Download July 8, 2016

In the markets:
U.S. stocks ended the holiday-shortened week on an up note, thanks to a very strong rally on Friday.
Indices were negative for the week going into Friday, but ripped higher on the stronger-than-expected
jobs report (more on that below). The benchmark S&P 500 LargeCap index ended the week at 2,129.90,
within one point of its all-time closing high, up +1.28%. The Dow Jones Industrial Average gained almost
200 points ending the week at 18,146, up +1.1%. MidCaps and SmallCaps rose a bit better than
LargeCaps, up +1.35% and +1.78% respectively. For the first time in 6 months, the Nasdaq Composite is
again closing in on the 5,000-level with a gain of +94 points, ending the week at 4,956 (+1.94%). Even
the defensive Utilities sector squeaked out a gain at +0.2%.
In international markets, Canada’s TSX rose almost 200 points to 14,259, up +1.39%. Markets were
mixed in Europe where the United Kingdom’s FTSE rose +0.19%, but other major markets were down.
Germany’s DAX fell --1.5%, France’s CAC 40 declined -1.95%, and Italy’s Milan FTSE slipped -1.4%.
Markets were also mixed In Asia, where Japan’s Nikkei plunged almost -3.7%, but China’s Shanghai
Composite gained 1.9%. Developed International markets as a group fell -1.02% (EFA) and Emerging
Markets as a group slipped -0.55% (EEM).
In commodities, precious metals continued to shine as Gold rose for a 6th straight week to $1367.40 an
ounce, up 1.67%. Silver also was bid up aggressively, adding an additional +2.49% to $20.35 an ounce.
But crude oil plunged -$4.16 a barrel to $45.12, down a sharp -8.44%.
In U.S. economic news, ADP reported on Wednesday that private-sector employment increased by
172,000 for June—May’s number was revised down slightly to 168,000 from 173,000. Analysts had
expected 160,000. ADP’s number is often looked at as an indication of the Labor Department’s
employment report that covers both private sector and government employment. According to ADP,
small private-sector businesses added 95,000 jobs last month, medium businesses added 52,000 and
large added 25,000. However, all of the gains in the ADP report came in the service sector, while
manufacturing lost 36,000 jobs.
Confirmation (with an exclamation point!) of the stronger U.S. labor market came with the
government’s release of the Non-Farm Payrolls (NFP) report on Friday (sparking a big stock market rally).
The NFP report showed jobs surging back last month, with a gain of +287,000 new jobs. The report
seemed to put to rest worries that the labor market and broader economy had taken a turn for the
worse. The sharp rebound in hiring fits with other labor market reports that indicate the labor market
remains the healthiest it’s been in years. Economists had not expected such a robust report, predicting
only 170,000 new jobs.
The U.S. unemployment rate rose +0.2% to 4.9% last month as more people entered the labor force in
search of work. As a result, the labor force participation rate rose slightly as well, to 62.7%.
In manufacturing, the news was not quite so good. U.S. factory orders fell -1% in May following a +1.8%
surge the previous month. Analyst expectations had been for a -0.8% decline. Total orders declined at
an annualized -1.9% rate, and ex-transportation annual orders were down -3.4%. Orders in the energy
sector improved following a sharp decline the previous month, although durable goods orders overall
were still down -2.3%.
The most important sector of the U.S. economy – services - was stronger in June as Markit’s final June
Purchasing Managers Index (PMI) services-sector data was revised marginally higher to 51.4, up +0.1
point. The U.S. service sector is home to most of America’s jobs and it has been offsetting a much
weaker (but smaller) manufacturing sector. While service providers have continued to report growth,
the rate of expansion has been slowing in part due to uncertainty over the economy and the upcoming
elections. According to Markit, survey respondents reported the fastest pace of new business since the
start of the year, but also subdued business confidence.
