Download August 12, 2016

In the markets:
U.S. stocks were mixed and little changed last week as the Dow Jones Industrial Average, the S&P 500,
and the Nasdaq Composite all posted new all-time highs during the week, but MidCap and SmallCap
indexes were slightly lower. For the week, the Dow Jones Industrial Average added a modest +32 points
to end the week at 18,576. The LargeCap S&P 500 also finished with a very slight gain of +0.05%. The
NASDAQ Composite rose +11 points to 5,232, up +0.23%. MidCaps and SmallCaps, which have been the
biggest gainers year-to-date, finished slightly in the red. The S&P 400 MidCap index gave up -0.31% and
the SmallCap Russell 2000 finished down a slight -0.12%.
International markets had a strong week compared to the U.S., as almost all major indexes finished in
the green. Canada’s TSX rose +0.67%. In Europe, the United Kingdom’s FTSE rallied another +1.8%. The
UK’s FTSE has risen 7 out of the past 8 weeks and is once again nearing all-time highs. Proving once
again that predictions are futile, economists from major institutions and think tanks worldwide had
predicted that the “Brexit” vote would plunge the United Kingdom into economic chaos and a certain
depression. On Europe’s mainland, Germany’s DAX rallied +3.34%, France’s CAC 40 was up +2.03%, and
Italy’s Milan FTSE added +2.23%. In Asia, China’s Shanghai Stock Exchange added +2.49%, ending 3
weeks of losses. Japan’s Nikkei was the big winner, up over +4% last week, and Hong Kong’s Hang Seng
Index rose 2.8%. As a group, Developed International markets rose +1.8% (EFA), and Emerging Markets
rose +2.4% (EEM).
In commodities, precious metals had a second down week with Gold giving up -$1.20 to close at
$1,343.20 an ounce. Silver, almost always more volatile, was also down a second week, giving up -0.58%
to end the week at $19.70 an ounce. The industrial metal copper was also negative, losing -0.65%.
Energy had a strong week, adding to gains from the prior week as West Texas Intermediate crude oil
rallied over +6.4% to $44.49 a barrel.
In U.S. economic news, the Labor Department’s Job Openings and Labor Turnover Survey (known by the
amusing acronym “JOLTS”) indicated the job market remains resilient. Job openings and hiring
increased as the JOLTS report showed there were 5.62 million job openings in June, up from 5.51 million
in May. In addition, there were 5.13 million people hired during the month, up 80,000 from May. In the
Labor Department’s Weekly Jobless Claims report, the number of people filing for unemployment
benefits declined by -1,000 to a seasonally adjusted 266,000 for the first week of August. Initial claims
have held below the key 300,000 threshold for 75 weeks in a row, the longest streak since 1970.
Economists had forecasted a decline of- 2,000. The smoothed 4 week average of claims rose slightly to
262,750. Continuing claims, those people already receiving benefits rose by 14,000 to 2.16 million.
Sentiment among small-business owners managed a slight gain according to the National Federation of
Independent Business (NFIB). However, the NFIB confidence index still remains below its long-term
average, despite rising for the fourth straight month. The NFIB optimism index rose +0.1 point to 94.6,
beating analyst expectations of a flat reading. Last month, 4 of the 10 NFIB indexes rose, while 4
declined, and 2 were unchanged. In its statement, the NFIB stated that, “small businesses continue to
be in maintenance mode-- meaning owners won’t increase spending.”
Retail sales in the U.S. paused in July after three straight months of gains the Commerce Department
reported. Sales were essentially flat after a gain of +0.8% in June. Economists had expected growth of
+0.4% for July. Auto sales were up +1.1% in July, the strongest since April. However, removing auto
sales, retail sales were actually down -0.3% - the weakest reading since January. Retail sales are a key
element of consumer spending, which is the backbone of the U.S. economy. On an annualized basis,
retail sales are up +2.3% over the past 12 months. Ian Shepherdson, Chief Economist at Pantheon
Macroeconomics stated “retail sales were disappointing, but not disastrous”. Amazon and other
Internet-only retailers saw a gain of +1.3%, while Macy’s announced the closing of 100 stores.
