Download May 20, 2016

In the markets:
U.S. stocks were modestly higher for the week. The tech-heavy NASDAQ composite index outperformed
its peers for the second week, and the SmallCap and MidCap indices outperformed LargeCaps. For the
week, the Dow Jones Industrial Average fell 34 points to 17,500, but the NASDAQ rose 51 points to
4,769, up 1.1% to lead the gainers. The LargeCap S&P 500 gained +0.28%, the S&P 400 MidCap index
gained +0.66% and the SmallCap Russell 2000 added +0.89%. The Dow Jones Transports gained +2.19%,
while the Dow Jones Utilities index declined -2.29%.
In commodities, precious metals experienced a 3rd consecutive week of losses as Gold declined -$21.40
to $1,252.90 an ounce, down -1.68% and Silver fell -3.39% to $16.55 an ounce. The industrial metal
copper was also weak, down -1.03%. Energy, though, continued to rally as a barrel of West Texas
Intermediate crude oil added another +$1.45 to end the week at $48.48, up +3.08%.
In international markets, Canada’s TSX added +1.24% and the United Kingdom’s FTSE rose +0.29%.
Mainland Europe was mixed: Germany’s DAX fell -0.37%, but France’s CAC 40 gained +0.78% and Italy’s
Milan FTSE rose +0.47%. In Asia, China’s Shanghai Stock Exchange was essentially flat at -0.06%, but
Japan’s Nikkei rallied +1.97%, and Hong Kong’s Hang Seng added +0.67%. Emerging Markets as a group
was down -0.2% (EEM), and Developed Markets as a group was up +0.60% (EFA).
In U.S. economic news, new filings for unemployment benefits fell by 16,000 last week to 278,000
exceeding expectations by 3,000. Claims had hit a 1-year high the previous week after a surge in New
York filings. The 4 week average is up to 275,750 from 268,250.
The National Association of Home Builders’ Housing Market Index was unchanged last month at 58.
Economists had expected a 1 point rise. Readings over 50 signal optimism among home builders. The
Commerce Department reported that housing starts rose +6.6% last month to 1.172 million units, but
were down -1.7% versus a year earlier. Economists had expected housing starts to rise 1.135 million
units. Building permits, used as gauge of future activity, rose +2.6% to 1.116 million but missed
expectations for 1.130 million. Sales of existing homes did better than permits and starts, rising last
month +1.7% to a 5.45 million annualized pace according to the National Association of Realtors,
beating forecasts for 5.4 million. The median home price was $232,500, up +5% over last month and
+6.3% vs. a year earlier.
The Labor Department reported that consumer prices rose +0.4% in April, the biggest gain in 3 years.
Gasoline costs spiked nearly 10% as energy costs continued to climb. Core CPI (ex- food and energy)
rose +0.2%, which was in line with expectations. Year over year, CPI climbed +1.1%, while core CPI rose
+2.1%. The Federal Reserve has set its inflation target at +2%, but its preferred inflation gauge, the core
PCE deflator, was up only +1.6% its latest reading.
In U.S. manufacturing news, the New York Fed’s Empire State Manufacturing Index plunged -18 points
to -9.02 in May from April’s 9.56, widely missing analyst expectations of 7. New orders, shipments, and
prices received all turned negative as well. In the city of brotherly love, the Philadelphia Fed
manufacturing index was -1.8 this month vs. -1.6 in April, missing expectations of a rise to 3. The new
orders gauge was -1.9 after a flat April.
Industrial production jumped +0.7% last month, according to the Federal Reserve. It was the best gain
in more than a year and beating expectations of a +0.2% rise. On a negative note, March’s decline was
revised downward to a steeper loss of -0.9%.
The Conference Board’s Index of Leading Economic Indicators (LEI) rose +0.6% to 123.9 in April, beating
estimates for a +0.5% gain. It was the first rise since November. Comprised of 10 components,
including the S&P 500 price change, manufacturers’ new orders, and housing permits, the index is
meant to signal swings in the business cycle and smooth out some of the volatility of individual
components. Ataman Ozyildirim, director of business cycles and growth research at The Conference
Board stated, “The U.S. LEI picked up sharply in April, with all components except consumer
expectations contributing to the rebound from an essentially flat first quarter.”