The Institute of Supply Management’s (ISM) non-manufacturing index soared to 56.5, a 7-month high
that widely exceeded analyst forecasts. Readings above 50 indicate expansion. The details of the report
were strong—new orders, which give an indication of future activity, came in strong, up 5.7 points to
59.9. The production sub-index rose to 59.5. Only 3 industries reported contraction in June, while 15
reported growth. ISM said the results show a “strong rebound.”
Minutes released from the Federal Reserve’s Open Market Committee meeting in June revealed unease
over the risks of financial shocks to the economy. Overall, a majority was still expecting to raise interest
rates in the short-term, but they were wary of potential financial shocks which could derail the
process—such as the United Kingdom’s “Brexit” referendum. The minutes gave no indication of
whether officials were considering a rate hike in July, September, or later in the year. Most members
still expected inflation to rise gradually to their 2% target and that transitory factors that had kept
inflation down had receded.
In Canada, the trade deficit was worse than expected in May at C$3.28 billion. Analysts had expected a
narrowing to C$2.6 billion. The April deficit was also revised sharply higher making the April and May
trade deficits the highest on record. Overall exports fell -0.7% to C$41.1 billion with an accompanying 2.3% decrease in volumes. Overall exports declined in 7 of the 11 categories, with actual shipments
lower across most industrial sectors.
In the United Kingdom, worries increased about the outlook for UK commercial property prices. Several
of the largest UK commercial real estate funds halted trading amid concerns that there would not be
enough liquidity to honor increasing demands for redemptions. Most of the funds invest directly in UK
real estate and in order to satisfy investor redemptions property assets must be physically sold off to
provide liquidity.
German Chancellor Angela Merkel stated that Britain’s vote last month to leave the European Union will
lead to only “limited” economic uncertainty in Germany. She said that the remaining 27 EU member
states should ensure that their economic bloc remains competitive, creates jobs and fosters growth.
In Italy, over 17% of bank loans are non-performing, according to the Wall Street Journal. That figure
works out to 360 billion euros or $401 billion of bad debt and is more than triple the percentage of bad
loans in the U.S. at the height of the financial crisis. Bank of Italy Governor Ignazio Visco said that public
money should be used to help Italy’s troubled banks. Italy’s banking system is considered to be perhaps
the most vulnerable in the Eurozone with its portfolio of non-performing loans.
Economists believe China’s economic growth likely moderated slightly in the second quarter. The
median forecast of 15 economists polled was that the economy likely expanded +6.6% from a year
earlier, down -0.1% from the previous quarter. China’s policymakers are facing a serious set of issues
including reducing industrial capacity to deal with defaults on debt, rising risks from capital outflows,
and a weakening currency, according to economists at Mizuho Securities Asia.
In Japan, the world’s largest pension fund, Japan’s Government Pension Investment Fund (GPIF), is
estimated to have lost a staggering -$43 billion (4.4 trillion yen) in the quarter ended June 30, 2016,
according to calculations by Morgan Stanley MUFG Securities. The losses came following a -5 trillion yen
loss for the fiscal year ended March 31, 2016. It was the worst performance for the fund since 2009.
The GPIF, known in Japan as “the whale” for its immense size, is being criticized for increasing its
Japanese equity exposure in 2014. In addition to losses in its own market, the yen’s strength is also
hurting the returns of its investments outside of Japan.
Finally, many market observers have commented on the unusual mix of recently-rallying assets. Defying
common wisdom, defensive assets (e.g., utilities, gold, and bonds) have rallied right alongside the more
usual offensive sectors. Much debate about what this means has ensued – is the bond market
predicting deflation? But wait, is gold predicting inflation? Are stocks giving an all-clear? If so, why
have utilities gone up, too?
It may well be that the common wisdom is simply inapplicable now, as we are in a condition never
before seen: widespread negative interest rates around the world (which also tend to hold down
interest rates in the U.S.). In this environment, all the old relationships and expectations may have to be
scrapped as we work our way through this unprecedented circumstance. Here is a table from Pension
Partners illustrating how widespread across both countries and maturities that negative interest rates
have become. Note that the U.S. is the odd man out among the countries shown, having no negative
interest rates at any maturity – yet.
(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)