Productivity declined for the third straight quarter, according to data released by the Labor Department.
In the second quarter, productivity fell -0.5%, well below expectations. Economists had forecast a +0.3%
gain. Annualized, productivity is down -0.4% for the trailing year, the first year-over-year decline since
mid-2013. Productivity measures how much an employee produces per hour of work. Higher
productivity is linked to a rising standard of living for workers because it tends to lead to higher wages
and larger profits for companies. The long-term rate of productivity increase has traditionally been
+2.2% per year.
The Labor Department reported that the price of imports to the U.S. rose for a fifth straight month, up
+0.1% in July. Higher costs of imported goods theoretically should support a rise in inflation, which has
remained below the Federal Reserve’s targeted level for years. Even with July’s rise, however, the cost
of imports is still -3.7% lower than a year ago. Export prices increased +0.2% last month, the fourth
consecutive rise, but remain -3% lower than this time last year.
In Canada, a CIBC economist warned that intervention into two of Canada’s hottest housing markets
could interfere with economic growth. Canada’s economy is facing difficult headwinds, but two bright
spots remain the Vancouver and Toronto housing markets. In a research note, CIBC Chief Economist
Avery Shenfeld said cracking down on the sector, which accounts for the largest portion of domestic
GDP, could smother the little economic growth there is. “Interest rate hikes or much tougher mortgage
policies could put a damper on house prices, but at the expense of economic growth,” he stated.
In the United Kingdom, fears of the consequences of the UK leaving the European Union appear to have
been hugely overblown, as retail spending rebounded +1.9% in July. The increase was the biggest rise in
6 months and up sharply from the +0.2% increase in June.
In Germany, economic growth flattened in the second quarter of the year, sparking fears that Europe’s
largest economy may be running out of steam. GDP grew by just +0.4% in the 2nd quarter, down sharply
from the 1st quarter’s +0.7% gain. Investment in construction and machinery was particularly weak. The
headline reading was supported by higher exports and strong state spending.
The latest Italian GDP readings show that the economy is also stagnant, with 0% growth in the 2nd
quarter following a +0.3% rise in the 1st. Italian Prime Minister Mario Renzi is battling to reduce bad
debt in Italy’s banking sector, which is currently carrying approximately 360 billion euro worth of bad
loans. Alberto Bagnai, economic policy professor at the University of Chieti-Pescara said, “There is no
way to solve the banking problem without economic growth. If the whole nation doesn’t start earning
more it simply can’t pay back its debts—public or private.”
Fresh Chinese economic data added to a multitude of other metrics that suggests the world’s second
largest economy is weakening. Both industrial output and retail sales fell short of expectations for the
month of July. A spokesman for China’s National Statistics Bureau said that the country’s economy was
still in a period of adjustment and is facing downward pressure.
Finally, the folklore of the markets has always been that complacency in the markets is bad news, as it is
thought to precede substantial declines. One way to measure complacency is by measuring fear, on the
theory that fear is the opposite of complacency. A widely followed “fear gauge” is the Chicago Board
Options Exchange Volatility Index, known as “VIX”, which measures the activity of “put” and “call”
option buying/selling. Nervous and fearful investors buy lots of puts for downside protection, which
results in the VIX going higher – thus the moniker “fear gauge”.
As many of the market’s indexes hit new highs last week the VIX dropped to an extremely low 11.18,
suggesting investors are very complacent. Many investors have become alarmed at the low VIX
readings, believing that the absence of fear is a very bad sign. However, researchers at the National
Bureau of Economic Research (reported by Mark Hulbert at marketwatch.com) decided to dig deeper
into historical data to see if that interpretation was correct. What they found was that the stock
market’s performance following low “complacent” VIX readings is no worse, on average, than it is after
higher readings. Perhaps another piece of Wall Street folklore can be consigned to the crowded
category of “sounds good, but isn’t true!”
(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com,
ft.com, guggenheimpartners.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics
Canada, Yahoo! Finance, stocksandnews.com, marketwatch.com, wantchinatimes.com, BBC,
361capital.com, pensionpartners.com, cnbc.com, FactSet; Figs 1-5 source W E Sherman & Co, LLC)