For a pdf version of the below commentary please click here Weekly Letter 7-25-2016

Commentary quick take:

 

  • Market statistics:
    • Global markets pushed higher on low volume
    • Earnings season helped move markets
    • VIX is now at the lowest point we have seen in more than two years

 

  • Earnings season for the second quarter is fully under way
    • So far, better than expected
    • Odd individual stock movements due to earnings
    • Energy is in the spotlight

 

  • US politics
    • Republican National Convention took place last week
    • Democratic National Convention is being held this week
    • Markets seem to be taking the 2016 election in stride

 

  • Europe
    • IMF cut global growth again due to Brexit
    • ECB held rates at zero
    • ECB seems to be preparing for further action at an upcoming meeting

 

  • Technical market view:
    • All three indexes extended their upward run
    • NASDAQ is getting very close to breaking out of the trading range

 

  • Hybrid investments strategy update:
    • No changes made to any of the models last week
    • Earnings season continues to drive stock performance

 

  • This week for the markets:
    • Central bank meetings and decisions
    • Politics could start to impact the markets

 

  • Interesting Fact: It is getting hot out there

 


Major theme of the markets last week: Summer trading

summer cartoon 7-25-16

Last week was the first trading week of the year that really felt and looked like a summer trading week. Summer trading is typically punctuated by a general lack of direction in the markets accompanied by low trading volume. The general lack of new information affecting the US economy accompanied by low expectations for a rate hike by the Fed at this week’s July meeting left many investors in a sort of limbo, unsure which way the US financial markets will move in the near term. Cash continues to play an integral role for many money managers and individual investors alike, as the market has a “feel” of being too high, yet there are very few other investments to turn to in the ultra-low interest rates environment we are currently moving through. One thing that was very obvious last week in the markets is that fear is not currently high in the minds of many investors as the VIX touched a near two-year low last week.

 


US news impacting the financial markets: The focus of the US news last week was on two things: the Republican National Convention (RNC) held in Cleveland, Ohio and second quarter 2016 earnings. The RNC took place during the majority of the week last week and was filled with speeches from people with the last name of Trump as well as a number of other politicians and well known individuals. Trump received the official nomination without too much of a fight, as expected, and the global financial markets seemed to pay little attention to the whole event. The lack of interest in the RNC was largely due to the market already knowing who was going to be nominated and that it will be a very close race in the fall between Clinton and Trump. With the Democratic National Convention (DNC) being held this week in Philadelphia we could see some market reaction, but it is still very early in the election cycle to really see any major market movements solely due to politics. While much of the national media was watching politics, the second quarter earnings season got fully under way last week with many well-known companies reporting their second quarter 2016 earnings results.

 

Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Advanced Micro Devices 36% Goldman Sachs 24% RLI -3%
American Airlines 7% Halliburton 26% Schlumberger 5%
American Express 9% Honeywell International 1% Sherwin-Williams -3%
AT&T 0% Intel 11% Skyworks Solutions 3%
Autoliv 1% IBM 2% Southwest Airlines -2%
Bank of America 6% J B Hunt Transport -4% Stanley Black & Decker 7%
Bank of New York 1% Johnson & Johnson 4% Starbucks 0%
Charles Schwab 0% Johnson Controls 4% Stryker 2%
Chipotle Mexican Grill -11% Lockheed Martin 14% Swift Transportation 10%
D.R. Horton 0% Manpower Group 5% Tupperware Brands 5%
DISH Network 19% Microsoft 19% Union Pacific 0%
Domino’s Pizza 5% Morgan Stanley 25% United Continental 2%
Dunkin’ Brands 2% Netflix 350% Unitedhealth 4%
eBay 0% Newmont Mining 57% VF 6%
General Electric 11% Philip Morris International -5% Visa 3%
General Motors 22% PulteGroup 12% Whirlpool 4%
Genuine Parts -2% Rambus 20% Yahoo! -350%

 

There were very few surprises last week in the earnings announcements, but there were a few notable stock movements. Netflix turned in a strong quarter, besting expectations of $0.02 per share by announcing $0.09 per share. This seems like it would be positive for the stock, yet Netflix saw its stock decline by more than 13 percent the day following the announcement as growth in new subscribers was anticipated to slow in the future.  Doing almost the reverse was Chipotle (CMG), which is still struggling with public perceptions of food poisoning. CMG posted a decline in new income of 82 percent for the second quarter as same store sales declined by 24 percent. However, the day following the announcement, CMG stock was up more than 5 percent on the hopes that the company will be able to turn things around. Earnings season can be a very wild time for even the biggest of stocks as investors and analysts alike adjust their positions and thoughts to the new information released.

 

According to Factset Research, we have seen 127 (25 percent) of the S&P 500 companies release their results for the second quarter of 2016. Of the 127 that have released, 68 percent have beaten earnings estimates, while 15 percent have met expectations and 17 percent have fallen short of expectations. When looking at revenue of the companies that have reported, 57 percent of the companies have beaten estimates, while 43 percent have fallen short. So far, the second quarter of 2016 earnings season looks to be doing pretty well, albeit expectations were so low that it is not entirely surprising to see so many companies beating expectations. Some of the major themes that seem to be coming up in many of the quarterly results include the potential impact of the Brexit, currency movements and the price of oil. This coming week is a very busy week and could set the tone for the rest of the companies that have yet to report earnings as there are a number of very large and influential companies that will be reporting.

 

This week is one of the two busiest weeks of the quarter for earnings being reported with more than 1,700 companies reporting. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Aflac Colgate-Palmolive Panera Bread
Alphabet ConocoPhillips PG&E
Altria Dow Chemical Phillips 66
Amazon.com Dr Pepper Snapple Public Storage
Amgen Eastman Chemical Raytheon
Anthem Exxon Mobil Regal Entertainment
Apple Facebook Simon Property
Aptargroup Ford Motor Six Flags Entertainment
Arthur J Gallagher General Dynamics Sprint
ADP Harley-Davidson Texas Instruments
Baker Hughes Hershey Twitter
Boeing J & J Snack Foods Under Armour
Bristol-Myers Squibb Kimberly-Clark United Technologies
Buffalo Wild Wings Marriott International Valero Energy
Cabela’s MasterCard Verizon
Caterpillar McDonald’s Waste Management
Chevron New York Times Whole Foods Market
Coca-Cola Northrop Grumman Xerox

 

The focus this week will be on large technology companies as Apple, Amazon, Google, Facebook and Twitter all report earnings for the second quarter of 2016. Apple is almost always a market mover as even if earnings come in exactly at market expectations the markets will react to what management has to say. Expectations are low for Apple this quarter, following last quarter’s release, which posted a decline in iPhone sales for the first time ever. With such a low bar having been set it would not be surprising to see Apple have a comeback quarter, easily beating market expectations. Energy is a second focus of the week this week as many of the very large integrated oil companies release their results for a quarter that saw oil prices rally through much of the quarter. Exxon, Chevron and ConocoPhillips have the most potential to shift the overall markets on the days they announce, but the industry will generally be looked at as a whole when the markets are evaluating how much of an impact energy will play on the markets going forward. Consumer products is a final major theme this week in the companies reporting earnings as Coca-Cola, Kimberly-Clark and Colgate-Palmolive all could set the tone for an entire sector with their earnings results.

 

Global news impacting the markets: The main stories last week in the global financial markets were a post-Brexit IMF report on the global markets and a meeting held by the ECB during the week. On Tuesday last week the IMF released a special world Economic Outlook Update, which dealt with the potential fallout from the Brexit and the UK leaving the EU. We are still very far from any concrete action being taken on the Brexit as the new PM in the UK, Theresa May, has said that she will wait until at least the start of the new year before invoking article 50, which starts the 2 year clock for the UK to negotiate leaving the EU. In the report, the IMF cut the global growth forecast from 3.5 percent down to 3.4 percent, saying “The Brexit vote implies a substantial increase in economic, political, and institutional uncertainty, which is projected to have negative macroeconomic consequences, especially in advanced European economies.” While the ECB updated its projection for a post-Brexit world, the ECB also made waves last week when it held one of its monthly interest rate setting meetings.

 

The ECB was largely expected to not move rates at the July meeting, opting instead to wait on the fallout from the Brexit prior to making any major adjustments to its current policies of quantitative easing. The ECB left its primary benchmark rate at zero and kept the deposit rate at -0.4 percent. It is widely expected that the ECB will increase its bond buying program at the meeting in either August or September, but there is a slight problem with the current buying program. Negative Interest Rate Policy (NIRP) is a phenomenon where governments are able to issue debts that carry a negative yield, meaning an investor will get back less than it put into the bonds if held to maturity. Currently there are a large number of European bonds that are trading at a negative interest rate and the ECB is only allowed to purchase bonds that have a yield of -0.4 percent or higher. As rates continue to push lower and lower into negative territory it is becoming very difficult for the ECB to find enough bonds that qualify for purchase. One simple fix, and the most likely course of action for the ECB, is to just do away with the rule of buying bonds that have a yield that is better than -0.4 percent. However, doing away with this rule would leave the bank open to taking greater long term losses on the fixed income investments than it has been willing to accept. This is just one of the many potential issues that NIRP could have. How it will all play out over time is very uncertain, as we have never before seen such a large amount of negative interest bearing paper in the global financial system.

 

Technical market review:

 

The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. The red line on the NASDAQ depicts the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. There are no red lines on the Dow of the S&P 500 charts as both indexes jumped higher, making new all times highs along the way. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 7-25-16

As can be seen in the charts above, the S&P 500 (upper left pane above) is the strongest of the three major indexes as it moved higher last week, but did so in a much more choppy fashion than the previous few weeks’ movements. The Dow (upper right pane above) is currently in second place as it too continued to push higher last week. The NASDAQ (lower left pane above) made up some significant ground last week as the index inched closer to making new all-time highs, joining the other two indexes in breaking out above its most recently trading range. While some of the equity indexes were making new highs, the VIX was pushing lower last week, putting in the lowest level that we have seen since August 26th of 2014.

 

Market Statistics:

 

Last week was a lackluster week for the financial markets as summer trading (lack of general market volume) seemed to be fully under way:

 

Index Change Volume
NASDAQ 1.40% Below Average
S&P 500 0.61% Below Average
Dow 0.29% Below Average

 

Volume was about 80 percent of an average week last week, which is pretty typical for summer trading here in the US. The movement that did happen last week was largely based on earnings results, with companies either moving higher or lower based on whether they beat or fell short of expectations. For the next month or so it is likely that we continue to see slow volume that starts to ramp back up in September and October as the seasonal shift away from trading fades into the lead up to holiday shopping.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Biotechnology 3.07% Telecommunications -0.87%
Healthcare Providers 2.55% Energy -1.41%
Semiconductors 2.51% Natural Resources -1.65%
Global Real Estate 2.33% Oil & Gas Exploration -2.06%
Technology 2.11% Commodities -3.41%

Technology saw the largest movements last week, led higher by Biotechnology and Semiconductors thanks to earnings results and a few key FDA decisions on drug approvals. Healthcare Providers took the second spot last week in what turned into a very interesting week for the sector as several of the big healthcare companies announced that they are pulling out of Obamacare plans for 2017. On the flip side, commodities had a difficult week last week as oil prices declined, which put pressure on the whole sector with everything from energy to natural resource companies feeling the pain of the falling oil prices.

Fixed income markets were mixed last week as bond traders and investors alike adjusted their positions for the upcoming July FOMC meeting, which takes place this week:

Fixed Income Change
Long (20+ years) 0.30%
Middle (7-10 years) 0.18%
Short (less than 1 year) -0.01%
TIPS -0.28%

Currency trading volume was average for a summer trading week last week. The largest movements were seen in currencies and in heavily natural resource dependent countries. Overall, the US dollar increased by 1.0 percent against a basket of foreign currencies. The strongest of the major global currencies last week was the Chinese Yuan, as it advanced by 0.57 percent against the value of the US dollar. The worst performance of the global currencies was the Australian dollar as it declined by 1.72 percent against the value of the US dollar. This was largely due to the decline in natural resource prices seen around the world last week.

Commodities were mixed last week, as precious metals and soft commodities declined:

Metals Change Commodities Change
Gold -0.39% Oil -5.19%
Silver -2.15% Livestock -2.69%
Copper 0.12% Grains -4.49%
Agriculture -2.86%

The overall Goldman Sachs Commodity Index declined by 3.41 percent last week, as Oil decreased 5.19 percent. The decrease in oil prices seemed to have more to do with the continued over supply of global oil when compared to global demand than any other major headline. One aspect to the current oil market that has some market participates a little concerned is that the pattern that has been emerging in oil prices since the beginning of June is eerily similar to the pattern that occurred in 2014 just before prices really started to move significantly lower. Some of the pattern is seasonal and due to the summer driving season, but still the similarities are hard to miss. The major precious metals were negative last week with Gold falling 0.39 percent, while Silver moved lower by 2.15 percent as the metals bounced around in a trading range last week. The more industrially used Copper increased by 0.12 percent, making it two weeks in a row of increases for Copper, while the precious metals have declined over the same time period. Soft commodities were weak last week with Agriculture overall falling 2.86 percent, while Livestock declined 2.69 percent and Grains declined 4.49 percent over the course of the week. Hot dry weather that has been nearly constant over the past 2 weeks in much of the Mid-West could start to have a noticeable impact on the US harvest if it continues much longer.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
PX 50 Czech Republic 3.2% RTS Index Russia -2.9%
BUX Index Hungary 2.9% BIST 100 Turkey -13.4%

Last week saw 81 percent of the major global markets turn in positive performance for the week. The best performing index last week was found in the Czech Republic, the PX 50 index, which turned in a gain of 3.2 percent for the week. The worst performing index for the week was found in Turkey, the BIST 100 Index, which turned in a loss of 13.4 percent. The losses in Turkey were due to the government continuing to purge out all of the “collaborators” of the failed coup that took place two weeks ago.

As mentioned above, the VIX continued to push lower last week, breaking down through the lowest point that we have seen during 2016 and hitting a low that has not been seen since August 26th of 2014.  The current reading of 12.02 implies that a move of 3.47 percent is likely to occur over the next 30 days. Despite being at these low levels, the VIX looks like it could keep pushing lower as the “fear” just does not seem to currently be in the markets. One thing to remember about the VIX is that it can change in a hurry, easily going from very low levels to very high levels in a short period of time.

For the trading week ending on 7/22/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model 0.20 % 5.36 % 9.89 %
Aggressive Benchmark 0.32 % 3.07 % -2.17 %
Growth Model 0.14 % 5.20 % 8.72 %
Growth Benchmark 0.25 % 2.52 % -1.46 %
Moderate Model 0.09 % 4.98 % 7.85 %
Moderate Benchmark 0.18 % 1.91 % -0.85 %
Income Model 0.04 % 5.42 % 8.19 %
Income Benchmark 0.09 % 1.08 % -0.23 %
S&P 500 0.61 % 6.41 % 5.42 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to any of the hybrid models over the course of the previous week. Movement was primarily driven by the precious metals holding. Overall, the models are still defensively positioned in dividend paying equities. The current areas of the markets that are of most interest for potential future investment include Mid-Caps, Technology and Healthcare. VF Corp released its latest quarterly results and saw a slight slowdown in spending, which sent the stock lower the following day. This week is a big week for earnings announcements from individual stock investments in the models as we have 9 companies releasing earnings this week. We could see an uptick in volatility due to earnings, but in general the stocks as a whole should see muted movements when compared to the markets.

 

Economic Release Calendar:

 

Last week was a slow summer week for the economic calendar in terms of the number of releases, with only one release that significantly missed market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 7/19/2016 Building Permits June 2016 1153K 1150K
Neutral 7/19/2016 Housing Starts June 2016 1189K 1165K
Negative 7/21/2016 Philadelphia Fed July 2016 -2.9 5
Neutral 7/21/2016 Existing Home Sales June 2016 5.57M 5.50M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Economic news releases started on Tuesday last week with the release of building permits and housing starts, both of which came in very close to market expectations and had no noticeable impact on the overall markets or on the housing related stocks. On Thursday the Philadelphia Fed released their latest Philly Fed index, which showed a -2.9 reading while the market had been expecting a reading of 5. This is potentially an issue as it indicates that manufacturing and business conditions actually deteriorated during the month of July in the greater Philadelphia region. This follows a similar trend that we saw last week on the Empire Manufacturing index, which showed a contraction for the same time period. Manufacturing has been weak now for the past 4 months and could present a very interesting problem for the Fed. Wrapping up the week last week on Thursday was the release of the existing home sales figures for the month of June, which like the other two housing related releases earlier during the week held nothing out of the ordinary.

