic data says we’re still in the Goldilocks zone.

  • Initial unemployment claims (312k) stayed low…there’s no hint of weakness in this data series.
  • The Conference Board consumer confidence index rose to 85.2, a new recovery high, but still closer to worried than to irrationally exuberant. The University of Michigan consumer sentiment ticked up to (a still modest) 82.5.
  • Personal income rose 0.4% in May after a 0.3% April increase. Private sector wage income is up 4.3% y/y (average hourly earnings are up 2.1%, and there are more people working).
  • Spending rose less than income, up only 0.2%. I’m not troubled: I like it when consumers save—that’s the fuel for future consumption. Borrowing to fund spending is what causes problems.
  • Inflation is rising, but still in the Fed’s comfort zone (especially since we know the Fed will be patient). Core PCE inflation (the Fed’s favorite) ticked up to 1.5% y/y, headline to 1.8% y/y.
  • The Markit U.S. flash manufacturing PMI rose to 57.5 in June from 56.4 in May, boosted by rising new orders and backlogs.
  • Durable goods orders (a volatile series) were weaker than expected in May, pulled down most by defense orders; non-aircraft/non-defense orders were ok/so-so.

Housing: improving activity, decelerating price appreciation.

  • New home sales surprised on the upside, rising to a 504k SAAR. Inventories remain tight (which bodes well for construction activity over the summer).
  • Existing home sales rose to a 4.89 million SAAR in May, above consensus and the highest level since October 2013…but still down 5% y/y.
  • The median existing home sale price ($213,400) was up 5.1% y/y. The share of sales which were distressed (foreclosures and short-sales) fell from 18% a year ago to 11%, a new cycle low. All-cash deals still represent 32% of sales.

Japanese CPI hits 3.7% y/y…but even at full employment, it’s not wage inflation.

  • That’s the reality (loss of the Yen’s purchasing power) consumers experienced. More than half was the tax increase, though. Energy prices are up a lot too.
  • The unemployment rate fell to 3.5%, the lowest since 1997. There are more job openings than unemployed workers.
  • Abe unveiled a further package of structural reforms. The market didn’t really react…key details had been leaked and the program wasn’t all that aggressive. The stock market was down despite Abe’s proposing a cut in the corporate tax rate.

China: a positive data point, another warning.

  • The HSBC Markit Flash China Manufacturing PMI rose to 50.8, its first reading above 50 in six months and its highest since November 2013.
  • Authorities flagged gold being pledged multiple times as collateral for loans…if the collateral isn’t all there, the banking system has a systemic risk (financial stability) problem.

Ukraine: not fixed, but off page 1 for the moment.

  • A dovish move by Putin (at his request, the Russian parliament rescinded its authorization for him to order troops into the Ukraine) reduced the risk of further sanctions.
  • Ukraine signed a free trade with the EU.

Europe: war risks fall, but PMI disappoints.

  • The composite Markit Flash Eurozone PMI (51.9) was above 50 for the twelfth consecutive month, but is trending down. Output prices fell for the 27th consecutive month (the deflationary consequence of weak demand). France continues to look weak.
  • German business confidence (IFO survey) continues to trend lower on Ukraine/Iraq fears.
  • The Bank of England, concerned about London house price bubble risks (up almost 20% y/y), took further tightened lending standards.


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About Sam Wardwell

Sam Wardwell, CFA, is Senior Vice President and Investment Strategist at Pioneer Investments. He joined Pioneer in 2003.
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