Download December 16, 2016

In the markets:
The major U.S. indexes ended mixed for the week as the Dow Jones Industrial Average inched closer to
the 20,000 level. Large caps were roughly flat while smaller-cap indexes, which have outperformed
large caps this year, fell back. The Dow Jones Industrial Average gained +86 points to end the week at
19,843, up +0.44%. The NASDAQ Composite was essentially flat, down -7 points (-0.13%) to 5,437. The
LargeCap S&P 500 retreated just -1 point to 2,258, while the MidCap S&P 400 fell -1.49% and the Russell
2000 SmallCap index tumbled -1.7%. Transports and Utilities diverged, with Transports falling -2.5% and
Utilities tacked on a second week of gains rising +1.8%.
In international markets, Canada’s TSX retreated -0.4% from last week’s big gain. In Europe, the United
Kingdom’s FTSE tacked on a second week of gains, rising +0.8%. Across the Channel, France’s CAC 40
rose +1.45%, Germany’s DAX tacked on 1.79%, and Italy’s Milan FTSE was up a fourth straight week,
surging +3.95%. In Asia, China’s Shanghai Composite plunged -3.4% erasing all of its gains for the year.
In contrast, Japan’s Nikkei had its sixth straight week of gains rising -2.1%. Hong Kong’s Hang Seng also
had a difficult week, falling -3.25%. As a group, developed markets (as measured by the MSCI
Developed Markets Index) were down -1%, while emerging markets (as measured by the MSCI Emerging
Markets Index) posted a steeper -2.8% loss.
In commodities, the Commodity Research Bureau’s CRB Index fell a second straight week down -0.29%.
Gold fell for a 6th straight week, losing -$24.50 to close at $1,137.40 an ounce, down another -2.1%. As
expected, Silver was weak as well, losing -4.4% to $16.22 an ounce. Oil attempted to break out of the
relatively narrow trading range it has been in since May, rising +2.8% to $52.95 per barrel of West Texas
Intermediate crude oil.
In U.S. economic news, the number of Americans who applied for new unemployment benefits fell by 4,000 to 254,000 last week, indicating the extremely low level of layoffs taking place in the economy. In
addition, the number remains below the key 300,000 threshold that economists view as a healthy job
market. Initial claims fell under 300,000 early last year and have remained below that level for 93
straight weeks, the longest streak since 1970. Continuing jobless claims, those already receiving
benefits, rose 11,000 to 2.02 million in the week ended Dec. 3.
Sentiment among homebuilders soared to its highest level in 11 years as construction firms anticipated a
less regulatory environment under the new Republican president. The National Association of Home
Builders (NAHB) sentiment index surged to a reading of 70, the highest level since July 2005 and beating
expectations by 7 points. NAHB attributed the gain to a “post-election bounce” in its statement.
“Builders are hopeful that President-elect Trump will follow through on his pledge to cut burdensome
regulations that are harming small businesses and housing affordability.” All three of the index’s subgauges showed improvement in December. Current conditions jumped +7 points to 76, while
expectations for the upcoming 6 months rose +9 points to 78. Both of these measures were the highest
since 2005. Prospective buyer traffic rose +6 points to 53, the first time that index has risen above 50 in
more than 10 years. All readings over 50 indicate improvement.
Housing starts tumbled -18% in November, pulling away from the 9-year high set in October. Following
the +25.5% surge in October, homebuilding activity fell more than expected in November due to broad
weakness in construction activity. Groundbreaking on new housing projects dropped to a seasonally
adjusted annual rate of 1.09 million units, according to the Commerce Department. Last month’s
decline was the largest in almost 2 years as all four regions declined. Analysts had noted that the
number of permits had been lagging starts, so the drop in starts was widely anticipated. However,
following last month’s drop in groundbreaking activity, building permits are now leading starts, which is
a positive sign for the housing market.
Retail sales growth remained positive in November, but had its smallest gain in 3 months. Sales were up
just +0.1%, predominantly due to weakness in auto sales. Across the board, most retailers reported
improved results last month. Home furnishings, groceries, gasoline, and restaurants were all notably
strong, with restaurant sales posting their strongest numbers since February. Yet auto dealers have
been forced to offer deeper discounts as demand appears to be leveling off after years of surging sales.