 

This week is a typical summer trading week, but there are an unusually large percentage of the releases that could impact the markets (highlighted in green below):

 

Date Release Release Range Market Expectation
7/26/2016 Case-Shiller 20-city Index May 2016 5.40%
7/26/2016 Consumer Confidence July 2016 96.00
7/27/2016 Durable Orders June 2016 -1.00%
7/27/2016 Durable Orders, ex-transportation June 2016 0.20%
7/27/2016 FOMC Rate Decision July 2016 0.38%
7/29/2016 GDP-Adv. Q2 2016 2.60%
7/29/2016 Chicago PMI July 2016 54
7/29/2016 University of Michigan Consumer Sentiment Index July 2016 90.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Tuesday with the release of the Case-Shiller 20 City Home Price Index for the month of May and Consumer Confidence for the month of July. Consumer Confidence will largely overshadow the Home Price Index as it has a more immediate potential impact on the markets. After the poor University of Michigan Consumer Sentiment reading two weeks ago the market will be watching the government’s consumer confidence measure extra close this week. On Wednesday the durable goods orders for the month of June will be released as we could see some very large movements when compared to May’s reading, thanks to a very large air show held in the UK during June at which many large plane orders were booked. The markets will have very little time to digest the durable goods orders on Wednesday, however, as the FOMC meeting for the month of July concludes on Wednesday and will likely take the spot light. The odds of a rate hike at this meeting are a paltry 2 percent, so the market will be much more interested in how Chair Yellen frames the potential rate increase at the next couple of meetings than what occurs at this meeting. On Friday, the government releases its advanced estimate for GDP during the second quarter of 2016 here in the US. Expectations are for a reading of 2.6 percent, up from the final reading of first quarter 2016, which was only 1.1 percent. The market will likely react to this release even if it comes in at market expectations as GDP here in the US is vitally important to many models that investors use when determining what stocks to own and when to make adjustments to their investments. Also on Friday, the Chicago area PMI for the month of July will be released. We will have to wait and see if this index goes the same direction as the Empire and the Philly index for the month of July. Wrapping up the week this week is the release of the University of Michigan’s Consumer Sentiment index for the month of July (final estimate), which is expected to show a slight pull back from the mid-month estimate. As mentioned above, all eyes this week will be on the Fed and its statement about rates as this could have far reaching impacts on the global financial markets.

 

Interesting Fact June was the 14th consecutive month for record heat

temp 7-25-16

According to the United Nations and NOAA, June was the 14th consecutive month of record high temperatures around the world. The first 6 months of 2016 was 1.3 Celsius warmer than any other year going all of the way back to the pre-industrial era of the 19th century.

 

Source: http://www.theguardian.com

For a PDF version of the below commentary please click here Weekly Letter 7-18-2016

Commentary quick take:

 

  • Market statistics
    • Markets increased on developments in the UK
    • Volume overall was lacking last week
    • VIX is now at the lowest point we have seen in more than a year

 

  • Earnings season for the second quarter has started
    • Alcoa kicked things off by beating expectations
    • With 7 percent of the S&P 500 reporting earnings, this looks like a pretty weak quarter
    • Financials turned in mixed results in this ultra-low rate environment

 

  • US politics
    • Republican National Convention is this week
    • Democratic National Convention will be held next week
    • Markets seem to be taking the 2016 election in stride

 

  • Japan
    • Nikkei turned in the best week of the year in terms of gains last week
    • Prime Minster Abe won reelection in a landslide
    • BOJ expected to provide bigger stimulus to the economy

 

  • UK
    • BOE held a rate meeting last week, leaving the rate unchanged
    • BOE set up to announce stimulus at the upcoming August meeting
    • New Prime Minister selected

 

  • Technical market view
    • All three indexes extended their upward run
    • Markets will likely remain choppy for the near term

 

  • Hybrid investments strategy update
    • Repositioned models last week
    • Increased exposure to the Russell 2000 and Precious Metals
    • Consumer staples had a rough week

 

  • This week for the markets
    • Earnings season for the second quarter of 2016
    • Politics could start to impact the markets

 

  • Interesting Fact: What is America’s land worth?

 

Major theme of the markets last week: Japan

funny 7-18-16

Japan was a major theme for the global financial markets last week as investors around the world became more hopeful for further stimulus from the government after the landslide election results for Prime Minister Abe. Abenomics (the economic recovery packages that PM Abe has implemented) now look set to grow even further as Japan continues to struggle to find a magic combination of stimulus that will get the economy in Japan moving forward. In the financial markets last week the Nikkei 225 (main Japanese index) increased by more than 9 percent, giving it one of the best weekly performances of any of the major global indexes that we have seen so far during 2016.

 

US news impacting the financial markets: The US markets last week traded largely on external news as the internal news focused on some of the recent shootings around the US. There was, however, some focus on earnings season being now fully underway for the second quarter of 2016 and on the upcoming Presidential election.

 

Second quarter 2016 earnings season officially kicked off last week after the markets closed on Monday with Alcoa releasing its earnings report. Alcoa beat analyst expectations of $0.09 per share when it posted earnings of $0.15 per share for the second quarter of 2016. Revenues also beat expectations, coming in at $5.3 billion versus the expected $5.2 billion. These results beat analyst expectations, but as we will likely see many times more during this earnings season, the results were not very good when compared to a year ago. For the second quarter of 2015, Alcoa posted revenues of $5.9 billion and earnings per share of $0.19. Although technically Alcoa surprised to the upside, the bar had been lowered so much that making less this year than last was actually seen as a win. This type of result is widely expected for second quarter 2016’s earnings reports as overall earnings are still expected to be down for the S&P 500 by 5.6 percent on a year-over-year basis.

 

Below is a table of the well-known companies that released earnings last week with earnings that missed expectations highlighted in red, while earnings that beat expectations by more than 10 percent are highlighted in green:

 

Alcoa 67% Delta Air Lines 4% Progressive -9%
BlackRock 0% Fastenal -6% U.S. Bancorp 2%
Citigroup 15% JPMorgan Chase 8% Wells Fargo -1%
CSX 7% Knoll Pushed Yum! Brands 1%

 

Aside from Alcoa, discussed above, the markets seemed to pay close attention to the earnings results of a few of the major banks that reported earnings last week. Citigroup turned in the best results, beating expectations by 15 percent, but JP Morgan and US Bancorp also turned in strong earnings reports. The laggard of the group was Wells Fargo, which saw earnings miss expectations. Much like all of the other banks, Wells Fargo cast blame on the low interest rate environment in which it currently has to operate. On a year-over-year basis, Wells Fargo saw earnings per share decline by 18 percent, which is in line with the year-over-year decline seen in Alcoa’s reported earnings. Delta Airlines reported a better than expected quarter after the hedging contracts it entered into for fuel over the past two years helped the company combat the rising cost of fuel during the quarter.

 

According to Factset Research, we have seen 35 (7 percent) of the S&P 500 companies release their results for the second quarter of 2016. Of the 35 that have released earnings, 66 percent have met or beaten earnings estimates, while 34 percent have fallen short of expectations. When looking at the revenue of the companies that have reported, 51 percent of the companies have beaten estimates, while 49 percent have fallen short. These figures are a bit lower at this stage than the first quarter of 2016 and could be a sign of trouble coming from the second quarter earnings season. All of the above percentages are somewhat unreliable as we have such a small sampling of companies that have reported earnings so far for the second quarter of 2016. We should have a much clearer picture of how earnings season will go after this week when we have 140 of the S&P 500 component companies report their results. We also start to see the earnings of the energy industry, which will be watched very closely to see if the industry has recovered along with the price of oil.

 

With earnings season picking up this week, the table below is much larger than last week. There are many well-known companies that will be reporting earnings that could have an impact on the overall markets. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Advanced Micro Devices Goldman Sachs RLI
American Airlines Halliburton Schlumberger
American Express Honeywell International Sherwin-Williams
AT&T Intel Skyworks Solutions
Autoliv IBM Southwest Airlines
Bank of America J B Hunt Transport Stanley Black & Decker
Bank of New York Johnson & Johnson Starbucks
Charles Schwab Johnson Controls Stryker
Chipotle Mexican Grill Lockheed Martin Swift Transportation
D.R. Horton ManpowerGroup Tupperware Brands
DISH Network Microsoft Union Pacific
Domino’s Pizza Morgan Stanley United Continental
Dunkin’ Brands Netflix Unitedhealth
eBay Newmont Mining VF
General Electric Philip Morris International Visa
General Motors PulteGroup Whirlpool
Genuine Parts Rambus Yahoo!

 

Two of the bellwether technology companies, Netflix and Microsoft, both release their earnings this week in a sort of kick-off to technology earnings. Investors will be closely watching the number of new subscribers added to Netflix during the quarter as well as the total number of subscribers lost to other platforms as these two numbers typically drive the immediate movements of the stock after an earnings announcement. For Microsoft, it will be all about Windows 10 and how it is being adopted by the general public. Last year Microsoft said it would get to a billion devices running windows 10 by 2018. For Microsoft to hit that lofty goal, we would need to be seeing a much faster adoption rate than many analysts have been predicting. This quarter’s earnings report should hold the number of Windows 10 adoptions and could push the stock either higher or lower, depending on what the number turns out to be. Two other companies that Wall Street will be very closely watching this week are Visa and American Express as both companies represent a very large number of credit card transactions that take place around the world. Both companies typically have a pretty good read on consumer sentiment and spending patterns, which can move the overall markets. American Express will also be closely watched this quarter in particular to see if Costco dropping it as the only card company accepted at its stores will have any material impact on the company. Lastly, this week the first of the major energy companies release their earnings results as both Halliburton and Schlumberger jump first for a sector that is under a lot of scrutiny from Wall Street.

 

In addition to earnings season taking a lot of the national financial media spotlight, the upcoming 2016 Presidential election was also in focus as the Republican National Convention gets under way this evening. There still seems to be a lot of disagreement within the Republican Party about the presumptive nominee being Donald Trump, as illustrated by Ohio Governor John Kasich opting out of making an appearance at the convention in his own backyard. But with the rules committee having already met and keeping in place the rules that were in place prior to Trump securing enough votes to be the nominee, it looks like there should not be any contest at the convention over who the Republican candidate will be. Next week it is the Democrats’ turn to hold their convention as Hillary Clinton will officially be nominated as the Democratic nominee for President. In general, the financial markets have not been reacting to the political process that has been so fascinating to watch. As we draw near to the election and policies and ideas start to become more and more important to voters, we could see the market start to react a little more to the upcoming election outcome.

 

Global news impacting the markets: Japan and the United Kingdom made many headlines last week that markets around the world seemed to react positively toward. Japan saw a huge move in its financial markets last week, adding more than 9 percent to the main Japanese index, the Nikkei 225. Much of this was achieved because of the election held on Sunday in Japan in which Prime Minister Shinzo Abe’s Liberal Democratic Party won in what is being described as a landslide victory. The victory was so resounding that the party actually gained enough seats to control Parliament with a greater than two-thirds majority, the strongest position ever for the party that has been largely in control for the last 61 years in Japan. So why did this election cause the Japanese financial market to jump so high? With these results, there are thoughts that Prime Minster Abe will be able to undertake an ever larger stimulus program for the economy and that he will face little if any meaningful opposition to his plans at any level of government. One aspect of the results that has some neighboring countries uneasy, especially China, is that with such a majority in government, Prime Minster Abe may be able to enact some constitutional revisions, one in particular being modifications to Article 9 in the Japanese constitution, which renounces Japan’s ability to wage war, which could put Japan on the path toward becoming a military super power. It is obvious that China would not want this to occur as Japan being a military super power could potentially cause many headaches for mainland China in the year ahead as it continues to deal with its rapid global expansion. One of the most likely things that we will see quickly in Japan will be a move by the Bank of Japan to try to further stimulate the economy. Former Fed Chair Ben Bernanke was in Japan last week and met with Abe about the economy in Japan. While no actions were immediately taken as a result of the meeting, it is likely that further negative interest rates and more government spending to try to boost exports, even at the expense of the Yen, are likely. While Japan’s political leadership remains largely unchanged, last week a new Prime Minster was put in place in the United Kingdom.

 

Following the Brexit vote and the announcement that Prime Minster David Cameron would be stepping down from his position as soon as October, the political system in the UK went into overdrive to try to come up with likely PM candidates. At the onset of last week, the potential PM candidates had been narrowed down to two. On Monday, one resigned, leaving only Theresa May running for the position. With May clearly going to be the next PM in the UK, Cameron resigned months earlier than expected last week and May became the PM on Wednesday evening, when she met with the Queen and was invited to form a new government. She has already filled several key cabinet positions, as Boris Johnson, one of the two leading Brexit politicians, became the Foreign Secretary and David Davis was named as the person in charge of leading negotiations between the UK and the EU to extract the UK from the EU. Davis has been a longtime Euro skeptic and is likely to be very verbose in his dealings with other EU members. One big question that still looms over the UK is when it will officially invoke Article 50, which formally announces to the EU the country’s wish to leave the union. PM May has said that she will take her time and hold many meetings with people well versed on the subject before making a decision as to the timing. However, the rest of the Europeans seem to be calling on the UK to invoke Article 50 so that the two-year clock gets moving and the process of the UK withdrawing can officially begin. Financial markets both in the UK and elsewhere around the world liked the fact that there will not be another election in the UK to decide on the next PM and that she seems to be moving forward with a level head about the Brexit.

 

Technical market review:

 

The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The red lines on the three major indexes depict the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 7-18-16

With the increase last week, the global markets officially recovered from the losses resulting from the Brexit vote. The US was no exception as both the S&P 500 and the Dow made new all-time highs several times during the week. As can be seen in the charts above, the S&P 500 (upper left pane above) is the strongest of the three major indexes as it has pushed the furthest above its resistance level (red line). The Dow (upper right pane above) is currently in second place as it too is above its most recent resistance level, but slightly less in terms of percentages than the S&P 500. The NASDAQ (lower left pane above) finally made it to and through its resistance level last week, but the index still has a significant way to go before it starts to make new all-time highs like the other two indexes. While some of the equity indexes were making new highs, the VIX was pushing lower, putting in the lowest level we have seen since August 10th of 2015 last week. The VIX really seems to be trading on bets that central banks around the world are about to embark on another major round of quantitative easing, which may or may not be correct. If we do not see some major central bank action in the next few weeks it looks like the VIX will move significantly higher than these levels.

 

Market Statistics:

 

Last week turned out to be a positive week for the US financial markets, thanks to positive developments in countries such as Japan and the United Kingdom:

 

Index Change Volume
Dow 2.04% Below Average
S&P 500 1.49% Below Average
NASDAQ 1.47% Below Average

 

With all three of the major US indexes up last week on very low volume, some pundits are questioning the validity of the movement. While the pundits are correct that the volume for the markets was about 80 percent of average, we are in the middle of summer trading when volume is typically lower than it would otherwise be. However, it would be nice to see volume pick up some on the days that the markets are moving significantly higher as the downside volume was still almost 1.5 times larger than the upside during the recent week’s movements. This means that fewer people are making trades and participating in the markets when they have moved higher, with more investors than average taking a wait and see approach on the sidelines.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Regional Banks 4.72% Medical Devices 0.29%
Materials 4.57% Consumer Staples 0.16%
Broker Dealers 4.56% Home Construction 0.10%
Financials 4.10% Real Estate -0.08%
Transportation 4.10% Utilities -0.97%

Sector movements last week were not split evenly between risk-on sectors and risk-off sectors, but there was some distinct lack of performance in the risk-off areas of the markets. Financial related sectors had a good week last week, making up three of the top five sectors in terms of performance as interest rates crept up and the prospects of further central bank stimulus around the world ran high. On the flip side, Utilities, Real Estate and Consumer Staples made up three of the bottom five performing sectors last week as investors seemed to be favoring higher risk assets. Home Construction also took a spot in the bottom five performing sectors as the US housing market appears to be moving into a horizontal period of time as prices have leveled off in many regions of the US.

