Download June 17, 2016

In the markets:
The major U.S. benchmarks all recorded losses for the week, with the smaller cap indexes bearing the
brunt of the selling. The Dow Jones Industrial Average fell 190 points to close at 17,675, down -1.06%.
The tech heavy NASDAQ composite gave up 94 points to close at 4,800, down -1.92%. The S&P 500
LargeCap index declined -1.19%, while the S&P 400 MidCap index and the Russell 2000 SmallCap index
ended down -1.28% and -1.65%, respectively. The defensive Dow Jones Utilities index gained +0.88%,
and the Dow Jones Transports index fell -2.25%.
In international markets, Canada’s TSX ended down -0.97%. The United Kingdom’s FTSE continued to
see weakness, down -1.55%. British voters are going to go to the polls next week to vote whether to
stay in the European Union or leave – the so-called “Brexit” vote. On Europe’s mainland, weakness was
seen across the board with France’s CAC 40 down -2.62%, Germany’s DAX index down -2.07%, and
Italy’s Milan FTSE down -1.15%. In Asia, markets had a very difficult week where Japan’s Nikkei plunged
over -6%, Hong Kong’s Hang Seng index fell over -4.15%, and China’s Shanghai index ended the week
down -1.44%.
Precious metals enjoyed their third week of gains as gold climbed +$25.30 to close at $1,301.60 an
ounce, up +1.98%. Silver rose +$0.19, ending the week at $17.52 an ounce, up 1.10%. The industrial
metal copper regained some of last week’s plunge, rising +1.33%. Crude oil was essentially flat, down
only two cents, ending the week at $48.86 a barrel for West Texas Intermediate crude.
In U.S. economic news, Initial jobless claims rose more than expected, up +13,000 to 277,000 last week,
according to the Labor Department. However, analysts are quick to point out that the increase was
primarily due to 19,470 claims in California that are “probably due in part to schools closing for summer
recess,” a Labor Department spokesman said. The median forecast of economists surveyed had
expected 270,000. Continuing claims increased by +45,000 to 2.16 million for the previous week. These
claims, reported with a one-week delay, reflect people who are already receiving unemployment checks.
In housing, the National Association of Home Builders (NAHB) sentiment gauge rose 2 points to 60, the
highest since January. Economists had expected a 1 point gain. Readings over 50 indicate growth. All
the main sub-indexes rose, including confidence about future sales. The NAHB noted “Builders in many
markets across the nation are reporting higher traffic and more committed buyers at their job sites—but
some headwinds remain, including a scarcity of available lots and labor.”
Actual housing starts fell -0.3% in May to an annualized rate of 1.164 million units, according to the
Commerce Department. That follows a +4.9% increase in April and is better than the 1.15 million
expected by economists. Building permits, a gauge of future construction activity, rose +0.7% to 1.138
million. Monthly housing starts have hovered above 1 million for the past year, but remain below the
1.5 million that represents a very healthy housing market. On a positive note, housing starts are up
+10.2% so far this year.
Small business optimism rose for a second straight month in May, according to the National Federation
of Independent Business (NFIB). The NFIB’s small business index rose to 93.8 last month, up +0.2 point
from April, and 12% of companies plan to add staff, up one percentage point. 27% of companies
reported that they had unfilled job openings. But sales and earnings trends weakened, with fewer firms
planning to step up spending, even though pessimism about the economy diminished.
Retail sales increased +0.5% last month, beating expectations as consumer spending remains strong,
according to the Commerce Department. Economists had expected retail sales to rise +0.3%. Ex-autos,
sales rose +0.4% and ex-autos and gas, sales were up +0.3%, both in line with expectations. Auto sales
gained +0.5% versus April as industrywide demand was slightly stronger than expected. Nonstore sales,
which represents e-commerce sales such as Amazon’s, continues to outpace overall retail sales-- up
+1.3% in April and a whopping +12.2% versus a year earlier.
Consumer prices rose +0.2% in May, missing forecasts by 0.1%, according to the Labor Department.
Core consumer prices, which exclude food and energy, also rose +0.2% matching expectations. Energy
prices gained +1.2% as gasoline prices increased. Shelter costs rose +0.4%, the biggest monthly gain
since 2007. Year-over-year consumer prices are up +1%, but down slightly from April’s reading. Core
inflation was 2.2%, up +0.1% from April.
Producer prices rose for a second straight month as the cost of energy products and services increased,
but a stronger dollar and lower energy prices is expected to keep inflation in check for a while. The
Labor Department said its producer price index for final demand increased +0.4% last month, following a
+0.2% rise in April. Year-over-year, producer prices are down -0.1%. Economists had forecast the PPI to
rise +0.3%. Excluding food, energy and trade services, producer prices dipped 0.1% last month,
following a 0.3% rise in April.
Industrial production fell -0.4% last month, missing analyst expectations of just a -0.1% drop, according
to the Federal Reserve. Manufacturing activity also fell _0.4%, also missing forecasts for a gain of +0.1%.