Showroom revenue fell -0.5% last month. Auto sales account for about 20% of total retail sales, and
without autos, sales rose +0.2% last month. Economists had forecast a gain of +0.3%.
Higher gas prices, more expensive rent, and an increase in medical bills all contributed to a higher level
of inflation last month, according to the Bureau of Labor Statistics. The Consumer Price Index (CPI), rose
+0.2% last month, matching forecasts. Inflation has been rising steadily since July, which is one of the
reasons the Federal Reserve increased interest rates this week. Annualized, the CPI advanced +1.7% to
its highest level in more than two years. The rate of inflation has almost doubled since this summer.
Higher gas prices at the pump were responsible for most of the increase. On a positive note, prices for
food have remained relatively low. The cost of food for November was flat for the fifth straight month.
Inflation at the wholesale level is also beginning to pick up according to the Labor Department’s
Producer Price Index (PPI). The PPI recorded its biggest gain in five months, jumping +0.4% in
November. The rise was largely due to a +0.5% increase in the cost of services, responsible for more
than 80% of the move. Year-over-year the PPI rose +1.3%, the biggest gain since November of 2014. A
rebound in the price of oil also contributed to the increase. Core PPI, a measure that strips out the
often-volatile food, energy, and trade-margin components rose a lesser +0.2%. Core PPI is up +1.8%
over the past year, the largest rise since mid-2014.
Industrial output in the U.S. fell last month, primarily due to a decline in electricity usage amid
unseasonably warm weather. Industrial production, which measures everything made by factories,
mines, and utilities, fell -0.4% from the previous month according to the Federal Reserve. It was the
third decline out of the last four months, and in line with economists’ expectations. Industrial output
had back-to-back gains in June and July, but has struggled since. Stephen Stanley, chief economist at
Amherst Securities stated in a note, “The sector is still just treading water.” In addition, capacity
utilization fell -0.4% to 75%--the lowest rate since March.
The Commerce Department reported that business inventories fell -0.2% in October, the biggest decline
in a year, as companies continue to reduce stockpiles. This is viewed as a positive by analysts because
investment in inventory to replenish shelves should contribute to fourth-quarter economic growth.
Inventory investment in the third quarter added half a percentage point to the U.S. economy’s 3.2%
annualized GDP growth rate. Economists had forecasted a drop of -0.1%.
On Wednesday, the Federal Reserve raised its key U.S. interest rate for the first time in a year, and
signaled that they would adopt a more aggressive stance in 2017. In a move that was widely expected,
the central bank raised its key short-term interest rate a quarter point to a range of 0.5%-0.75%. The
vote was unanimous. In addition, the Fed’s so-called “dot plot” indicated the central bank plans three
additional rate hikes next year instead of the prior forecast’s two. Myles Clouston, senior director of
NASDAQ Advisory Services stated, “What they did was highly anticipated. There was a slight surprise in
next year, looking at an additional rate hike. Overall, the Fed remains pretty steady overall, looking at
gradual raises in interest rates in the long run."
Two measures of manufacturing activity, in the Fed’s Philadelphia and New York regions, climbed this
week in another indication of the optimism among corporations following the election of Donald Trump
to President. The Philadelphia Fed’s manufacturing index jumped almost +14 points to 21.5—the
highest in 2 years. The New York Fed’s Empire State index rose over +7 points to 9. In both gauges,
readings over 0 indicate improving conditions. In both cases, measures of future business conditions
also saw significant improvement. The Empire State’s future business conditions surged +20 points to
50.2, the highest level in almost 5 years. The Philadelphia Fed’s future general activity measure also
rocketed up over +23 points to 52.6, its highest level since January of last year.
In international economic news, the Bank of Canada warned that rising household debt and the growing
proportion of highly indebted households threaten the Canadian economy. The central bank is
expecting new mortgage rules to help ease the continued rise in household indebtedness that exposes
the country to economic shock. Bank of Canada governor Stephen Poloz told reporters that debt levels
are a risk to the economy that could be dangerous in an economic crisis. He likened the situation to a
“large tree that has a crack in it. The situation may improve or worsen over time, but there’s no
immediate crisis until the wrong kind of storm comes along.”