Fixed income markets were negative last week as bond traders and investors alike adjusted to the prospects of more stimulus from Japan and potentially Europe:

Fixed Income Change
Long (20+ years) -3.63%
Middle (7-10 years) -1.65%
Short (less than 1 year) -0.01%
TIPS -0.97%

Currency trading volume was average last week, as there was a little retracement in the two currencies that have moved the most over the past four weeks. Overall, the US dollar increased by 0.12 percent against a basket of foreign currencies. The strongest of the major global currencies last week was the British Pound, as it advanced by 2.15 percent against the value of the US dollar. Much of the movement in the Pound occurred after the announcement that Theresa May would be taking over as PM sooner than the anticipated October hand-off. The worst performance of the global currencies was the Japanese Yen as it declined by 4.82 percent against the value of the US dollar. This was largely a reversal of the gains we had been seeing over the past four weeks as the BOJ is likely to take bigger actions after the election results than was first thought, which would lead to an even weaker Yen.

Commodities were mixed last week, as precious metals declined, while Oil moved higher:

Metals Change Commodities Change
Gold -2.82% Oil 1.48%
Silver -0.73% Livestock -2.07%
Copper 6.07% Grains -0.90%
Agriculture -0.42%

The overall Goldman Sachs Commodity Index advanced by 0.61 percent last week, as Oil increased 1.48 percent. The increase in oil seemed to be nothing more than a little bounce after oil declined by more than 8 percent two weeks ago, with bargain hunters thinking they had found a good entry point on oil. The major precious metals were negative last week with Gold falling 2.82 percent, while Silver moved lower by 0.73 percent as the safe haven aspects of the two metals seemed to be less in demand than it had been over the past few weeks. The more industrially used Copper increased by 6.07 percent, making back the entire decline seen two weeks ago. Soft commodities were weak last week with Agriculture overall falling 0.42 percent, while Livestock declined 2.07 percent and Grains declined 0.90 percent over the course of the week.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Nikkei 225 Japan 9.2% OMX Copenhagen Denmark 0.9%
AST Index Austria 7.0% BUX Index Hungary 0.2%

There were no major global indexes that turned in negative performance last week, which is a rare feat. The best performing index last week was found in Japan, the Nikkei 225 Index, which turned in a gain of 9.2 percent for the week. The worst performing index for the week was found in Hungary and was the BUX Index, which turned in a gain of 0.2 percent.

As mentioned above, the VIX continued to push lower last week, breaking down through the lowest point that we have seen during 2016 and hitting a low that has not been seen since August 8th of 2015.  The current reading of 12.67 implies that a move of 3.66 percent is likely to occur over the next 30 days. Some of the movement in the VIX is likely due to the UK clearing up some of the uncertainty hanging over the Brexit vote with the new PM being seated and a new cabinet being formed. The Brexit vote seems to now be a waiting game until the UK decides how best to proceed.

For the trading week ending on 7/15/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model 0.16 % 5.15 % 10.71 %
Aggressive Benchmark 2.29 % 2.75 % -2.48 %
Growth Model 0.18 % 5.05 % 8.56 %
Growth Benchmark 1.78  % 2.27 % -1.71 %
Moderate Model 0.13 % 4.88 % 7.75 %
Moderate Benchmark 1.28 % 1.73 % -1.02 %
Income Model 0.01 % 5.37 % 8.14 %
Income Benchmark 0.64 % 0.98 % -0.32 %
S&P 500 1.49 % 5.76 % 4.78 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were multiple changes made to the hybrid models over the course of the previous week. The first move was to remove the hedging position that was held across all models early during the week. The volatility over the past two weeks in the stock baskets owned within the models has been minimal with the baskets even holding up well during downward moving trading days. There did not appear to be any reason for maintaining the hedge in the current market environment, so it was removed. In addition to removing the hedging position, new positions were initiated in three different areas of the markets. The first new position is in precious metals, using the Rydex Precious Metals Fund (RYPMX); this position was purchased because as central banks increase stimulus around the world, it is typically a very good thing for the precious metals market and gold and silver both hold their value against falling currencies very well. The second new position was in the Midcap Value space through the use of Rydex Mid Cap value (RYAVX). The mid cap market has been performing well in the past two months of volatility and looks like it will continue to do well in the near term. The final positions purchased last week were in the Russell 2000 space, which is the small cap area of the market. Different funds were used in different models based on risk levels of the models to get exposure to the small caps, but all are focused on capturing a large amount of the movement of the Russell 2000. With the adjustments last week, the models have swung from being defensively positioned to more offensively positioned. All funds that were purchased over the course of the past week are tradable positions, meaning if the markets turn negative again, the positions can be sold quickly and the models moved back toward defensive positions.

 

Economic Release Calendar:

 

Last week was a typical summer week for the economic calendar in terms of the number of releases, and the results were mixed with one significantly beating and one significantly falling short of expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 7/14/2016 PPI June 2016 0.50% 0.30%
Neutral 7/14/2016 Core PPI June 2016 0.40% 0.10%
Slightly Negative 7/15/2016 Empire Manufacturing July 2016 0.55 5
Positive 7/15/2016 Retail Sales June 2016 0.60% 0.20%
Neutral 7/15/2016 Retail Sales ex-auto June 2016 0.70% 0.40%
Neutral 7/15/2016 CPI June 2016 0.20% 0.30%
Neutral 7/15/2016 Core CPI June 2016 0.20% 0.20%
Negative 7/15/2016 University of Michigan Consumer Sentiment Index July 2016 89.5 93

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the economic news releases started off on Thursday with the release of the Producer Price Index (PPI) for the month of June, which came in very close to market expectations and indicated that there is very little inflation at the producer level in the US. Friday was a busy day in terms of economic news releases with the Empire Manufacturing index kicking things off and missing expectations of a reading of 5, but still managing to print a reading above zero with a reading of 0.55, which technically means there was expansion in manufacturing activity, but that it was so slow it was unnoticeable. This release, however, was overshadowed by the retail sales figures that were released at the same time as the Empire Manufacturing index. Retail sales, both including and excluding auto sales, beat market expectations during the month of June. However, the growth seen in retail sales is still very slow compared to where many economists and the Fed would like to see it. Also released on Friday was the Consumer Price Index (CPI). Much like the PPI released earlier during the week, it showed that while prices increased during the month of June, they increased at a much slower rate than the Fed would have liked to see. Wrapping up the week last week on Friday was the release of the University of Michigan’s Consumer Sentiment index for the month of July (first estimate), which missed expectations to the downside last week as it printed a reading of 89.5, while the market had been expecting a reading of 93, like it was at the end of June. This is a negative sign for the overall US economy because if consumers lose confidence in the US economy and pull back on spending it would be very difficult for the Fed to step in and meaningfully reverse what would likely be a downward trend.

 

This week is a typical summer trading week and there are a relatively small number of economic calendar releases. There is only one release this week that really has a chance of impacting the overall markets (highlighted in green below):

 

Date Release Release Range Market Expectation
7/19/2016 Building Permits June 2016 1150K
7/19/2016 Housing Starts June 2016 1165K
7/21/2016 Philadelphia Fed July 2016 5
7/21/2016 Existing Home Sales June 2016 5.50M

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Tuesday with the release of two housing related figures, those being building permits and housing starts for the month of June. As is typical, the markets will likely pay more attention to housing starts than building permits as a gauge for the overall US housing markets. With both expected to be over a million units, however, it would take a drastic difference between expectations and print for the markets to take much notice. On Friday the one release that could materially impact the markets is set to be released, that being the Philadelphia Fed Index, which is expected to show a reading of 5, much like the Empire Manufacturing index from last week. The key with this release will be that it stays positive. It can print a number below 5, but it needs to stay positive. If it prints a negative number it could spook the markets that the recovery in manufacturing that we have seen over the past two months was nothing more than a blip on the radar.  Wrapping up the economic news releases this week is the release of existing home sales for the month of June, which is expected to show 5.5 million units, which is middle of the road in terms of sales for the height of the summer selling season.

 

Interesting Fact What is America’s land worth?

 map image

According to the latest Federal Reserve’s Flow of Funds report, the value of all the US land is $14.488 trillion.

 

Source: www.slate.com

 

For a PDF of the below commentary please click here Weekly Letter 7-11-2016

Commentary quick take:

 

  • Market statistics:
    • Markets saw choppy trading during the shortened trading week last week
    • Markets pushed higher to end the week, thanks to the jobs report
    • VIX fell by more than 10 percent, leaving it near 2016 lows

 

  • Jobs recovery seen in the US labor market
    • Surprisingly high payroll figures last week
    • Surprisingly weak revision to the May payroll figures
    • Will it be enough to push the Fed to act?

 

  • US Fed seems stuck
    • Odds of a rate hike increased a little last week
    • Odds of a rate cut decreased last week
    • Looks difficult for the Fed to manage a single rate hike in 2016

 

  • Earnings season for the second quarter has arrived
    • Alcoa kicks things off on Monday
    • Expectations are very low for the quarter
    • Overall earnings expected to decline by 5.6 percent for the S&P 500

 

  • Europe could slow down further
    • IMF report cites Brexit for slowdown risk in 2017
    • ECB still failing to see inflation

 

  • Technical market view:
    • All three indexes broke below their trading ranges
    • All three indexes bounced back into their trading ranges at the end of the week
    • Markets will likely remain choppy for the near term

 

  • Hybrid investments strategy update:
    • Remains defensively positioned
    • With uncertainty in earnings season, investment changes will be opportunistically driven in the near term
    • Defensive positioning in consumer driven product companies continues to do well

 

  • This week for the markets:
    • Earnings season for the second quarter of 2016
    • Political uncertainty
      • In the US with the conventions at the end of the week
      • In the UK with the next Prime Minister likely being chosen this week

 

  • Interesting Fact: What’s in a rating?

 


Major theme of the markets last week: US Jobs reports dominated the financial media last week.

jobs cartoon

The primary focus of the global financial markets last week was the US labor market figures, which were released on Friday and showed a significant rebound after the dismal May figures. While the payroll numbers looked strong at first glance, other developments in more behind-the-scenes figures still paint a less than stellar picture of what is going on in the US labor market. The markets, however, seemed to run with the headline figures and pushed the indexes ever closer to all-time high closing levels.

 

US news impacting the financial markets:

 

As mentioned above, the US financial media was obsessed with the labor department’s figures about the US labor market during the month of June. You may remember that the May figures produced just prior to the June FOMC rate meeting showed a huge drop in the payroll figures, with private nonfarm payrolls declining from an April level of 130,000 (under the expected 170,000) all of the way down to a revised -6,000 jobs during the month of May. Public payroll figures also experienced a similar decline with the figure moving from 123,000 in April down to only 11,000 during the month of May. With such a nose dive seen on both public and private payroll figures in May there was a lot riding on the June figures and high hopes that the labor market would show a drastic recovery. On Friday, the Bureau of Labor Statistics did not fail to deliver; it posted that public nonfarm payrolls increased by 287,000 jobs during the month of June and private payrolls increased by 265,000 jobs during the month as well. With such a huge swing in the numbers, going from the worst reading since 2010 to the best reading of the past 9 months, many investors and economists questioned the reasons behind the extreme movements. One of the reasons floated and covered by the media was the thought that college graduation had something to do with the dislocation in the jobs figures, but that does not add up as most colleges finish up with graduation in June. It seems the high June number could indicate that many new jobs were created for the June college grads, but it fails to explain the steep decline in May. One other theory is that the Fed needed poor jobs figures to help justify holding off on raising rates, so the figures released for May were poor enough to allow the Fed to hold off on raising rates at the June meeting. This seems fairly plausible since the jobs report was the single most cited reason for the Fed not increasing rates. Whatever the reason for the wide variation in the payroll figures, the average of the two months comes out to just below 150,000 jobs, which is slow job growth but certainly not anything investors should panic about. One interesting aspect to the releases on Friday was that the overall unemployment rate in the US increased from 4.7 to 4.9 percent, thanks in large part to an increased number of people who have started to look for work, but currently cannot find any. This could also be attributed to unemployed recent college graduates.

 

With the jobs market having “recovered” from the dip in May, many economists and financial pundits are once again starting to debate whether the Fed will raise the Fed Funds rate and if so, when.  While the latest Fed watch figures have shifted a little in favor of a rate hike at some point in the future, the odds are still very low that the next hike will occur during 2016. As you can see in the table to the right, the odds of a rate cut have now all but disappeared, looking all of the way out to the February 2017 meeting. The odds of a rate hike, however, have been steadily increasing after the July meeting (July odds for a hike still hover right at zero) and increase all of the way to 32 percent at the December meeting. The Fed will be watching developments in the labor market and price inflation to determine when it will be the correct time to increase the Fed funds rate. Other aspects the Fed will likely be keeping close tabs on, even if it doesn’t explicitly say so, are developments with the Brexit, the value of the Yen and the overall growth of the global economy. All of this will likely be weighted in determining the correct timing for the next (second) rate hike.

Fed funds 7-11-16

Second quarter 2016 earnings season officially kicks off today after the market closes with Alcoa releasing its earnings report. With Alcoa being a very large multinational aluminum company, it has been dubbed the company that officially kicks off earnings every quarter. One thought that is common on Wall Street is that if Alcoa beats earnings estimates the quarter’s results for the overall markets will likely be better than expected and vice versa if it falls short of expectations. Over the course of the second quarter we saw Aluminum prices recover about 9 percent after having fallen for the majority of the previous 18 months. With some price recovery in Aluminum Alcoa should post strong quarterly results.

cartoon 7-11-15

This week is the start of earnings reporting season and with it there are several well-known companies that report earnings that could have an impact on the overall markets. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Alcoa Delta Air Lines Progressive
BlackRock Fastenal U.S. Bancorp
Citigroup JPMorgan Chase Wells Fargo
CSX Knoll Yum! Brands

 

As mentioned above, Alcoa will be very closely watched for the overall direction of earnings season, but a few of the large financial institutions may have more of a noticeable impact on the markets this week. With JP Morgan, US Bancorp, Wells Fargo and Citigroup all releasing earnings during the same week, and in most cases on the same day, the markets could get very uneasy if the financial institutions talk about the Brexit vote in a long-term, negative light.

 

Expectations for earnings this quarter are very low. It is expected (according to Factset Research) that earnings on the S&P 500 will have declined by 5.6 percent during the second quarter. This expected earnings decline has accelerated to the downside; at the end of March the expected decline in earnings for the second quarter of 2016 was only a loss of 2.8 percent. If this decline or any aggregate earnings decline occurs with the second quarter earnings season it will represent the first time that the US economy has seen two consecutive quarters of earnings declines since the third and fourth quarter 2008. Thus far for the second quarter we have seen 113 companies issue forward looking guidance with 81 issuing negative guidance and 32 issuing positive guidance.

 

Global news impacting the markets:

 

Global news last week was fairly muted as there were reports from the International Monetary Fund (IMF) and the European Central Bank (ECB) addressing future expectations for Europe. The IMF released a report last week that lowered the overall expected growth for the Eurozone for 2017 from 1.6 percent down to 1.4 percent with the primary reason for the change being the Brexit vote and uncertainty over the future of trade between the UK and the EU. However, the potential impact of the Brexit vote on the overall EU is very difficult to determine and the potential impact figures vary wildly depending on where you look. The ECB released its latest meeting minutes last week and within them investors were able to see some of the discussion about the upcoming potential Brexit vote (the vote occurred after the ECB meeting) and how a vote to leave could impact the EU overall. There was also an interesting section in which the ECB noted concern regarding the general lack of inflation, despite all of the easy money it is pushing into the financial system. Typically, when a central bank is pumping millions of dollar or Euros or whatever the local currency may be into the system, prices increase because there is more money in the economic system chasing the same quantity of goods. Despite billions of Euros having been added to the European economy over the past few years, the ECB has failed to get much, if any, movement in inflation.

 

Technical market review:

 

The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The red lines on the three major indexes depict the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 7-11-16

In the charts above, though it is a little difficult to see, two of the three indexes managed to break out above the resistance levels of their respective trading ranges on Friday last week after the markets rallied on the jobs data. Both the S&P 500 (upper left pane above) and the Dow (upper right pane above) are virtually tied in terms of simple technical strength. Both are above their resistance levels and both are making new highs as of Friday. The breakout occurred just a short time after having recently broken through the trading range to the downside directly following the Brexit vote in the UK. Having broken below and now breaking above, it is pretty easy to make the case that the trading range is likely just widening, more so than forming any real trend. The NASDAQ (lower left pane above) has made it to the resistance level of the trading range, but has so far failed to break above, leaving the index in third place in terms of technical strength. While the indexes were moving higher last week, the VIX was continuing to push lower after falling more than 40 percent two weeks ago. Last week the VIX moved lower by 10.63 percent and now sits at 13.20, which is very close to the lowest level that we have seen in 2016. The lowest point that the VIX has reached so far during 2016 was 13.20 on April 1st 2016. The VIX looks like it could have overshot a little to the downside given the uncertainty surrounding the Brexit vote and weakness being seen in parts of Asia.

