For a PDF version of the below commentary please click here Weekly Letter 7-17-2017

Commentary quick take:

 

  • Major developments:
    • Chair Yellen’s semiannual testimony
    • Weak inflation data in US
    • Summer trading

 

  • US:
    • Congress back in Session
    • Healthcare reform hits another snag
    • Chair Yellen on Capitol Hill
    • Weaker than expected inflation data
    • Earnings season starts strong
    • Trumps’ Russian problems build

 

  • Global:
    • Bank of Canada raised rates
    • Brexit: round two
    • Weakness in Japan

 

  • Technical market view:
    • All three US indexes moved higher
    • NASDAQ broke out of range
    • VIX at second lowest point ever

 

  • Hybrid investments strategy update:
    • No changes to the models
    • Potential investment in International

 

  • This week for the markets:
    • Earnings season gets further underway
    • Healthcare reform bill
    • Slow summer trading

 

  • Interesting Fact: Aging Japan

 

Major theme of the markets last week: Bulls and bears on vacation

Last week felt like a true summer trading week. Congress was back in session and uncertainty surrounding the Republicans’ healthcare bill in the Senate continued to build as Majority Leader Mitch McConnell delayed the start of the August recess by a full two weeks. There were two significant stories last week: Chair Yellen’s testimony and the financials kicking off second quarter earnings season. Neither of these received much market reaction as a very lackadaisical attitude continues to prevail in the market.  Even ongoing uncertainty over the Trump administration due to the seemingly never-ending Russia investigation failed to derail the bull market as the three major US indexes pushed higher for the week, led by the technology heavy NASDAQ.

 

US news impacting the financial markets:

The US financial media focused on three main themes last week: Chair Yellen’s Congressional testimony, second quarter earnings releases and President Trump’s continued Russian headaches. On Wednesday and Thursday last week, Fed Chair Yellen testified before both houses of Congress, giving her semiannual economic update on the Hill. There were no significant deviations in her prepared remarks from what other Fed officials had been saying, though a few interesting answers were given in the Q&A sessions. One question repeatedly asked was whether she would stay on as Chair of the Fed if President Trump asked her to. It is not uncommon for new administrations to ask Fed chairs to stay on under their administration, but there have been rumors since November that President Trump would not be offering Chair Yellen a second term. This uncertainty over her future as Fed Chair may be what is leading her to outline so much of what she thinks should happen, both toward the end of this year and well into next year, so that if she is removed it would be difficult for the next Fed chair to completely change the course that has been publicly outlaid. One item that did come up several times was that she expects changes in the future to be gradual, both when speaking about shrinking the Fed’s balance sheet and when discussing future rate hikes. The US financial markets cheered her use of the word gradual and moved noticeably higher right after she said it. During the Q&A sessions, Chair Yellen also acknowledged that inflation is running at a slower pace than she had anticipated, but she kept with her line that the reasons for the low rate of inflation are transitory in nature and that the Fed’s target rate for inflation remains unchanged. This lower than expected inflation rate was backed by economic data released last week with the CPI and PPI both showing a general lack of inflation as prices held steady during the month of June. Aside from Chair Yellen speaking last week, the financial markets seemed to be intently watching the first of the major companies report earnings for the second quarter of 2017.

 

Financials were the largest of the companies to release earnings last week during the first full week of second quarter earnings. 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:

 

Citigroup 6% Helen Of Troy 13% Taiwan Semiconductor -25%
Delta Air Lines -1% J P Morgan Chase 8% WD-40 Company 12%
Fastenal 4% PepsiCo 8% Wells Fargo 6%

 

Solid single digit earnings beats from the three big financial institutions last week set an upbeat tone for the remainder of earnings season. Trading volume and profits declined across the board, but were offset by stronger credit and other divisions within the financial institutions. The outlooks for the remainder of 2017 and even further into the future, however, was not as positive as many investors had been hoping for, which pushed the stock prices lower on earnings release day for each of the major financials. WD-40 turned in a very good second quarter, showing that the slow retail growth is a real thing that will be seen in corporate earnings this quarter. Typically, WD-40 does well when future economic growth is less certain as people choose to clean and repair household products using many of the WD-40 products rather than buying new products. Taiwan Semiconductor missed expectations on Thursday after seeing slowing chip sales from the mobile phone division of the company. This had knock on effects on stocks such as Apple as Taiwan Semiconductor is one of the largest suppliers of parts for building iPhones. Revenues were also down at another significant iPhone part supplier, Foxconn, as demand was seen to be slowing at the company. We will have to wait and see if a slowdown in Apple sales comes to fruition and has reverberating effects in the technology industry or not.