Production of autos and related parts plunged -4.2%, the sharpest drop since early 2014. American
producers are still battling the effects of weak energy prices, a stronger dollar, and stagnating global
growth. On a positive note, mining output (including oil drilling) rose +0.2% - its first increase since
August. However, drilling and servicing at wells dropped a further -7.9%. Those numbers may stabilize
as analysts point to Baker Hughes rig count data that show that oil rigs are beginning to come back
online. Capacity utilization, which measures the amount of plant capacity that is in use, fell to 74.9%,
down -0.4%.
Manufacturing in the Empire state rebounded in June after a weak reading the prior month, according
to the New York Fed. The Empire state manufacturing index swung to positive territory coming in at 6.0,
up +15 points from the deeply negative May reading. A positive reading indicates improving conditions.
Economists had forecast -3.5. Orders and shipments were also positive for June and the six month
outlook also improved. In Philadelphia, the Philly Fed index rose to 4.7 signaling growth following
May’s reading of -1.8. It was only the 2nd positive reading in the past 10 months; however, the details of
the report were not optimistic. The indicators for new orders, shipments, employment and work hours
all remained negative. The disparity is due to the fact that the headline value of the Philly Fed current
conditions index is based on a single stand-alone question, unlike the Institute for Supply Management’s
index which is based on a composite of components.
On Wednesday, the Federal Reserve voted to keep rates steady, which was widely expected. However,
the Fed signaled that markets might still be too complacent about the chances for rate hikes later in the
year. While economists don’t expect a hike at the next meeting in July, individual members’ projections
for future policy still point to two hikes this year. Six Fed officials now see just one hike this year, up
from just one back in March. Fed Chair Janet Yellen stated in a post-meeting press conference that the
United Kingdom’s vote whether to leave the European Union later this month (“Brexit”), played a factor
in the decision to leave rates unchanged.
In international economic news, the Conference Board of Canada stated that Canada’s economy is
expected to grow by +1.5% this year, with British Columbia to lead the country in growth. Four
provinces will have a GDP growth rate of more than +2%: British Columbia, Ontario, Manitoba, and
Prince Edward Island. The Conference Board sees a “two-speed” Canadian economy, with resource
dependent provinces in recession or growing slowly, and most of the rest of the country strengthening
as manufacturing exports grow.
The Bank of England has issued a fresh warning that a vote to leave the EU in next week’s referendum
risks impeding economic growth, forcing the pound lower, and sending shockwaves through the global
economy. The Bank of England’s Monetary Policy Committee voted unanimously to maintain its bank
rate at just 0.5% and to keep the size of its asset purchase program at 375 billion pounds.
German Chancellor Angela Merkel said China’s push to produce higher quality exports is turning the
country into a competitor in global markets and underscoring European concern about Chinese trade
and investment. Her three day trip to China included joint cabinet talks in Beijing and a chance to
ensure that “diverging interests” between the two countries “aren’t swept under the carpet,” Merkel
told reporters in Shenyang. Merkel said she and Chinese leaders had very intensive talks regarding
China’s bid for market-economy status, which would make EU penalties against Chinese exports more
difficult.
In Japan, the yen surged to its strongest against the dollar since the fall of 2014 as the Bank of Japan
abstained from adding any stimulus that could slow its advance. Japan’s currency gained against all 31
of its major peers after Governor Kuroda and his board chose to continue to gauge the economic impact
of their negative interest-rate policy. The dollar extended its losses that have made it the worstperforming currency this year behind the pound after the Federal Reserve kept interest rates steady and
suggested the pace of further action will be slower than previously indicated.
Chinese domestic banks are lending large amounts of cash to boost the near-term economic outlook,
despite the nation’s swelling pile of debt. New yuan loans rebounded to 985 billion yuan last month,
surpassing all estimates, according to the People’s Bank of China. The central bank is determined to
keep credit flowing so that its economy continues to grow, but at the cost of rising debt risks. China’s
debt load is now 250% of its gross domestic product, according to Bloomberg Intelligence estimates.
Finally, are you favoring stocks right now because investment grade bonds are yielding a near 0%
return? If so, Mark Hulbert, in a research piece published at MarketWatch.com, says that is a terrible
rationale. To be fair, almost everyone seeks the return of stocks when bonds are yielding near zero. But
his research shows that bond valuations have almost nothing to do with how the stock market is likely to
actually perform. Over the past century, stocks have been just as likely to fall as rise when bonds have
been less than an ideal alternative. To demonstrate this, he calculated the stock market’s performance
since 1871 for various states of stock earnings yield vs the yield on the 10 year treasury note. What he
found, as demonstrated by the chart below, is that there is no consistent relationship. The implications
for investing are that you should base investing decisions in the stock market based on the stock
market’s own valuation criteria, not on whatever the bond market may be doing.
(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)