 

Market Statistics:

 

Last week turned out to be a positive week for the US financial markets, despite the trading week being shortened by the Fourth of July holiday:

 

Index Change Volume
NASDAQ 1.94% Below Average
S&P 500 1.28% Below Average
Dow 1.10% Below Average

 

With all three of the major US indexes up more than 1 percent it was a good week for the markets by most standards. Volume was lacking, but that was expected. With Monday being a holiday there were only four trading days in the week last week, rather than the typical five. Being down a day almost always has a noticeable impact on the trading volume. However, this year the impact was very muted as each of the indexes managed to attain 90 percent of the week average. If trading volume was typical, last week it should have been near 80 percent, so we saw a good amount of volume, with much of the volume coming on Friday on the back of the jobs report.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Home Construction 4.56% Financials -1.05%
Biotechnology 3.19% Natural Resources -1.10%
Medical Devices 2.72% International Real Estate -1.11%
Semiconductors 2.70% Energy -1.35%
Software 2.18% Oil & Gas Exploration -2.78%

The sectors that made the positive list last week, in terms of top performance, were some of the hardest hit sectors of the markets over the recent volatility, as investors seemed to be embracing risk last week after there was little new development in the Brexit situation. With the price of oil declining by more than 8 percent it was not surprising to see that the Oil and Gas Exploration and Energy sectors made up the bottom two spots on the list of underperforming sectors last week. Financials also made the list last week, despite the US government releasing the latest results of its stress tests, to which all but one bank easily passed, with the one bank that failed (Barclay’s) being given until December of 2016 to fix the deterioration of its balance sheet before the government takes any action.

Fixed income markets were mixed as bond traders and investors alike adjusted some of their bond positioning after the stellar jobs report on Friday:

Fixed Income Change
Long (20+ years) 2.16%
Middle (7-10 years) 0.63%
Short (less than 1 year) -0.03%
TIPS 0.42%

Currency trading volume was low last week, thanks to the holiday on the fourth. Overall, the US dollar increased by 0.69 percent against a basket of foreign currencies. The best performance of the global currencies was the Japanese Yen as it gained 2.14 percent against the value of the US dollar. While you may think that a strengthening currency is a positive thing, it is not positive in this case as a weak Yen has been the key to the economic plan in Japan as it tries to boost its economy through exporting goods and services. The weakest of the major global currencies last week was the British Pound, for the third week in a row, as it declined by 2.56 percent against the value of the US dollar. With the uncertainty surrounding what will happen next with the UK, it would not be surprising to see the Pound continue to struggle against many of the other global currencies as currency traders typically do not like long-term political uncertainty affecting their trades.

Commodities were mixed last week, as precious metals advanced, while agriculture declined in value:

Metals Change Commodities Change
Gold 1.64% Oil -8.06%
Silver 2.56% Livestock -3.40%
Copper -5.36% Grains -3.21%
Agriculture -2.50%

The overall Goldman Sachs Commodity Index declined by 5.47 percent last week, as Oil decreased 8.06 percent. Oil decreased after various reports out of the US showed our reserves increasing more than anticipated headed into the summer months here in the US. The major precious metals were positive last week with Gold advancing 1.64 percent, while Silver moved higher by 2.56 percent as the safe haven aspects of the two metals continued to see demand. The more industrially used Copper decreased by 5.36 percent, which interestingly enough puts it almost exactly back where it was two weeks ago. Soft commodities were weak last week with Agriculture overall falling 2.50 percent, while Livestock declined 3.40 percent and Grains declined 3.21 percent over the course of the week.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
CASE 30 Index Egypt 3.5 % Nikkei 225 Index Japan -3.7 %
BUX Index Hungary 2.6 % Caracas General Index Venezuela -5.6 %

Last week, the global indexes were split almost down the middle in terms of gains and losses for the week. The best performing index last week was found in Egypt, the CASE 30 Index, which turned in a gain of 3.5 percent for the week. The worst performing index for the second week in a row last week was found in Venezuela, the Caracas General Index, which turned in a loss of 5.6 percent. The situation in Venezuela only seems to be getting worse with some residents being forced to go into neighboring countries to buy basic food staples as shortages have made them very scarce in most of Venezuela.

The VIX has now officially given back all of the upward movements seen in the immediate aftermath of the Brexit vote as it moved lower by an additional 10.63 percent last week.  The current reading of 13.20 implies that a move of 3.81 percent is likely to occur over the next 30 days. With all of the uncertainty surrounding the Brexit vote and what it means for the future of the UK and the EU overall, it seems the VIX is very low, but that could be attributed to the fact that the VIX looks out only 30 days and the likelihood of anything happening with the Brexit vote over the next 30 days is in fact very low as well.

For the shortened trading week ending on 7/8/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model 0.37 % 4.98 % 9.49 %
Aggressive Benchmark -0.02 % 0.44 % -4.67 %
Growth Model 0.44 % 4.86 % 8.36 %
Growth Benchmark -0.01  % 0.48 % -3.43 %
Moderate Model 0.50 % 4.75 % 7.64 %
Moderate Benchmark -0.01 % 0.45 % -2.27 %
Income Model 0.54 % 5.36 % 8.13 %
Income Benchmark 0.00 % 0.34 % -0.95 %
S&P 500 1.28 % 4.21 % 3.24 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes made to the hybrid model over the course of the previous week. The markets seem to have gotten a little ahead of themselves with the recent rally as they are pricing in what needs to be a very unexpectedly positive second quarter earnings season to justify the current levels of many stocks. We will likely see many companies and a few sectors in aggregate fall short of expectations. It is this type of opportunity that we are watching for to add to positions or initiate new positions. The areas of most interest currently remain mid-caps and healthcare.

 

Economic Release Calendar:

 

Last week was a shortened summer week for the economic calendar in terms of the number of releases, but there were three releases that beat expectations (highlighted in green below) and none than missed market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Positive 7/6/2016 ISM Services June 2016 56.5 53.3
Neutral 7/6/2016 FOMC Minutes Previous Meeting N/A N/A
Neutral 7/7/2016 ADP Employment Change June 2016 172K 152K
Positive 7/8/2016 Nonfarm Payrolls June 2016 287K 175K
Positive 7/8/2016 Nonfarm Private Payrolls June 2016 268K 170K
Slightly Negative 7/8/2016 Unemployment Rate June 2016 4.9% 4.8%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week the economic news releases started on Wednesday with the release of the services side of the ISM index, which came in better than anticipated with a reading of 56.5 compared to the expected 53.3 reading. The meeting minutes from the June FOMC meeting were also released on Wednesday, but held little new information and ended up having no noticeable impact on the overall markets. On Thursday the first of the employment data for the week was released with the ADP employment change figures for the month of June, which showed a gain of 172,000 jobs, higher than the expected 152,000 jobs. This was a good indicator that the jobs number released on Friday may end up better than expected. On Friday the government released a trove of information about the US employment situation with the biggest releases being the surprise payroll figures as both figures beat expectations by nearly 100,000 jobs or more. As explained above, this came after the dismal revision to the already poor May figures. Overall, the unemployment rate increased from 4.7 to 4.9 percent, but this was largely due to the increase in the labor force participation rate, which went from 62.6 up to 62.7 percent. The U6 unemployment rate went from 9.7 percent down to 9.6 percent in a sign that the rate that the Fed likes to look at showed improvement as well as the payroll figures.

 

This week is a typical summer trading week and there are a relatively small number of economic calendar releases, but there are several that could impact the overall markets (highlighted in green below):

 

Date Release Release Range Market Expectation
7/14/2016 PPI June 2016 0.30%
7/14/2016 Core PPI June 2016 0.10%
7/15/2016 Empire Manufacturing July 2016 5
7/15/2016 Retail Sales June 2016 0.20%
7/15/2016 Retail Sales ex-auto June 2016 0.40%
7/15/2016 CPI June 2016 0.30%
7/15/2016 Core CPI June 2016 0.20%
7/15/2016 University of Michigan Consumer Sentiment Index July 2016 93

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Typically the price indexes, both the Producer Price Index and the consumer Price Index, do not impact the overall direction of the financial markets, but this week could be the exception, as they could provide enough of a push to get the odds of a Fed rate hike this year to increase in a meaningful way. Currently, inflation is running very low in the US economy and the price indexes are one of the first places inflation would be seen in the data released by the government. Expectations, however, for the release of the Producer Price index, both overall and core readings, are for very little inflation being seen. On Friday the Empire Manufacturing index for the month of July is set to be released with expectations of a reading of 5, which is very close to the inflection point of zero between expansion and contraction. Barring this release missing expectations widely, retail sales will likely be the focal point of the day on Friday. Retail sales for the month of June are due out on Friday with expectations that sales will have increased by a measly 0.2 percent during the month, while sales excluding auto sales will have increased by 0.4 percent. Both of these retail sales readings are extremely low and susceptible to dipping under zero, which could cause a negative market reaction. Also released on Friday is the consumer price index for the month of June, which like the PPI earlier in the week is expected to show very weak inflation. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment index for the month of July (first estimate), which is expected to show no change over the reading at the end of June. In addition to the scheduled economic news releases this week there are nine speeches by Fed officials that the markets will likely be watching very closely, to see if it drops any hints as to how the Fed is thinking about moving forward in light of recent global events that could impact global growth in 2016 and 2017.

 

Interesting Fact What’s in a rating?

 

There were 60 AAA-rated companies by the S&P rating agency in 1980, a number that fell to 30 by 1995, six by 2008 and down to just two as of the second quarter of 2016. The two companies are Johnson and Johnson as well as Microsoft.

 

Source: Fortune         

For a PDF version of the below commentary please click here Second Quarter 2016 in Review

Second Quarter 2016 in Review:

Brexit flag star leaving

The second quarter of 2016 saw the US financial markets ultimately move very little during the quarter, despite the focus on two major themes: the US Federal Reserve rate decisions and the Brexit vote. Going into the second quarter, the US markets were coming off of a very strong bounce that started with the turnaround in oil. The rally in oil that began in February started to level off near the end of the first quarter. Entering the second quarter, the focus of the financial markets turned to the decisions by the Federal Reserve about the Fed funds rate. Initial expectations had been for four interest rate hikes during 2016, but that expectation dwindled down to two expected rate hikes and by the end of the second quarter of 2016 market expectations had moved down to zero rate hikes during 2016, with some pundits talking about a potential rate cut. What changed so much in the Fed’s thinking? Many changes occurred during the second quarter.

 

The US Federal Reserve maintains a dual mandate, which includes price stability and full employment. To try to achieve these two goals the Fed has a wide variety of policy actions it can utilize with the primary policy action being the adjustment of the Federal Funds rate, which is an interest rate that large financial institutions use to lend to the Fed and other institutions. The level of the Fed Funds rate also has an impact on many other fixed income instruments and interest rates. When the Fed Funds rate is high, the Fed is said to be implementing a tightening Fed policy. When it is low, the Fed is said to be loosening monetary policy. For years the Fed Funds rate was essentially zero in an effort to jump start the US economy into a recovery following the depths of the Great Recession of 2008-2009. Late last year the Fed took the first step in what will likely be many steps of normalizing the Fed Funds rate by increasing the rate 0.25 percent. After taking that initial step forward on rates, the markets have been obsessed with trying to determine when the Fed will raise rates again as the effects of rates moving upward on fixed income investments and many other ancillary investments can be very large. Rates are typically moved during scheduled Federal Reserve FOMC meetings, held eight times per year at an interval of about every 6 weeks. Immediately following four of the eight meetings, Chair Yellen holds a press conference. The markets typically put more weight for the chance of a rate hike on meetings with a scheduled press conference than meetings without a scheduled press conference. With no rate hike in April (which had no scheduled press conference), investors and many money managers initially thought there was a high probability of a rate hike at the June or July meeting, with the June meeting favored because of the scheduled press conference. Expectations for a rate hike in the near term were raised higher than normal after a question and answer session at Harvard just before Memorial Day at which Chair Yellen said that rates would “probably” increase in the next few months. But early in June we saw dismal employment figures for the month of May, missing all expectations to the low side and showing the weakest jobs growth the US economy had seen in several years. These releases seemed to spook the Fed as it shied away from raising rates at the June meeting. With the labor market showing weakness and being the primary driving force in the Fed increasing rates (since prices here in the US have been stable and increasing slower than the Fed would like for the past two years), it was not entirely unexpected that the Fed would not increase rates at either of the meetings during the second quarter of 2016. One other aspect that weighed heavily on the minds of the FOMC members as they debated the merits of raising rates at the June meeting had to be the looming Brexit vote that was held just over a week after the conclusion of the June Fed meeting.

 

Brexit is a term that was hardly ever spoken or heard of prior to a month ago and now it is a term that anyone who has watched the financial media over the past month has been inundated with. On June 23rd the UK held the promised referendum vote on whether the UK should leave the European Union. This vote was the major driving force of market movement over the course of the second quarter, as the markets moved lower when polls or other media indicated a Leave vote was likely and higher when polls or other media indicated that the Remain vote would win. Nearly all of the polls, however, indicated that the results were easily within the margin of error of the poll and likely to be very close. Despite this, in the final days leading up the vote the global financial markets seemed set on the outcome of the vote being for the UK to remain in the EU, which pushed the global markets to the highest levels of the quarter. After the voting was concluded in the UK and the voter turnout figures were released (ahead of any actual voting results), many, if not all, of the major betting houses and odds makers called the vote at 52 percent Remain and 48 percent Leave. The British pound increased nicely against the US dollar and the Euro as it looked like the Remain vote had indeed managed to pull out a win. Then the actual polling results started to come in, with New Castle and Sunderland being the first to officially release their voting results. New Castle came in very close, with Remain garnering 50.7 percent of the vote and the Leave vote garnering 49.3 percent. The vote in Sunderland was surprising and an omen of what would come throughout the evening. Sunderland was expected to be a very close race with the winning vote expected to win by only a few tenths of a percent. When the results were released, however, 61.3 percent of the voters in Sunderland had voted to Leave, while only 38.7 percent had voted to Remain. After these results were announced the global financial markets and the currency trading markets around the world realized that the polls had likely been incorrect and started to react. The British Pound started to move down and the US dollar, the Euro and the Yen all started to strengthen. As more regions started to announce their vote counts, it became more and more clear that the Leave vote was going to win the vote and the Brexit would have officially passed, leaving the UK and the rest of the world in a very precarious position.

 

In the aftermath of the Brexit vote all of the global financial markets moved lower with the hardest hit areas being Japan, down because of the Yen’s strength; and Europe, which saw some of the largest single day losses in the markets since the height of the Great Recession back in 2008. The British financial institutions where among the hardest hit companies with some of the major banks seeing declines in excess of 20 percent during the day following the vote. The global financial markets largely recovered the losses realized from the Brexit vote over the week of trading that followed the vote, making the declines much less damaging than they could have been. With all of this occurring within a week of the end of the second quarter, the markets at the end of the quarter were in a very precarious spot as no one really knows what will happen going forward with the UK decision or how it could impact other members of the EU and the global financial markets.

 

Looking to the future:

 

The future for the financial markets seems very uncertain. The situation in the UK and other countries affected by the Brexit vote remains uncertain and will likely remain uncertain until at least October when the new Prime Minister for the UK is elected. Even after a new PM is elected in the UK, it is unlikely that anything will move forward quickly as the UK will likely try to negotiate as much as possible without officially announcing that it is leaving the EU. We are likely years away from seeing any major movement with the Brexit vote and even after the decision and timing of the UK’s departure has been decided upon, it will likely be many more years until the impacts of the Brexit vote are truly felt, either for the better or worse. With such a long time horizon for the fallout from the Brexit vote, the global financial markets will likely ignore what is going on with the Brexit vote outcome. The US Federal Reserve, while still very relevant to the financial markets, will also likely be on hold for the time being with regard to increasing interest rates as we are now just as likely to see a rate cut as we are to see a rate hike by the end of 2016, with both odds being very low. That leaves the global financial markets, and the US markets in particular, looking for reasons to move from the current levels either higher or lower. We will likely see the markets once again start to look at the fundamentals for investing in companies. Factors such as whether the company is growing sales, growing dividends, making shareholder friendly decisions and actually running a viable business will start to matter more to the financial markets. Earnings season for the second quarter will be very important as we will see if there was any recovery in earnings due to the increasing oil prices seen through much of the second quarter. Expectations for second quarter earnings are very low, so the bar should be easy to clear for most companies, but it will likely not be enough to push the market meaningfully higher as sideways movements seems like the most likely outcome moving forward from here. Strong stock picks and tactical movements to opportunities as they arise become even more important in a sideways moving market. Being able to recognize and take advantage of emerging opportunities leads to good returns in an otherwise flat return environment.