Across the Atlantic, in the United Kingdom the Bank of England left base borrowing costs unchanged at
record lows of 0.25% but warned that higher inflation and slower wage growth may weigh on
consumers’ budgets next year. The Bank’s 9-member committee voted unanimously to keep rates on
hold and maintain the current program of quantitative easing in place. In minutes of its final meeting of
the year, the Monetary Policy Committee said it would continue to trade the effects of the weaker
pound raising inflation against the prospects of slower economic growth and employment. For now,
they saw little need to change policy as little had appeared to have changed since last month’s report.
On Europe’s mainland, France’s national statistics agency Insee reported a steady uptick in French
economic growth at the end of the year and the start of next year could be weighed down by political
uncertainties. The French economy is set to gather momentum after a weak summer, Insee said - just as
the country braces for an unpredictable French presidential election, the effects of the UK’s “Brexit”
decision, and the impact of Donald Trump’s election as U.S. President. Insee said economic growth will
rebound to +0.4% quarter-on-quarter at the end of this year, and forecasts growth of +0.3% for the first
quarter of 2017.
In Germany, the economy is ending the year on a strong footing with a key index indicating growth
accelerated in the final quarter. IHS Markit said its composite Purchasing Managers Index (PMI) was
54.8 this month, capping the economy’s strongest three-month stretch since the second quarter of
2014. While the services PMI declined slightly, it still remained well above the key 50 level that indicates
expansion. The manufacturing PMI rose to 55.5, the highest in almost 3 years. Markit economist Philip
Leake stated the PMI “signaled a strong end to the year for German private-sector firms.”
In Italy, the world’s oldest bank is in trouble amid Italy’s political crisis. Banca Monte dei Paschi di Siena
(MPS) has put forward a $5.3 billion recapitalization plan that was approved by shareholders but
received skeptically by investors. The bank has asked the European Central Bank for a third extension
until January 20, 2017 to raise more capital. The European Central Bank had rejected the request earlier
this year, but extended it to the end of the year. MPS is Italy’s 3rd largest bank and the oldest surviving
bank in the world, established in 1472. The centuries-old bank has outlived many dynasties and
kingdoms and is now in trouble after more than 500 years of existence. When the European Banking
Authority published the results of its EU-wide stress test of 51 banks in the bloc, MPS was rated the
weakest lender.
In Asia, the U.S. Federal Reserve may have rudely interrupted the Chinese Communist Party’s annual
economic planning meeting for the second year in a row. During last year’s Central Economic Work
Conference, the Fed raised interest rates for the first time in a decade. This week, the U.S. central bank
raised rates again, and hinted at three more increases next year. Over the past 10 years, high interest
rates in China compared with rock-bottom yields in the United States drew foreign capital into China.
This fueled China’s renminbi decade-long currency appreciation versus the U.S. dollar. But those money
flows are now moving in reverse as the interest rate spread narrows between the two. The move puts
Beijing in a difficult position as Chinese officials attempt to stop the fall of the renminbi against the
dollar without negatively impacting growth or raising Chinese companies’ already high debt burdens.
The Bank of Japan (BOJ) is likely to give a more optimistic view of the economy at next week’s rate
review, sources say. A pickup in emerging Asian demand along with positive signs in private
consumption improves the odds for a solid, export-driven recovery. An upgrade from the BOJ would
reinforce market expectations that the central bank will hold off on further stimulus measures in the
near future. “Global economic conditions are improving, and consumption appears to be picking up,”
said one of the sources. “All in all, we’re seeing more bright signs for the economy.” The BOJ’s ninemember board will reach a final decision after scrutinizing its closely-watched “Tankan” quarterly
business sentiment survey.
Finally, as the Dow closes in on the 20,000 milestone, Mark DeCambre at MarketWatch
(www.marketwatch.com) penned an article that asks the question, is reaching 20,000 really that
significant? After all, the Dow Jones Industrial Average represents only 30 stocks out of the thousands
that make up the broader market. Outsized moves in any of the 30 components can have a very big
effect in the overall index. As an example, the latest surge in Goldman Sachs has contributed about a
third of the Dow’s recent 1,000 point move. In addition, 1000-point moves aren’t as meaningful as they
used to be. When the Dow moved from 1,000 to 2,000 it was a 100% move, and the move from 4,000
to 5,000 was a 25% move. But a 1,000 point move from 19,000 to 20,000 represents just a 5.3%
advance.
Whether Dow 20,000 will be a ceiling or another milestone remains to be seen. But in any event, this
1,000 point marker is less of a Herculean feat than ever before, as the following chart illustrates.
(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)