 

According to Factset Research, we have seen 30 (6 percent) of the S&P 500 companies release their results for the second quarter of 2017. Of the 30 companies that have released earnings, 80 percent have beaten earnings estimates, while 10 percent have met expectations and 10 percent have fallen short of expectations. When looking at revenue, of the companies that have reported, 83 percent of the companies have beaten estimates, while 17 percent have fallen short. The overall earnings growth rate for the S&P 500 that we have seen thus far stands at 6.8 percent, with materials and financials being the top performing sectors by earnings. It is still very early in the earnings season, but second quarter earnings have started strong.

 

This week, earnings season for the second quarter gets fully under way as there are more than 30 well-known companies reporting earnings across several different market sectors. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Abbott Labs Goldman Sachs Philip Morris
American Express Harley-Davidson Charles Schwab
Bank of America Honeywell Sherwin-Williams
Bank Of New York IBM Schlumberger
Blackrock J.b. Hunt T-Mobile
Colgate-Palmolive Johnson & Johnson Travelers
Capital One Lockheed Martin United Airlines
CSX Morgan Stanley UnitedHealth
Dish Network Microsoft Union Pacific
eBay Netflix U.S. Bancorp
General Electric Progressive Visa

 

Following in the footsteps of several large financial institutions last week, Bank of America, Goldman Sachs, Blackrock and Bank of New York report their earnings this week. Barring some major deviation from what we heard last week from JP Morgan, Citi and Wells Fargo, the market seems to have already priced in a good second quarter and weaker than expected outlook from these stocks this week. Microsoft and Netflix are the first of the major technology companies to report this quarter and will be closely watched by Wall Street this week. Visa is a bellwether stock that Wall Street likes to follow closely as the company impacts so many transactions around the US that it has a very good feel for the overall health of the US consumer. UnitedHealth may make more headlines than usual this week as the debate over healthcare reform is ongoing and could likely impact the company in a significant way. As mentioned several times above, healthcare reform is a political football that remains in play, as is the investigation into relations with Russia in Washington DC.

 

We may have to wait at least another week, if not two, before we know whether the Senate can make it through a procedural measure to get the healthcare reform bill to the floor for a vote. With Senator John McCain out of Washington DC for a major surgery and unable to cast his vote, action was delayed in DC, at least for the time being. Fighting for each vote is not the ideal way to get a bill passed, but it seems to be the course of action being taken. The buying of votes is something the media focused on last week, as an amendment in the healthcare reform that came to light last week targeted the state of Alaska. It was the only qualifying state to receive as much as $100 million in federal funding under a very small clause in the bill dubbed the “Caribou Kickback.” As is commonly the case, healthcare was not the only debacle last week in Washington DC, as the Trump family has become further entangled in the situation with Russia. Last week, the media focused on a meeting that Donald Trump Jr. had while on the campaign trail with a Russia lawyer and several other connected Russians. The meeting was confirmed by Trump Jr. himself when he released a string of e-mails about the meeting. We will have to wait and see if this meeting was a crime with actual consequences or whether it is rolled into the bigger Trump/Russia issue that the administration cannot seem to get away from.

 

Global news impacting the markets:

 

Global financial markets last week focused on the US and Chair Yellen’s testimony before Congress, but there were other items of interest in the global media unrelated to the US. The first was a rate hike by our northern neighbors in Canada; the Bank of Canada increased rates by 0.25 percent at its July meeting. This move was widely anticipated, however, and had little impact on the global markets. The second item of interest was Brexit.