 

Have a great third quarter!

Peter Johnson

 

Time for the Second Quarter Numbers:

 

The following is a numerical representation of the second quarter of 2016. The three major US indexes and the VIX turned in performance as follows:

 

Index 2nd Quarter 2016
S&P 500 1.90%
Dow 1.38%
NASDAQ -0.56%
VIX 12.04%

The major US markets were very range bound during the quarter, for the most part staying within 3 percent of the starting value, even with the Fed decisions and the Brexit vote. The VIX, while it spiked upward on the Brexit vote, ended the quarter only 12 percent higher than it started, and spent the majority of the second quarter hovering near its lowest points of 2016 thus far. Low returns and low volatility seem the most likely course for the markets for the remainder of the year.

 

Hybrid Model Performance (net of a 1% annual management fee):

 

Model 2nd Quarter 2016
Aggressive 2.80 %
Growth 2.63 %
Moderate 2.50 %
Income 2.45 %

The hybrid models were defensively positioned for much of the second quarter, holding both inverse mutual funds as well as a large allocation to cash.

 

Globally, almost half of the markets turned in positive results for the second quarter, while half declined in value. The best performances among the upward moving markets were as follows:

 

Country Index 2nd Quarter 2016
Pakistan KSE 100 14.02%
Argentina Merval 13.02%
Philippines PSEi 7.35%
India BSE Sensex 6.54%
Russia RTS Index 6.23%

 

The top three indexes for the quarter are within countries that are difficult for foreigners to invest in and not on too many investors’ radar, but turned in strong results in most cases due to the bounce in oil and other commodity prices during the second quarter. India and Russia saw solid figures, with India’s results largely due to Prime Minister Modi signing several key trade deals with other countries. Russia bounced back, thanks in large part to the recovery in oil prices and the lack of military adventures being undertaken during the quarter.

 

Members of the European Union made up four of the bottom five performing indexes during the second quarter of 2016:

 

Country Index 2nd Quarter 2016
Poland WIG -8.71%
Czech Republic PX 50 -9.22%
Italy MIB -10.59%
Portugal PSI 20 -11.29%
Venezuela Caracas General -11.83%

The worst performance globally during the second quarter was found in Venezuela as the country tries to deal with a very unstable government, sky rocketing inflation and prices, food shortages and low oil revenues. It seems like only a matter of a short period of time before the Government of President Maduro is overthrown in Venezuela. Portugal, Italy, Czech Republic and Poland being in the next four worst performing index positions was not entirely surprising as many of the outlying European countries had a difficult time following the Brexit vote; unlike many global markets, their markets did not rebound.

For those of you who follow and are interested in the style box performance of various investments throughout the quarter, below is the standard style box performance for second quarter 2016:

 

Style /  Market Cap Value Blend Growth
Large Cap 3.91% 2.00% 0.19%
Mid Cap 4.18% 2.73% 1.25%
Small Cap 3.75% 3.40% 3.02%

Value investing won across the board during the second quarter of 2016 with all three market caps seeing value beat out blend as well as growth investing. Mid cap value investments posted the strongest performance during the second quarter. Overall, however, small caps performed very well during the quarter with some of the performance being due to the vast under performance seen in small caps during the first quarter of 2016. The large value trade also performed well and will likely continue in the near term as investors choose to hold large value/dividend oriented companies as opposed to long bonds to achieve their income needs.

 

The following table gives the performances of the top-performing sectors for the second quarter of 2016:

Sector Change
Commodities 12.55%
Natural Resources 12.25%
Energy 11.24%
Medical Devices 10.80%
Oil & Gas Exploration 9.45%

Many of the top performing sectors during the second quarter were related to the large upward move in commodities, and oil in particular, seen during the quarter. Medical Devices made the list solely due to a few large merger and acquisition deals that were announced during the quarter.

 

The bottom-performing sectors for the second quarter of 2016 were as follows:

 

Sector Change
Consumer Services -1.39%
Broker Dealers -3.21%
Consumer Discretionary -3.78%
Technology -4.34%
Transportation -5.48%

It was not surprising to see Transportation at the bottom of the list with such a large increase in the price of oil; the sector had been one of the top performing sectors while oil prices were moving lower. Seeing Consumer Discretionary and Consumer Services on the list of worst performing sectors is a little concerning as the consumer is the backbone of the US economy and the key driving force behind growth. If the consumer slows down its spending in a meaningful way, it could spell trouble for the overall health of the US economy.
Commodities were mixed throughout the second quarter as some assets declined, while others increased:

 

Commodities Change
GSCI Commodity Index 12.55%
Gold 7.51%
Silver 21.73%
Copper -0.12%
Oil 19.28%

 

Oil continued to rally during the second quarter after coming off the strong rally to finish out the first quarter. While global supply has largely remained unchecked during the increase, global demand does appear to have picked up a little. The safe haven aspect of Gold and Silver were seen at the end of the second quarter as investors fled to the metals in the wake of the Brexit vote.

 

The fixed income market was positive across the board, which was quite unexpected by the markets going into the second quarter:

 

Fixed Income Change
20+ Year Treasuries 7.00%
10-20 Year Treasuries 4.09%
7-10 Year Treasuries 2.83%
3-7 Year Treasuries 1.45%
1-3 Year Treasuries 0.52%
Short (less than 1 year) 0.15%
TIPS 1.80%

 

 

Going into the second quarter, many financial professionals, myself included, thought that the risk in the fixed income market was interest rates increasing during the quarter. That did not materialize and in fact rates moved lower on many of the fixed income investments during the quarter as demand increased, thanks in large part to negative interest rate policies being implemented in several key sovereign bond markets around the world during the quarter. Moving forward, it seems unlikely that rates will move much lower in the near future, but with all of the uncertainty surrounding central banks around the world, almost anything could realistically happen at this point. One thing remains clear: as interest rates start to move higher (they eventually will), bond prices will decline and investors in bonds will see their mark to market values decline, and then move back to par at maturity, which in some cases will be a very long time.

For a PDF version of the below commentary please click here Weekly Letter 7-5-2016

 

Commentary quick take:

 

  • Market statistics:
    • Markets dipped on Monday, only to recover through the rest of the week
    • Bond yields dipped to new lows
    • VIX fell by almost 43 percent

 

  • Brexit impact continues
    • Brexit vote pushed markets lower on Monday
    • Markets recovered losses through the remainder of the week as it became clear that the Brexit vote will not be sorted out any time soon
    • Italian banks under pressure from Brexit
    • British Pound continues to trade at levels not seen since 1985

 

  • Global manufacturing data was released last week
    • Overall manufacturing picked up in June
    • Germany saw strong growth in manufacturing
    • China’s manufacturing slowed, causing some concerns

 

  • US Fed seems stuck
    • Odds of a rate hike increased a little last week
    • Odds of a rate cut decreased last week
    • Looks difficult for the Fed to manage a single rate hike in 2016

 

  • Technical market view:
    • All three indexes broke below their trading ranges
    • All three indexes bounced back into their trading ranges at the end of the week
    • Markets will likely remain choppy for the near term

 

  • Hybrid investments strategy update:
    • Remains defensively positioned
    • Strong performance for the month of June
    • Won by not losing

 

  • This week for the markets:
    • Focus will likely remain on the repercussions of the Brexit
    • Low bond yields
    • Central Bank interventions in the markets

 

  • Interesting Fact: Juno is where?

Major theme of the markets last week: Markets recover from Brexit vote

cartoon 7-5-16

Last week was a very interesting week for the global financial markets as it was the first full trading week after the Brexit vote. After continued declines on Monday, the global markets recovered much of the losses from the Brexit results. The recovery in the financial markets was accompanied by a large decline in the VIX as investors came to the realization that while the UK voted to leave the EU, it does not mean that anything will happen quickly or that the UK will ultimately decide to leave the EU. The risk on trade was very apparent last week, with the exception of European banking shares as these companies saw their stock prices remain under pressure for much of the week without enjoying the recovery that many other companies around the world participated in.

 

Global news impacting the markets:

 

Last week the focus of the global financial news was related to the fallout of the Brexit vote as the world tried to understand what the immediate implications of the Brexit vote would be and how it could impact various companies and organizations that operate within the UK. In the absence of finality or political clarity surrounding the vote over the previous week, investors seem to be shrugging off the vote as having little chance of forcing the UK to leave the EU in the near future. The most immediate reaction from the Brexit vote was the large number of members of parliament in the UK that have resigned or been forced out of their positions, including many of the main figures in the vote to Leave corner. Boris Johnson dropping out of the race last week to replace Prime Minster David Cameron in October was a surprise to the global markets and many voters in the UK. Many thought he would lead the new party in negotiations with the EU about the formal departure of the UK from the union. With sustained levels of “uncertainty,” pertaining to how various countries will deal with the Brexit vote, and the unlikely resolution of the Brexit in the next few quarters or even years, the global markets at the end of last week turned to other topics for motivation to move the markets.

 

One topic the markets seemed to latch onto was the situation in Italy, concerning the poor performing loans that plague the country’s banking system. While there is no direct correlation between the Italian bank loans and the Brexit vote, many economists think there will be added pressure on Italy to fix its banking system quickly and not dilly dally around, waiting for the EU to offer a bailout. According to the Wall Street Journal, 17 percent of the banking loans in Italy are considered to be sour (bad loans at this point). This compares to the US having 5 percent sour loans at the height of the crisis in 2008-2009. With many savers in small banks that have already gone under in Italy over the last few years, having lost their deposits with the bank, there are fears that a banking crisis in Italy could materialize very quickly if banking stock prices in Italy continue to push lower. This problem in Italy has been known for an extended period of time and thus far the Italian government has failed to do much, if anything, about it. The officials and bank executives in Italy seemed to be hoping that the ECB would raise interest rates, which would help the bank become more profitable, despite the bad loans being carried. But now with the Brexit vote, there is a higher chance of further monetary easing from the ECB, as opposed to tightening, which the Italians were counting on. While the situation with the Italian banks could get out of hand very quickly, it is unknown if the negative impacts would spill over into the rest of Europe or if the problems would be contained. The ECB and other members of the EU have repeatedly put the task of fixing the problem on the Italians, telling them to deal with it. So, the ECB may just sit back and watch a little longer than they otherwise would if it were another country in trouble.

PMI 7-5-16

In other parts of the world last week, many countries including Japan released their latest manufacturing data, with mixed results being shown. The chart to the right from Econoday shows the latest reading on manufacturing, as measured by PMI in several different countries and regions. As you can see, the Eurozone (EMU, top bars) shows that overall, the Eurozone expanded their manufacturing during the month of May, when compared to June readings. Germany was the largest contributor to this positive change in PMI as its manufacturing data posted a 28 month high. The big concern on this chart and in the PMI data is China, which is right in the middle of the above chart. China releases two different versions of PMI, one that the government officially releases that said China saw a reading of 50 during June, which happens to be exactly at the inflection point between expansion and contraction, and one put out by a private firm Calxin. The Calxin reading for the month of June was 48.6, which is depicted above. The Calxin reading has long been seen as a more accurate reading of the manufacturing activity in China. With China visibly slowing down further, there is greater risk of a hard economic landing in China, which could have large ripple effects on the rest of the world. This is an area of the world that the global markets are watching very closely, as it has the potential to be by far the most disruptive event to the financial markets in the near term, and expectations are running high that the government will step in at some point in the near future and really push a lot of infrastructure spending in an attempt to get the economy in China moving forward again.

US news impacting the financial markets:

 

There was little US news that had any noticeable impact on the US financial markets last week as the markets traded with relatively light volume toward the end of the week, heading into a long three day weekend for the markets. One of the most interesting aspects of the financial markets here in the US last week was the yield on the 10-year US government bond, which hit very low levels right after the Brexit vote and has continued to push lower. The chart below form Bloomberg depicts the yield on the 10-year US Treasury and, as you can see, it currently yields about 1.4 percent.

10 year yield 7-5-16

If you factor in the Fed projected long-term inflation rate of 2 percent, investors in long 10-year treasuries are expecting to get a real return of -0.6 percent per year by holding 10-year treasuries. The real return is the yield of the bond minus the expected inflation rate. Yields this low on 10-year US government bonds is an indication of just how pessimistic investors are about the future growth of the US economy. Even with the yield so low, US treasury bonds still look great compared to many other sovereign bonds that are currently trading. According to the latest Fitch Rating agency report, there are currently $11.7 trillion dollars of debt trading globally with a negative yield. This means that the interest rate on the bond is actually negative and someone who purchases a bond and holds it to maturity will actually get less in total than they paid for the bond. In light of negative yields, the paltry 1.4 percent yield on US government bonds looks great! At least investors don’t have to worry if the government that issued the bonds will still be in place at the maturity of the bond with the US government. The other focus of the US financial news last week had to do with the Federal Reserve and speculation as to when it will potentially increase interest rates in the future.

Fed funds 7-5-16

The table to the right shows the current odds of interest rate changes at the next five FOMC meetings. As you can see, the odds for the next meeting are higher for a rate cut than a rate hike. The chance of a rate cut, however, has decreased significantly across all of the next five meetings, when compared to this time last week, thanks in large part to other central banks taking a wait-and-see approach to the Brexit fallout. If other central banks around the world had decided to cut rates early last week to help offset the Brexit risk, the US Fed would likely have gone along with it. With the financial markets recovering around the world, there does not appear to be an urgent need for a rate cut and thus the odds of one have diminished significantly. The flip side of interest rates is that there is currently only a 19 percent chance that the US Fed will manage to increase the interest rate in 2016.

sinking

Technical market review:

 

The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The red lines on the three major indexes depict the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 7-5-16

As you can see in the above charts, all three of the major indexes broke down through their closest support level early last week as a result of the negative markets movements with the Brexit vote. However, the markets formed what is known as a “V” shaped recovery and rebounded, gaining almost all of the Brexit declines back in just four trading days. Are these movements technically a “breakdown?” Some market technicians would say it was not technically a break down since there was no persistence to the markets staying below the support levels; it was more of a knee jerk reaction. Others would say it was a meaningful breakdown. I fall in between the two schools of thought as it clearly was a breakdown and did move through by a meaningful amount, yet it did recover quickly. I will keep the old support levels and there is likely much more significance in terms of actual strength at these levels than at the flash levels hit during Monday’s trading last week. In terms of technical strength, the Dow (upper right pane above) is in first place with the S&P 500 (upper left pane) in second, while the NASDAQ (lower left pane) remains in third place. All three indexes, however, are trading above the halfway point of their respective trading ranges with the Dow and the S&P 500 near the very top of the range, so we could get some meaningful breakout soon. The VIX was on a very wild ride last week, briefly touching almost 27 on Monday during the height of the fear trading over the Brexit. As the markets calmed down, however, so too did the VIX, ending the week at only 14.77, after having declined nearly 43 percent for the week.

 

Market Statistics:

 

Last week turned out to be a very positive week for the US financial markets, despite a rough start to the trading week:

 

Index Change Volume
NASDAQ 3.28% Above Average
S&P 500 3.22% Above Average
Dow 3.15% Average

 

All three of the major US indexes posted gains in excess of 3 percent for the first time since the week of November 16th, 2015, in what turned out to be a very large relief rally. As mentioned above, much of the relief was due to nothing really bad coming out of the Brexit vote, at least not yet. Volume was above average on two of the three major US indexes, which was unusual as the week leading up to the fourth of July is typically a slow week for the markets as it is a middle-of-the-summer trading week when volume is typically lower than average.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Utilities 5.92% Semiconductors 1.32%
Biotechnology 5.51% Healthcare Providers 1.20%
Infrastructure 5.28% Basic Materials 1.13%
Real Estate 5.24% Regional Banks 0.98%
Telecommunications 5.21% Broker Dealers 0.45%

There was an interesting mix in the sector performance last week as Utilities took the top honors with Biotechnology coming in second place. Very rarely are these two sectors together in the top two spots as they represent the polar opposites in terms of risk and return expectations for investors. Utilities is the most defensive of sectors, while Biotechnology is the least defensive sector out there. One reason for the results of last week is that investors were, for the most part, really defensive (buying Utilities) and yet a relatively small number of investors were very bullish on the hardest hit sector of the past few months (Biotechnology), hoping to get a magnified bounce when the markets turned around, which they did. On the flip side, it was not surprising to see that two financial related sectors took the bottom two spots—Regional Banks and Broker Dealers—both of which have some exposure to continued uncertainty from the Brexit. The other three sectors that made up the bottom 5 sectors seemed to have almost random reasons for being in those positions.