On Wednesday, the minutes from the Fed’s April policy committee meeting were released and they
surprised many traders. In March, Fed Chair Janet Yellen gave a speech in which she stated that
“caution is especially warranted” when it comes to raising rates with global risks so high and
policymakers so low on conventional ammunition to counteract a downturn. But the minutes revealed
a much more hawkish consensus within the Fed. Most participants agreed that an interest-rate increase
would be appropriate in June if the economy continued to improve. From the minutes: “Most
participants judged that if incoming data were consistent with economic growth picking up in the
second quarter, labor market conditions continuing to strengthen and inflation making progress toward
the committee’s 2% objective, then it likely would be appropriate for the committee to increase the
target range for the federal funds rate in June.” On Thursday, New York Fed President William Dudley
reinforced that notion, saying at a press briefing that “a tightening in the summer, the June, July
timeframe is a reasonable expectation.”
In Canada, slowing car sales and inflation stuck below the central bank’s target points to gathering
softness in Canada’s economy. Retail sales fell -1% in March, worse than the +0.6% forecasted
According to Statistics Canada. Receipts at new car dealers fell -3%, as well as sales of furniture, building
materials, and food and beverages. Leslie Preston, an economist at Toronto Dominion Bank stated “the
retail data just shows, there isn’t a lot of momentum in the Canadian economy as we headed into the
second quarter, and we have the uncertainty of the shutdowns related to the Alberta wildfires.”
Canada’s dollar touched a 6-week low as Friday’s data contributed to the list of economic setbacks.
European equities rose as strength in commodities, bank, and energy stocks offset concerns about an
earlier than expected US Federal Reserve interest-rate hike. Preliminary estimates from the European
Union’s statistics agency reported that consumer prices in April were down -0.2% from the same time
last year. April was the second month this year that the Eurozone was in deflation.
In the United Kingdom, a leading credit ratings agency warned that a British exit (“Brexit”) from the
European Union could eventually lead it to downgrade the ratings of multiple EU countries as well as
Britain. In a report, Fitch Ratings said a vote in favor of a “Brexit” from the European Union would weigh
on the economies of multiple EU countries and increase political risks in Europe.
The International Monetary Fund (IMF) is demanding that Europe release Greece from all payments on
its bailout loans until 2040. The new IMF proposal, shared late last week, goes far beyond what
Greece’s Eurozone creditors, led by Germany, have said they are willing to do to help the country regain
its financial health. Germany is returning the pressure on the IMF to dilute its demands and rejoin the
Greek bailout program as a lender instead of an opinionated spectator.
In Japan, first quarter GDP rose +0.4% on a quarter-over-quarter basis and +1.7% year-over-year, both
measures beating expectations. The Japanese economy again avoided official recession as gains in
government and consumer spending outweighed a decline in business investment. But, according to a
poll of 10 private organizations conducted by the Nikkei, economic growth is forecast to contract -0.4%
in the April through June quarter.
A series of Chinese economic reports showed that the country’s economy slowed again after a
temporary pickup in March. Gauges of industrial production and retail sales as well as fixed asset
investment all missed analyst expectations. Some interpretations of the reports were positive, however,
insisting that China’s growth is moderating as opposed to coming to a sudden halt and are less negative
than the headlines would suggest.
Finally, a recent paper by Rob Arnott of Research Affiliates puts the spotlight on the “hollowing out” of
the U.S. middle class. Entitled “Where’s the Beef? Lies, Damned Lies, and Statistics”, the paper notes
that American households, which have been “pinched’ by rising prices at a higher than headline
inflation, have generally not benefited from the unrelenting stimulus of quantitative easing and zero
interest rates and instead have experienced a decade of zero growth in income and spending power.
For example, the price of beef has soared over the past 5 years—up 80% cumulatively at the end of last
year, but the official U.S. Consumer Price Index (CPI) is up only 7%, or 1.4% a year. Despite what the
official numbers may say, surveys suggest that the average American’s daily experience is one of going
backward.
For average Americans, the four biggest expenses are rent, food, energy, and medical care, in
approximately that order. These four expenses have been increasing at a faster rate than headline CPI,
which simply ignores two of them and minimizes the others. According to the BLS, these four
components comprise about 60% of the “aggregate population’s consumption basket”, but for
struggling Americans, it’s closer to 80%, and for the working poor can reach as much as 90% of total
spending.
The middle class is being squeezed by rising costs and almost no gains in real income—and consequently
the middle class is disappearing. As the following graph depicts, 53% of American considered
themselves middle class in 2008. But just six years later, that number had plummeted to 44%. At this
rate of decline there would be no middle class at all in 30 years! The largest move was among those
self-identifying as “Lower Class”, rising from 2008’s 25% to today’s 40%, a rise of an astounding 15
percentage points. Even the self-identified “Upper Class” reported a drop, from 21% to 15% of the
populace.
(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)