Fixed income markets were positive as bond traders and investors alike continued to adjust their positioning to the market’s reaction to the Brexit vote:

Fixed Income Change
Long (20+ years) 3.72%
Middle (7-10 years) 0.92%
Short (less than 1 year) 0.03%
TIPS 1.11%

Currency trading volume was high last week, thanks to traders continuing to adjust their positions around the British Pound and the Japanese Yen. Overall, the US dollar decreased by 0.08 percent against a basket of foreign currencies. The best performance of the global currencies was the Canadian Dollar as it gained 0.64 percent against the value of the US dollar, thanks to the increase seen in the price of oil throughout the week. The weakest of the major global currencies last week was the British Pound, for the second week in a row, as it declined by 2.57 percent against the value of the US dollar. With the uncertainty surrounding what will happen next with the UK, it would not be surprising to see the Pound continue to struggle against many of the other global currencies as currency traders typically do not like long-term political uncertainty affecting their trades.

Commodities were mixed last week, as metals advanced, while Grains declined in value:

Metals Change Commodities Change
Gold 1.90% Oil 3.33%
Silver 10.95% Livestock 0.21%
Copper 6.06% Grains -3.46%
Agriculture 1.62%

The overall Goldman Sachs Commodity Index advanced by 2.68 percent last week, as Oil increased 3.33 percent. Oil seemed to increase last week as violence in the Middle East picked up with the conclusion of a long religious holiday. The major metals were positive last week with Gold advancing 1.90 percent and Silver rocketing higher by 10.95 percent as the safe haven aspects of the two metals saw increased demand due to uncertainty about the Brexit. The more industrially used Copper increased by 6.06 percent, thanks to the mainly positive PMI numbers that came out from around the world over the course of the week. Soft commodities were strong last week with Agriculture overall gaining 1.62 percent, while Livestock advanced 0.21 percent and grains declined 3.46 percent over the course of the week. Corn continued to be under a lot of pressure last week due to a shift in the weather pattern that could impact a large amount of US production.

Last week, the vast majority of the global financial markets turned in positive gains for the week with some areas of the world that had been most hard hit by the Brexit vote seeing some of the largest gains. The best performing index last week was found in Argentina, the Merval Index, which turned in a gain of 8.5 percent for the week. The worst performing index last week was found in Venezuela, the Caracas General Index, which turned in a loss of 5.9 percent. It continues to look like President Maduro’s days as President in Venezuela are very numbered.

After gaining almost 73 percent over the course of just three weeks’ time last week, the VIX gave back nearly all of that gain in a single week. With the markets moving strongly higher it was not surprising to see that the VIX moved lower, but declining by almost 43 percent over the course of a single week is a large move for the VIX.  The current reading of 14.77 implies that a move of 4.26 percent is likely to occur over the next 30 days. With all of the uncertainty surrounding the Brexit vote and what it means for the future of the UK and the EU overall, it seems the VIX is very low, but that could be attributed to the fact that the VIX looks out only 30 days and the likelihood of anything happening with the Brexit vote over the next 30 days is in fact very low as well.

For the trading week ending on 7/1/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

Last Week June 2016 2016 YTD Since 6/30/2015
Aggressive Model 2.85 % 3.56 % 4.59 % 9.08 %
Aggressive Benchmark 2.97 % -0.70 % 0.46 % -4.65 %
Growth Model 2.66 % 3.31 % 4.40 % 7.89 %
Growth Benchmark 2.32  % -0.54 % 0.49 % -3.42 %
Moderate Model 2.37 % 3.13 % 4.22 % 7.07 %
Moderate Benchmark 1.66 % -0.34 % 0.46 % -2.26 %
Income Model 2.30 % 3.33 % 4.80 % 7.54 %
Income Benchmark 0.83 % -0.14 % 0.34 % -0.95 %
S&P 500 3.22 % 0.09 % 2.89 % 1.93 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

After participating in very little of the downside of the markets two weeks ago, the hybrid models last week far exceeded expectations with the snap back rally we saw at the end of the week last week. The hybrid model remains defensively positioned as knee jerk reaction by the markets does not constitute a signal that everything is fine and more offensive positioning is warranted. Winning by not losing really showed its true colors during the month of June, as is depicted in the chart of the hybrid models below:

performance 7-5-16

The chart above shows the S&P 500 drawn with the red line, while each of the risk levels of the hybrid models are drawn in the other color lines. The models were defensively positioned throughout much of the month, as they remain currently. You can see that the drops in the red line were greatly smoothed out by each of the models due to their defensive positioning. Even the decline that occurred on the indexes with the Brexit vote (right hand side of the chart) were successfully muted by this defensive positioning, which also happened to capture much of the upside gains that followed the Brexit decline. Moving forward, defensive positioning will likely remain warranted, but opportunities will be taken if good investments are seen. Currently, Mid Cap Value and Healthcare remain the top areas of the market we are closely monitoring for an entry position.

 

Economic Release Calendar:

 

Last week was a typical summer week for the economic calendar with two releases that beat expectations (highlighted in green below) and none than missed market expectations:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/28/2016 GDP – Third Estimate Q1 2016 1.10% 1.00%
Neutral 6/28/2016 Case-Shiller 20-city Index April 2016 5.40% 5.50%
Positive 6/28/2016 Consumer Confidence June 2016 98.0 93.1
Slightly Negative 6/29/2016 Personal Income May 2016 0.20% 0.30%
Slightly Positive 6/29/2016 Personal Spending May 2016 0.40% 0.30%
Neutral 6/29/2016 Core PCE Price Index May 2016 0.20% 0.20%
Slightly Negative 6/29/2016 Pending Home Sales May 2016 -3.70% -1.40%
Positive 6/30/2016 Chicago PMI June 2016 56.8 50.8
Slightly Positive 7/1/2016 ISM Index June 2016 53.2 51.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week started off with the third estimate of GDP for the US being released on Tuesday with the revision coming in very close to expectations and having little noticeable impact on the markets. The markets, however, did see a positive reaction to the release of the Consumer Confidence Index as measured by the government for the month of June when it handedly beat expectations. The increase in confidence did not spill over into increased spending, however,  as the personal income and spending reports released on Wednesday for the month of May indicated. We may see a nice uptick in the June reading for personal spending. We need to start seeing some of this confidence in the spending figures or the confidence will do nothing to help the US economy grow. A slightly negative surprise was released on Wednesday as the pending home sales figure for the month of May showed a decline of 3.7 percent when compared to the expected 1.4 percent decline. This decline in pending sales seems to indicate a US housing market that is slowing down and starting to move in a sideways fashion. On Thursday the Chicago area PMI for the month of June was released with a reading of 56.8 being shown, much higher than the expected 50.8 reading. We will have to wait and see if this positive manufacturing data is the start of a trend or just a single point anomaly. Last week wrapped up on Friday with the release of the ISM index for the month of June, which came in slightly higher than expected, but had little impact on the markets as most traders were already out the door heading to a long Fourth of July weekend.

 

This week is a shortened trading week and there are a relatively small number of economic calendar releases, but there are several that could impact the overall markets (highlighted in green below):

 

Date Release Release Range Market Expectation
7/6/2016 ISM Services June 2016 53.3
7/6/2016 FOMC Minutes Previous Meeting N/A
7/7/2016 ADP Employment Change June 2016 152K
7/8/2016 Nonfarm Payrolls June 2016 175K
7/8/2016 Nonfarm Private Payrolls June 2016 170K
7/8/2016 Unemployment Rate June 2016 4.8%

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Wednesday with the ISM Services index for the month of June, which is expected to show a reading of 53.3. After the slightly better than expected reading on the overall ISM late last week, it is reasonable to think that the ISM index could beat market expectations as well. The markets on Wednesday, however, will likely be much more focused on the FOMC meeting minutes being released from the last FOMC meeting, at which the Fed ultimately decided not to increase the Fed funds rate. There should be nothing new of note in the minutes, but it may shine a little light on the members who changed their thinking from four expected rate increases this year down to only 2 expected increases this year. On Thursday, the first of the employment related figures for the week is released, the ADP Employment change figure for the month of June, which is expected to show that 152,000 jobs were created during the month of June. On Friday, the big releases of the week are set to be released, those being related to the unemployment rate here in the US for the month of June. Overall, the unemployment rate in the US is expected to tick up from 4.7 to 4.8 percent, thanks in large part to increased participation in the labor market. The more important figures to watch on Friday, however, are the payroll figures after the bombshell that that dropped on the market last month. Expectations are for the figures to return to normal, around 170,000 jobs each after posting sub 40,000 jobs for the month of May. The revision to the May figures could also be interesting to see on Friday. Jobs growth needs to get back on track if there is any chance of the Fed increasing the interest rate, either this year or probably through the first half of 2017 as well. In addition to the scheduled economic news releases this week, there are also three speeches being given by FOMC members that the market will likely be watching very closely for signs that the projection from the Fed about the timing of increases to the Fed funds rate is changing.

 

Interesting Fact Jupiter is now being observed by the Juno spacecraft.

 

The Juno space craft on Monday successfully entered the orbit of Jupiter after traveling 1.8 billion miles over the course of the past 5 years (top speed for Juno is 165,000 miles per hour). It has been 10 years since another space craft has been by Jupiter, but Juno is there to stay as its mission is to gather new information about the makeup of Jupiter from an altitude of about 3,000 miles above the clouds.

Juno 7-5-16

Source: nasa.gov

 

Have a great week!

Peter Johnson

 

A referral from a client is a tremendous compliment and a huge responsibility that can never be taken lightly.

For a PDF version of the below commentary please click here Weekly Letter 6-27-2016

Commentary quick take:

 

  • Market statistics:
    • Markets were rocked by the surprise Brexit vote
    • Volume spiked on Friday after the vote was in
    • Chair Yellen didn’t impact the market
    • VIX spiked higher by 32 percent for the week

 

  • Brexit Vote is done; they are leaving!
    • Leave won by more than a million votes
    • Prime Minister Cameron resigned, effective October
    • Flight from risk assets around the world
    • Gold jumped $65 an ounce on Friday
    • British Pound trading at levels not seen since 1985
    • Will the vote have any impact?
    • Does this mean the EU will fall apart?

 

  • Chair Yellen testimony
    • Statement was little changed
    • Q&A session held little new information
    • Chance of a rate hike this year all but gone
    • Chance of rate cut by the Fed is now in the cards

 

  • Technical market view:
    • All three indexes are either at or below their support levels
    • VIX second highest this year
    • Markets could break either way in the coming days

 

  • Hybrid investments strategy update:
    • Defensively positioned
    • Performed very well on Friday
    • For the week, declined only slightly
    • Took advantage of some of the market dislocations on Friday

 

  • This week for the markets:
    • Brexit will still be the main topic
    • Bond yields around the world likely to be a hot topic
    • Bank of Japan is likely to announce some sort of stimulus to try to weaken the Yen

 

  • Interesting Fact: The world’s largest land owner may surprise you.

 


Major theme of the markets last week: “Leave” won the Brexit vote!

Brexit cartoon

Much to the dismay of many people around the world last Thursday, the people of the UK voted to leave the EU in the Brexit vote that so many financial professionals and pundits alike had been talking about for months. The vote turned out to be a surprise to many, despite all of the data coming in during the week or two leading up the vote, which showed the race was too close to call and that the majority of the pools were within the statistical margin of error. The surprise may not have been experienced by the financial markets alone as leading up to and following the vote, the most googled terms coming out the UK was, “What is the EU?” The global financial markets reacted negatively, as one would expect, after the markets were caught by surprise on Friday, pushing lower almost without exclusion around the world on the first trading day after the vote. The British Pound was hammered by nearly 10 percent versus the value of the US dollar as the currency saw one of its worst trading days ever. While the vote is now behinds us, the aftermath of the vote is still very much in question. Will the UK actually leave the EU? Was the vote binding? Will the process be fast or slow? What country will hold a vote to leave next? And, perhaps the most important question following the vote: “Is this the beginning of the end for the European Union?”
Global news impacting the markets:

 

US news that impacted the financial markets was moved down this week for obvious reasons, given the significance of the events in the UK and their impact on the global markets. On Thursday last week, the long awaited Brexit vote was held in the UK and, as expected, the world was on pins and needles awaiting the results as the vote started to be counted Thursday evening. Voting day had some bad weather in parts of the UK, but in general voter turnout was high and in the end the vote, while close in terms of percentages, was not very close in terms of the actual number of votes cast for each side. The Leave camp managed to get 17,410,742 votes, while the Remain camp only pulled in 16,141,241 votes, with a difference of 1,269,501 more votes for Leave than Remain. Voter turnout was high at 72.16 percent; much higher than here in the US, where a good presidential election vote sees turnout of just over 50 percent. Historical voter turnout in the UK runs about 65 percent, looking back over the past few election cycles, so even by British standards the turnout was strong. With the crushing blow dealt to the current government in the UK, Prime Minister David Cameron announced that he would be stepping down as Prime Minister in October and that he would hold off on invoking Article 50 at this week’s EU meeting. A few more of the high points from the vote that could affect the financial markets in the near term:

 

    • The process could take a very long time
    • There are several ways this vote could be overridden
    • The EU cannot kick the UK out
    • Article 50 has not been triggered

 

While the vote is behind us, what the vote actually means is currently open for interpretation. First, the UK will not be leaving the EU any time soon. Article 50 of the Lisbon treaty is the only article that deals with and outlines how a country may decide to leave the EU, after being a member. The government of the country that wishes to leave must formally let the other EU member countries know of its wish to leave the union. Once formal notice has been given, the country leaving and the EU have a two-year clock that starts for the negotiations. If no deal is reached in the two-year time period, all ties that are the result of the EU agreement are severed at the end of the two years. However, there is nothing that says, even after a vote like we saw last week, that the UK has to start the two-year clock. The winning group from the vote last week has already called for the start of informal negotiations between the UK and the EU, to discuss the best way to move forward.  To that request, however, German Chancellor Angela Merkel said there will be no discussions, either formal or informal, between the UK and the EU about the UK leaving until Article 50 has been enacted. The vote itself is also being called into question.

 

The Brexit vote was an “advisory non-binding referendum,” which technically means that it was done so that members of parliament could check the temperature of the UK citizens as it relates to how they feel about being part of the EU. Parliament would have to vote to leave the EU in order for the UK to formally trigger Article 50. One outcome is that parliament could essentially ignore that the vote even occurred. Another option that is already moving forward to try to stop the Brexit is a petition of the general public that wants more rules on a Leave vote. For example, Leave must garner at least 60 percent of the vote in an election that sees at least 75 percent voter turnout. A third option is for a new general election with which the Remain camp wins a clear majority in the government; this “new vote” would supersede the Brexit vote. A fourth, and perhaps most intriguing option for the UK staying in the EU, and probably the most welcome by the EU, is that a significant change to the “conditions” could mean that a new referendum vote would need to be called. Several news outlets online have pointed to this fourth option as the most likely outcome from this mess. The fourth option means that if the UK formally announces to the EU that it wants to leave and negotiations start under Article 50, that if the changes and or concessions given to the UK by the EU are enough of a “change in conditions,” that a new referendum vote would need to be called for. One example would be if the EU offered to not allow the free movement of immigrants to the UK from the rest of the EU. That would mean the immigration card that the Leave vote played hard during the campaign would no longer be valid. This would effectively be offering an olive branch for the UK to stay. The EU cannot afford to go easy on the UK in this situation because if they did give the UK everything the Leave party wants, other countries would surely start to demand the same type of things and the whole premise of the EU would fall apart.

 

This stopping of the snowball effect in the EU has to be the number one priority of countries like Germany and other strong EU member countries. Already, there are calls for the next country to vote to leave being The Netherlands, France, Poland or Switzerland; with each country coming up with its own interesting acronym for the Leave term being combined with the country’s name. A few countries that get much more from being a member of the EU than they would on their own include countries such as Greece and Spain, which would never realistically vote to leave the EU because of the large amount of handouts each receives under various agreements between EU member countries.

 

Where does all of this leave the UK and the rest of the world? In limbo, is the best way to describe it. Financial companies based the UK seem to have taken the brunt of the vote downdraft with several banks in the UK falling in excess of 20 percent on Friday and continuing to slide in early trading on Monday. Demand for safe haven assets increased substantially on Friday, as one would expect, and volatility across various types of financial instruments increased, also as expected. Going forward, the global financial markets will probably move on various announcements that come from both sides in Europe, as well as central banks around the world as they all attempt to quell the downward market movements. Swap lines were open all day (as they always are) among central banks on Friday and several governments stepped in to affect the value of their currencies, but in general the markets behaved very well for how big of an event we could have very easily seen. Japan, however, seems to have been thrown into an even deeper hole by the Brexit vote as the Yen strengthened by a large amount on Friday, making the policies of Abenomics even less beneficial to the Japanese economy than prior to the vote when it was already not working very well.

 

US news impacting the financial markets:

 

It is a very interesting week for the US financial markets when the Chair of the Federal Reserve holds her twice per year testimony and almost no one is talking about it. Chair Yellen spoke on Tuesday and Wednesday last week to members of Congress and gave her assessment of the US economy as well as her thoughts about the economy moving forward. She also took questions for many hours from various members of both houses. Her prepared remarks were nearly identical to the statement she read at her press conference after the rate decision two weeks ago and held very little new information. If anything, she was a little more cautious in thoughts as to the timing of a rate hike, making July look like it is now off the table for a potential rate hike as well, much like June was. This moved the Fed watch numbers from between a 10 and 38 percent chance of a rate hike at the next few meetings a little bit lower. However, the movement after the Brexit vote is what really caught many people off guard. As you can see in the table above, after the Brexit vote occurred, the chance of a rate hike by the Fed here in the US essentially went to zero for the July, September and November meetings. Once you get to the December and February meeting, there is now only a 15 percent chance of a rate hike. The more interesting thing in the table above is the percentage chance of a rate decrease, ranging from 6 percent at the July meeting all of the way to a peak of 19 percent at the November meeting. We went from how fast and high rates could go to rates could be cut all in the span of less than two days; it was very interesting to watch. With the prospects of rates being lower for a lot longer than was generally expected, it was not surprising to see the yield on the 10-year US government Bond fall briefly below 1.5 percent. Low rates for a long and even longer period of time seems to be the norm at this point and there looks to be very little that will change this situation here in the US.

Fed watch 6-27-16

Technical market review:

 

The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The red lines on the three major indexes depict the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 6-27-16

It is difficult to see in the above charts, but there was a lot of movement on the charts on Friday (the furthest right points on the charts) last week. All three of the above indexes moved lower with the Dow (upper right pane above) breaking through its lower support level to the downside. Both the S&P 500 (upper left pane above) and the NASDAQ (lower left pane above) came crashing down to their support level and did not break through to the downside. Monday will be a very telling day for these two indexes as they technically look poised to potentially bounce higher, but the political uncertainty may be too much for technical trading. While the markets were pushing lower, the VIX (lower right pane above) spiked all of the way up to the highest level we have seen since February of this year. Volatility was seen to have picked up in the two weeks leading up to the vote, as was expected. At this point, the VIX still has some room to move higher, especially if the negotiations in the UK between the Labor party and other political parties get out of hand. The next few weeks will probably be very volatile, both in terms of VIX movements as well as market movements, with large swings both up and down as investors try to sort out what will happen to the UK and, in turn, the EU.

 

Market Statistics:

 

Last week was a negative week for the US financial markets as well as many markets around the world as investors listened to Chair Yellen early in the week then watched the Brexit vote unfold late in the day on Thursday:

 

Index Change Volume
Dow -1.55% Above Average
S&P 500 -1.63% Above Average
NASDAQ -1.92% Way Above Average

 

Not surprisingly, volume was above average across the board last week, with the first jump in volume being due to Chair Yellen testifying before Congress and the second being on Thursday and Friday surrounding the Brexit vote. While the markets were down in a big way on Friday, when looking at the week as a whole, it turned out to not be all that bad of a week for the US financial markets. Moving ahead, volatility will likely remain in earnest as the Brexit decisions, discussed above, are worked through.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Telecommunications 0.53% Technology -4.23%
Medical Devices -0.01% Transportation -3.66%
Real Estate -0.03% Financials -3.38%
 Preferred Stocks -0.03% Broker Dealers -3.24%
Healthcare Providers -0.15% Basic Materials -3.22%

Three of the five best performing sectors of the markets were defensive sectors last week as Telecommunications, Real Estate and Preferred Stocks all had good weeks on a relative basis. Medical Devices as well as Healthcare Providers also made it into the top 5 list, thanks in large part to healthcare overall seeing muted downside trading last week. The sector had declined so much leading up to last week that investors decided not to sell and put further downward pressure on the group. On the downside, it was not surprising to see Financials and Broker Dealers make the bottom five list as any exposure to financials seemed to be hit last week, thanks to the British banks falling on average 20 percent on Friday. One sector that is very concerning to see on the list of the bottom five is the Transportation sector. Typically the Transportation sector is a defensive sector and a leading indicator of the overall health of the US economy. Seeing this sector struggling so much is cause for concern about the near-term future movements for the financial markets here in the US.

Fixed income markets were positive as bond traders and investors alike adjusted their positioning to Chair Yellen’s comments early in the week and the flight toward safety that was seen after the Brexit vote at the end of the week:

Fixed Income Change
Long (20+ years) 0.13%
Middle (7-10 years) 0.44%
Short (less than 1 year) 0.03%
TIPS 0.34%

Currency trading volume was high last week, thanks to traders adjusting massive positions to the new world, post Brexit vote. Overall, the US dollar advanced by 1.61 percent against a basket of foreign currencies. The best performance of the global currencies was the Japanese Yen, much to the chagrin of Prime Minster Abe, as it gained 1.87 percent against the value of the US dollar, thanks to one of the largest moves in the Yen that we have seen without BOJ intervention. The weakest of the major global currencies last week was the British Pound, as expected give the vote results, as it declined by 5.06 percent against the value of the US dollar. The decline in the pound on Friday was the steepest daily decline of the last 10 years and pulled the pound down to a level not seen since 1985, in terms of its value. In the grand scheme of things, the 10 percent correction seen in the pound on Friday was not as bad as it could have been. Some pundits had been calling for an even larger decline in the pound should the UK vote to leave and thankfully that did not materialize.

Commodities were mixed last week, as metals advanced, while Oil and most agricultural commodities lost value:

Metals Change Commodities Change
Gold 1.66% Oil -2.23%
Silver 1.75% Livestock -3.81%
Copper 2.90% Grains -9.02%
Agriculture -5.01%

The overall Goldman Sachs Commodity Index declined by 2.30 percent last week, as Oil decreased 2.23 percent. The majority of the decline in Oil was seen after the Brexit vote as future demand for oil was called into question by the result of the vote, which made little sense. The major metals were positive last week with Gold advancing 1.66 percent and Silver gaining 1.75 percent as the safe haven aspects of the two metals saw increased demand due to uncertainty about the Brexit. The more industrially used Copper increased by 2.90 percent. Soft commodities were weak last week with Agriculture overall falling 5.01 percent, while Livestock gave back 3.81 percent and grains declined 9.02 percent over the course of the week. Corn in particular was hit very hard last week as hedge funds unloaded some of their more volatile positions (corn being one of them) and pushed corn prices down 12 percent during trading on Friday, which is the steepest decline in corn prices in more than 3 years.

Last week was a very mixed week for global financial markets as there were 6 markets that turned in positive results, while the rest posted losses. The best performing index last week was found in Sweden, and was the OMX Stockholm 30 Index, which turned in a gain of 4.8 percent for the week. The gain isa little misleading, however,  as the market in Sweden was closed for a holiday on Friday, so there was no negative trading as a result of the Brexit vote. The worst performing index last week was found in Spain and was the IBEX 35 Index, which turned in a loss of 6.9 percent. The decline in Spain was mainly because of the weakness in the economy and the feared domino effect that could result from the Leave vote out of the UK. The bond yields in Spain also spiked on Friday, as did the cost to insure Spanish bonds. While other countries look primed to be the next to explore leaving the EU, Spain looks far too weak to realistically consider the prospects of willingly leaving, in whole.

The VIX made it three weeks in a row of gains last week after advancing by 32.72 percent for the week. In total, over the past three weeks the VIX has now gained almost 73 percent and moved from one of the lowest points thus far for 2016 up to nearly the highest of 2016. With the markets seemingly not giving a lot of chance to the Brexit vote going through, it was not surprising to see such a large move in the fear gauge when the vote was tallied. The current reading of 25.76 implies that a move of 7.44 percent is likely to occur over the next 30 days. Last week I mentioned that the VIX would likely be higher leading up to and through the Brexit vote after such odd movements in the index over the previous few weeks. My thinking remains that the VIX still has some upside to move, given the uncertainty over the whole situation with the EU and the UK, even after such a large move over the past few weeks.

For the trading week ending on 6/24/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model -0.09 % 1.68 % 6.03 %
Aggressive Benchmark -1.33 % -2.44 % -7.41 %
Growth Model -0.15 % 1.68 % 5.06 %
Growth Benchmark -1.01  % -1.79 % -5.60 %
Moderate Model -0.11 % 1.80 % 4.57 %
Moderate Benchmark -0.71 % -1.18 % -3.86 %
Income Model -0.04 % 2.43 % 5.10 %
Income Benchmark -0.34 % -0.49 % -1.77 %
S&P 500 -1.63 % -0.32 % -1.25 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

Going into last week, as we had been for the past several weeks, we were very defensively positioned. Leading up to Friday, it looked like the markets were going to end up with a large gain for the week, of which we would have participated in a good portion of, but certainly not the whole move. Then on Friday our defensive positioning really proved what it was worth as the hybrid models all gave up significantly less than the markets and easily made up the performance deficit that had grown earlier in the week. On Friday we took the large decline at the open of trading to fill out positions for some accounts that were light on individual stocks, ETFs and or mutual funds. Our hedging position remains in place as the cost of some downside protection pales in comparison to the downside it protects against. Going forward, the hybrid models remain defensively positioned and ready to take further advantage of market dislocations, should they arise.

 

Economic Release Calendar:

 

Last week was a slow week for economic news releases in terms of the number of releases, but the markets did have bigger things to focus on:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/22/2016 Existing Home Sales May 2016 5.53M 5.50M
Neutral 6/23/2016 New Home Sales May 2016 551K 560K
Negative 6/24/2016 Durable Orders May 2016 -2.20% -0.60%
Slightly Negative 6/24/2016 Durable Orders, ex-transportation May 2016 -0.30% 0.10%
Neutral 6/24/2016 University of Michigan Consumer Sentiment June 2016 93.5 94

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The economic news releases last week started on Wednesday with the release of the existing home sales figure for the month of May, which came in as expected at just over 5.5 million units sold during the month. The May new home sales figure was released on Thursday and it too came in very close to market expectations and had little impact on the overall markets. On Friday, while the world was watching the fallout from the Brexit vote the previous day, the government released the latest readings for durable goods orders for the month of May, which were shown to have declined by 2.2 percent overall and by 0.3 percent when transportation was removed from the calculation. Both of these figures were not positive developments for the overall health of the US economy, but investors did not pay any attention at all to the figures as they were acutely focused on the fallout of the Brexit vote and its impact on the markets. Wrapping up the day on Friday was the University of Michigan’s Consumer Sentiment Index for the month of June, which came in slightly below expectations, but even on a typically boring Friday afternoon this release would have had very little if any noticeable impact on the markets, so it was completely ignored with all that was happening in the global markets last Friday.

 

This week is a typical summer week for economic news releases and there are a few releases that could have a noticeable impact on the markets (highlighted in green below):

 

Date Release Release Range Market Expectation
6/28/2016 GDP – Third Estimate Q1 2016 1.00%
6/28/2016 Case-Shiller 20-city Index April 2016 5.50%
6/28/2016 Consumer Confidence June 2016 93.1
6/29/2016 Personal Income May 2016 0.30%
6/29/2016 Personal Spending May 2016 0.30%
6/29/2016 Core PCE Price Index May 2016 0.20%
6/29/2016 Pending Home Sales May 2016 -1.40%
6/30/2016 Chicago PMI June 2016 50.8
7/1/2016 ISM Index June 2016 51.4

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

This week the economic news releases start on Tuesday with the release of the third estimate (should be final this time) of GDP for the first quarter of 2016 here in the US. The second estimate released a month ago showed the GDP estimate to be 0.8 percent growth. If we see this number revised higher it would technically be a positive development, but with it being such a low number, it will not really matter all that much. Consumer confidence released later during the day on Tuesday may have a larger impact on the markets if it is seen to fall below the expected 93.1 level for the month of June, which had many concerning things occur during the month, such as the possibility of a rate hike and a lot of negative information released about the Brexit vote. On Wednesday, personal income and spending will likely trump the pending home sales figure as well as the Core PCE price index, which are also released at the same time. None of these releases should have much impact on the markets overall unless they come in very different than is expected. On Thursday, the Chicago area PMI for the month of June is expected to print 50.8, dangerously close to the 50.0 inflection point between expansion and contraction. If we see this number dip below 50 it would be a negative development for the markets overall. On Friday, all of the June manufacturing data is aggregated together and released in the form of the ISM Index for the month of June, which is expected to safely remain above 50 at 51.4. Much like the Chicago number released on Thursday, if this release dips below 50 it would be a negative development for the economy overall here in the US. While the above economic news releases may be of interest to the overall markets, the impact of the release are very small when compared to the potential impact of the ongoing Brexit talks, which could have a much more significant impact on the overall global markets.

 

Interesting Fact The world’s largest land owner may surprise you.

 

The Queen of the UK is the legal owner of one-sixth of the Earth’s land surface.

 

Source: http://www.newstatesman.com/global-issues/2011/03/land-queen-world-australia

For a PDF version of the below commentary please click here Weekly Letter 6-20-2016

Commentary quick take:

 

  • Market statistics:
    • Markets were down by more than 1 percent in the US
    • Volume was average, thanks to quadruple witching on Friday
    • No change from the US Fed
    • VIX spiked higher by 35 percent at one point during the week last week

 

  • FOMC June meeting yielded no change:
    • Very dovish statement
    • Kept rates unchanged
    • Lowered outlook for rates going forward
    • One dot missing on the longer run dot plot projection
    • Nikkei declined as the Yen advanced on the Fed announcement

 

  • Brexit 4 days away:
    • Anti-Brexit law maker killed last week
    • Odds are tightening
    • “What if” scenarios are surfacing more and more
    • Central banks around the world seem to be waiting

 

  • Trouble in Venezuela continues
    • OPEC forcing regime change?
    • China met with opposition leadership about debt repayments

 

  • Technical market view:
    • All three indexes are in the middle of their trading ranges
    • VIX spiked over 20 in the middle of the week
    • VIX ended the week at the highest level since February

 

  • Hybrid investments strategy update:
    • Defensively positioned
    • Fed decision on rates had little noticeable impact on the models
    • Waiting on Brexit vote

 

  • This week for the markets:
    • Chair Yellen gives her semiannual testimony before Congress
    • All eyes will be on the Brexit vote

 

  • Interesting Fact: Denver International Airport is larger than San Francisco

 

 


Major theme of the markets last week: Brexit vote is upon us

funny 6-20-16-2

Source: Alexander Dubovsky www.cartoonmovement.com

 

The news cycle of the past few months has focused on two main topics: the US Federal Reserve decision at the June meeting and the Brexit. With the Fed decision now behind us, the full attention of the global financial markets falls on the Brexit vote, which is being held on Thursday in the UK. In what has been called a potential “beginning of the end” moment for the EU, voters will take to the polls on Thursday under the dark cloud of a member of parliament, who was against the UK leaving the EU, having been killed last week as she was heading to a rally. The latest polls show that the race will end up much closer than was thought two weeks ago when the exit contingent was leading in many of the polls. Investors seem to be taking few chances, pushing up the price of VIX-based investments and moving into conservative areas of the investable markets. Markets will likely remain on edge until the vote and then quickly try to decipher the results, which should be known while the US markets are still open on Thursday afternoon.

 


US news impacting the financial markets:

 

Here in the US last week the focus of the week was on the US Federal Reserve’s FOMC meeting for the month of June, which was held on Tuesday and Wednesday last week, concluding with the release of the statement about interest rates and a press conference held by chair Yellen. The June meeting yielded no change on the Federal Funds rate, which stayed between 0.25 and 0.5 percent, as it has been since the last rate hike back in December of 2015. The vote was unanimous at this meeting as even Kansas City Fed President Esther George voted to keep rates unchanged after dissenting at the March and April meeting; she argued that rates should have been increased at those previous meetings.  While June had seemed to be a target for the second rate hike for several months, all of that was thrown out the window with the poor employment figures released two weeks ago, which showed very weak jobs growth during the month of May. The Fed statement was one of the most dovish statements the Fed has released in a very long time. The Fed is often referred to as either dovish or hawkish. If the Fed is said to be dovish, it is being more accommodative and keeping interest rates low and keeping prospects for higher rates in check. A Fed that is being more hawkish wants rates to be higher, is in favor of taking action faster and is generally much more proactive than reactive in policies. With the majority of the projections being moved lower and the uncertainty over foreign actions and events such as the Brexit and the slowdown in China, the current Fed is taking a dovish stance with a sort of wait-and-see mentality. Now that the June meeting is behind us and the markets have had time to recalibrate their expectations for future rate hikes, the Fed Watch numbers from the CME group are little changed, as you can see in the chart to the right. With the language about the prospects of the rates being increased in the next few meetings removed from the statement, it was not surprising to see the July expectation percentage decrease. However, the final three major meetings of the year saw the odds of a rate hike remain roughly unchanged. What did change, quite dramatically, last week were many of the Fed projections released in the statement.

Fed watch 6-20-16

The expectations for GDP here in the US from the Federal Reserve were lowered for 2016 from 2.2 percent down to 2.0 percent, while the 2017 projection was lowered by a tenth of a percent down to 2.0 percent. The longer run expectation of 2.0 percent growth here in the US was unchanged. The unemployment rate expectations were largely unchanged with the rate being between 4.6 and 4.8 percent for the foreseeable future, which is a level slightly lower than the current level of 5.5 percent, which was seen in the latest report from the Department of Labor. The inflation expectation figures were largely unchanged and remain below the targeted rated of 2 percent until at least 2018. Some of the biggest changes in the projections came in the expected Fed funds rate projections. Expectations went from seeing two rate hikes during 2016 down to only a single rate hike during 2016 and from two rate hikes in 2017 down to a single rate hike in 2017. The longer run projection of the Fed funds rate was also lowered from 3.3 percent down to 3.0 percent. On the dot plot (a plot that shows each Fed officials’ expectations for the Fed funds rates at various points in time) one Fed official, James Bullard, decided that the “usefulness of the model involving long-run forecasts may have come to an end in the last year,” and chose to withhold even placing his dot on the chart for the long run projection. So why the downtrodden expectations? Chair Yellen at her press conference conceded that some of the headwinds she has been watching over the past several quarters that she initially labeled as “transitory in nature” may be more persistent than first thought. She also pointed out that other factors, such as China slowing down and the Brexit vote, played a role in the decision that was made. While the US Federal Reserve is supposed to worry about only two things—full employment and price stability—it is obviously worrying about many more factors in the current environment when making its decisions.

 

Global news impacting the markets:

 

At the conclusion of the Fed meeting here in the US on Wednesday the global investment community focused on the Brexit vote, which is taking place on Thursday this week. As mentioned above, a member of parliament was killed last week as she was going to a rally for the Stay campaign, which put a temporary halt on both campaigns out of respect for her. Going into last week it looked like the latest polls showed that the Exit vote was widening its lead over the Stay campaign, but after last week the polls have tightened down and are now within the margin of error of most of the polls. Immigration remains one of the main topics for the Exit vote as they are trying to spin that Turkey becoming a member of the EU would lead to a large number of Turkish people migrating to the UK under the EU free movement agreement. With every poll that came out last week it seemed the VIX (fear gauge) here in the US would move. If the polls showed Exit gaining, the VIX would move higher; if it showed them giving up ground, the VIX would move lower. While the financial markets around the world were focusing on the Brexit vote last week there were also a few developments in Venezuela that will likely get more attention in the coming weeks.

 

As mentioned a few weeks ago, Venezuela is in real economic trouble with the price of oil still much lower than where the country needs it to be to service its outstanding debts and provide basic staples to its citizens. Inflation has been running rampant and shortages of basic food staples as well as electricity and gasoline are commonplace and only getting worse. President Maduro looks to be on his way out as public opinion of him is near all-time lows and there is building political pressure to overthrow the government. China last week sent an “unofficial” envoy to Venezuela to meet with the heads of the opposition movement to make sure that a new government in Venezuela, should it come to power, would still honor the debts that China has with the country. China is currently the largest foreign lender to the country ($65 billion since 2005) and does not want to be left holding the bag if a new government decides it does not want to pay the previous government’s obligations. The leader of the opposite group Henrique Capriles also made headlines last week as he had meetings with the Presidents of Argentina and Paraguay as well as officials in Brazil. Revolution looks to be coming once again to Venezuela and while it may not be led by as charismatic a character as Huge Chavez the last time it occurred, the changes will likely be just as dramatic. Hopefully, the changes will benefit the global financial markets and not make the country, with such vast oil reverses, even more reclusive.

 

Technical market review:

 

With the three major US markets all moving noticeably lower last week all three markets now find themselves in the middle of their respective trading ranges. While the three equity markets pushed lower last week, the VIX came alive and moved significantly on fears that the Brexit may actually take place and the UK would leave the European Union. The VIX made quick work of the previous high level (16) of the past two months and easily blew through the average level of the VIX that we have seen over the past year. At one point last week the VIX had managed to increase by almost 35 percent over the course of less than three full trading days. This type of volatility was expected as we move closer to the Brexit vote, as the downside to an Exit vote seems to far outweigh potential positive gains if the vote is to stay in the EU. The charts below show each of the three major indexes, plus the VIX, drawn with green lines. The red lines on the three major indexes depict the closest resistance levels, as represented by points that have been tested on each index several times in the last 6 months. The blue lines represent the closest level of support for each of the indexes, established by points that the markets have touched in the past prior to bouncing higher. For the VIX, the red line remains the rolling 52-week average level of the VIX.

4 charts combined 6-20-16

We will likely see the equity markets make a run at either the upper or lower ends of their respective trading ranges this week as we will likely see a lot of volatility leading up to the vote and each of the trading ranges is only about 3 percent wide. The VIX is currently projecting a move of more than 5.5 percent over the next 30 days. The direction of the move is unknown, but moving 5.5 percent in either direction will easily move the indexes out of their trading ranges.

 

Market Statistics:

 

Last week was a negative week for the US financial markets as investors weighed no rate hike by the Fed and increased uncertainty about the Brexit vote:

 

Index Change Volume
Dow -1.06% Above Average
S&P 500 -1.19% Average
NASDAQ -1.92% Average

 

Volume overall last week was about average, but it was actually much lower than average if you factor in Friday’s trading being largely due to quadruple witching. Quadruple witching occurs when there are four different options contracts expiring on the same day, which happens only four times per year. Typically, volume is high on these days as investors in certain options contracts have to either buy or sell the underlying asset to close out the option contract. If we had seen a normal option contract day on Friday, the overall weekly volume for the three major indexes would have been below average across the board.

 

When looking at sectors, the following were the top 5 and bottom 5 performers over the course of the previous week:

 

Top 5 Sectors Change Bottom 5 Sectors Change
Telecommunications 2.02% Biotechnology -4.20%
Residential Real Estate 1.71% Pharmaceuticals -3.21%
Utilities 0.56% Financial Services -3.15%
Infrastructure 0.02% Regional Banks -3.11%
Energy -0.03% Transportation -2.18%

The top 5 sectors for the week last week were a little interesting as defensive sectors such as Real Estate and Utilities made the list, as did offensive sectors such as Telecommunications and Energy. There were not any clear trading trends last week as the volatility was just too high to glean any sensible information from the movements. The negative performing sectors were much clearer as Biotechnology and Pharmaceuticals led the way down in a big way, with most of this decline attributed to Hillary Clinton leading in the polls against Donald Trump. Banks also made the negative list as Financial Services and Regional Banks moved lower after the Fed announcement that rates were going to be unchanged at the conclusion of the June meeting.

Fixed income markets were positive as bond traders and investors alike adjusted their positioning to Chair Yellen’s comments on Monday:

Fixed Income Change
Long (20+ years) 0.62%
Middle (7-10 years) 0.24%
Short (less than 1 year) 0.02%
TIPS -0.36%

Currency trading volume was high last week, thanks to the Fed decision and the looming Brexit vote. Overall, the US dollar declined by 0.45 percent against a basket of foreign currencies. The best performance of the global currencies was the Japanese Yen, much to the chagrin of Prime Minster Abe, as it gained 2.46 percent against the value of the US dollar, thanks to the US dollar falling after there was no rate hike by the Fed. The weakest of the major global currencies last week was the Swedish Krona as it declined by 1.00 percent against the value of the US dollar. At the conclusion of this week we will likely see the British pound either up by more than 2 percent or down by more than 2 percent, depending on which way to vote turns out.

Commodities were mixed last week, as metals advanced, while oil and most agricultural commodities lost value:

Metals Change Commodities Change
Gold 1.82% Oil -1.77%
Silver 0.67% Livestock -1.05%
Copper 1.38% Grains 0.52%
Agriculture -0.09%

The overall Goldman Sachs Commodity Index declined by 1.14 percent last week, as Oil decreased 1.77 percent. Oil’s decline seemed to have more to do with the global supply and demand imbalance that we have been seeing over the past year than anything else. The major metals were positive last week with Gold advancing 1.82 percent and Silver gaining 0.67 percent as the safe haven aspects of the two metals saw increased demand due to uncertainty about the Brexit. The more industrially used Copper increased by 1.38 percent. Soft commodities were weak last week with Agriculture overall falling 0.09 percent, while Livestock gave back 1.05 percent and Grains added 0.52 percent over the course of the week.

Last week there were only two global markets that managed to turn in positive performance for the week. The best performing index last week was found in the Philippines, and was the PSE Index, which turned in a gain of 1.5 percent. The worst performing index last week was found in Japan and was the Nikkei 225 Index, which turned in a loss of 6.0 percent. The losses in Japan were due to the strengthening Yen after the US Fed announcement. The Yen increasing in value against the US dollar typically puts downward pressure on the Nikkei as it makes the exports from Japan more expensive to foreign buyers. With Japan relying so heavily on exports and the US Fed looking like it will be very slow to increase rates here in the US, it was not surprising to see such a large decline in the Nikkei. Now Japan is stuck because Abenomics was working, in large part thanks to the falling Yen, and that trend now looks like it may have come to an end, meaning that the Bank of Japan will have to come up with some new financial engineering to try to get its economy growing once again.

After increasing more than 26 percent two weeks ago, the VIX increased another 14 percent last week as uncertainty over the Brexit vote was clearly seen in the fear gauge. The movement in the VIX seemed to reflect a lot of pent up fears about the future for the financial markets in the near term as we lead up the vote. The current reading of 19.41 implies that a move of 5.6 percent is likely to occur over the next 30 days. As always, the direction of the move is unknown. It would not be surprising to see the VIX move in a wild fashion leading up to, and even going through, the Brexit vote on Thursday.

For the trading week ending on 6/17/2016, returns in the hybrid hypothetical models* (net of a 1% annual management fee) were as follows:

  Last Week 2016 YTD Since 6/30/2015
Aggressive Model -0.97 % 1.77 % 6.13 %
Aggressive Benchmark -1.62 % -1.13 % -6.15 %
Growth Model -0.74 % 1.83 % 5.22 %
Growth Benchmark -1.26  % -0.78 % -4.64 %
Moderate Model -0.45 % 1.91 % 4.68 %
Moderate Benchmark -0.90 % -0.48 % -3.17 %
Income Model -0.25 % 2.47 % 5.15 %
Income Benchmark -0.45 % -0.14 % -1.43 %
S&P 500 -1.19 % 1.33 % 0.39 %

*Model performance does not represent any specific account performance but rather a model of holdings based on risk levels that are like my actual holdings, the hypothetical models are rebalanced daily to model targets.

 

There were no changes to the hybrid models over the course of the previous week as the models remain defensively positioned. The defensive positioning in the models will likely remain in place through the Brexit vote, and any trades that need to be made as a result of the outcome of the Brexit vote will likely be made early next week. Trading on the day of big announcements is typically an error as the markets over- or under-react to major news with some consistency. It is typically better to let the dust settle and then move into new positions. Healthcare and Midcap Value remain the two primary areas of the market that look the most attractive in the current environment and are the most likely candidates for near term investments within the models.

 

Economic Release Calendar:

 

Last week was a typical week for economic news releases in terms of the number of releases, but we did have more positive news in the releases than we have seen during the past few weeks:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 6/14/2016 Retail Sales May 2016 0.50% 0.30%
Neutral 6/14/2016 Retail Sales ex-auto May 2016 0.40% 0.40%
Neutral 6/15/2016 PPI May 2016 0.40% 0.30%
Neutral 6/15/2016 Core PPI May 2016 0.30% 0.10%
Positive 6/15/2016 Empire Manufacturing June 2016 6.0 -4.7
Neutral 6/15/2016 FOMC Rate Decision June 2016 No Change No Change
Neutral 6/16/2016 CPI May 2016 0.20% 0.30%
Neutral 6/16/2016 Core CPI May 2016 0.20% 0.20%
Positive 6/16/2016 Philadelphia Fed June 2016 4.7 1.2
Neutral 6/17/2016 Building Permits May 2016 1138K 1147K
Neutral 6/17/2016 Housing Starts May 2016 1164K 1155K

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

Last week, the releases kicked off on Tuesday with the release of retail sales for the month of May showing that sales were slightly better than anticipated, which was slightly positive for the financial markets. The markets, however, paid little attention to the releases as they were focused on the upcoming Fed decision the following day. On Wednesday, the Producer Price Index (PPI) showed muted inflation at the producer level ahead of the announcement by the Federal Reserve. Also ahead of the Fed statement was the release of a very positive reading on the Empire manufacturing index, which posted a 6.0 reading, while the markets had been anticipating a -4.7 reading. The positive 6 reading means that manufacturing in the greater New York region actually expanded during the month of June, as opposed to contracting, which was expected. This is a very positive development for both the region and the US economy overall. This release, however, was largely ignored as it came out just prior to the Fed decision. The rate decision came out at 2 pm eastern time and, as discussed above, left the Fed funds rate unchanged. On Thursday the Consumer Price Index (CPI) showed much the same low inflation as we saw on the PPI earlier during the week, diminishing the hopes for a rate hike at the July FOMC meeting. Later during the day on Thursday the second of the positive manufacturing releases of the week was released with the Philadelphia Fed index posting a positive 4.7, while the market had been expecting a reading of only 1.2. We will have to wait another month to see if both of these positive manufacturing indicators turn into a trend or it they were just the latest in what has turned out to be very volatile indicators. On Friday the start of the housing related releases for the month of May were released with housing starts and building permits, both of which came in very close to market expectations and remained well over the 1 million units level.

 

This week is a slower than typical week in terms of the number of economic news releases that are set to be released:

 

Date Release Release Range Market Expectation
6/22/2016 Existing Home Sales May 2016 5.50M
6/23/2016 New Home Sales May 2016 560K
6/24/2016 Durable Orders May 2016 -0.60%
6/24/2016 Durable Orders, ex-transportation May 2016 0.10%
6/24/2016 University of Michigan Consumer Sentiment June 2016 94

Data for table from Econoday.com, Bloomberg and Yahoo Finance

 

The week starts off on Wednesday with the release of existing home sales for the month of May, which are expected to post a reading of 5.5 million units. New home sales figures for the month of May is set to be released on Thursday and is expected to show 560,000 units sold during the month. Both of these releases, combined with the two releases at the end of last week about the housing market, will give investors a pretty good idea of how the US housing market is doing now that we have moved into the heart of the selling season for 2016. Friday holds the largest release of the week this week when the durable goods orders for the month of May are released. Last week we saw retail sales increase more than expected, but it would be very nice to see durable goods orders increase rather than see the expected decline in orders. Durable goods orders are typically a better reading of spending in the US as they signal confidence in the US consumer since the items are, by their nature, higher dollar times. Wrapping up the week on Friday is the latest reading from the University of Michigan’s Consumer Sentiment Index for the month of June (second estimate), which is not expected to change much at all when compared to the first estimate for the month of June released two weeks ago. In addition to the scheduled economic news releases, the markets will likely be paying very close attention to testimony by Chair Yellen before Congress this week in her semi-annual address. She is unlikely to say anything of substance that is new at the hearing, but it is always entertaining to hear the questions from members of Congress and how she attempts to answer them.

 


Interesting Fact Denver International Airport is huge!

 Fly DIA

DIA is larger in terms of land area than Manhattan, San Francisco and Miami. DIA also has enough space to increase from the current 6 runways to 12 runways in total if there is enough demand for it in the future.

Source: www.TheDenverchannel.com

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