 

The second round of meetings for the Brexit is due to officially start again this week. The first round comprised more pleasantries between the teams than anything else, so this week could form how the negotiations will move forward. The EU has repeatedly made it clear that the divorce bill between the UK and the EU must be settled prior to other negotiations taking place. This settlement was not well received by some in the UK, including foreign Secretary Boris Johnson, who last week said the EU could “go whistle” over a request for a large settlement from the UK. Trying to lighten the spirit of the debates with a little dark humor following Johnson’s comment last week, EU chief negotiator Michel Barnier said, “I am not hearing any whistling, just a clock ticking.” His comment surprisingly sums up the situation very well: the EU would be glad to negotiate with the UK on EU terms. In the end, their terms are all that really matters as failed negotiations will greatly hurt the UK if the two-year clock is hit with no deal. The next major deadline in the negotiations is late October, which is when the EU will decide if “sufficient progress” on the Brexit has been made, allowing trade talks to proceed. Fears of no deal or a poor deal for the UK have already greatly impacted business investment in the UK and we are starting to see some of the major multinational companies operating in the UK pull back by relocating operations to mainland Europe. JP Morgan CEO Jaime Dimon last week alluded to the fact that the company could relatively easily move operations out of the UK if a deal does not look like it could be beneficial to the company.

 

In Asia last week, the economic data released was mixed with Japan showing some weakness, posting a second month of declines in manufacturing orders. On a year-over-year basis, orders were shown to have declined by 4 percent, as the country continues to struggle to grow despite Abenomics throwing a significant amount of resources at the economy. Data out of China last week pointed toward a growing economy for the second quarter as the country is set to release its official growth rate for Q2 2017 this week, with expectations of 6.8 percent growth being seen.

 

Technical market review:

 

There were no changes to the technical trading ranges on the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

With the gains seen in the NASDAQ last week, all three of the major US indexes are now above their most recent trading ranges. The Dow (upper right pane above) remains the strongest of the three indexes as it is the furthest above its most recent trading range and making new highs. The S&P 500 (upper left pane above) is close behind in second place as it too is above its most recent trading range and making new all-time highs. The NASDAQ (lower left pane above) jumped back above its most recent trading range last week, but closed out the week right at the previous high point, landing it in third place in terms of technical strength. While the indexes were moving higher last week on the thought that the Fed will have a tough time raising rates again this year, following the slightly negative inflation data that was released, the VIX was happily moving lower. The VIX last week briefly touched the second lowest point ever going all of the way back to the early 1990’s.

 

Hybrid model performance and update

For the trading week ending on 7/14/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.40% 7.05% 12.84%
Aggressive Benchmark 1.91% 11.07% 10.86%
Growth Model 0.42% 6.10% 10.92%
Growth Benchmark 1.48% 8.60% 8.75%
Moderate Model 0.37% 4.71% 8.54%
Moderate Benchmark 1.06% 6.18% 6.57%
Income Model 0.35% 4.12% 7.72%
Income Benchmark 0.54% 3.22% 3.71%
Quant Model 1.30% 11.18%
S&P 500 1.41% 9.85% 19.20%

*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. One area of the markets that is currently being evaluated for more potential investment is international markets. Currently, the hybrid models have a partial position in the frontier market through the FRN ETF. Additional investment in the international space would help diversify the models away from being largely dependent on the US financial markets. Valuations on several of the international indexes are currently below US valuations, providing a potentially more attractive investment at the current time.

 

Market Statistics:

 

All three of the major US indexes made it two weeks in a row of gains by moving higher last week:

 

Index Change Volume
NASDAQ 2.59% Below Average
S&P 500 1.41% Below Average
Dow 1.05% Below Average

 

Uncertainty over whether the Fed will be able to increase rates again in 2017 added fuel to the US bull market that pushed higher last week. Summer trading was clearly seen, however, as volume overall remained below average on each of the three major indexes. As we move further into earnings season for the second quarter we will likely see volume pick up, as is historically the case.

 

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
Semiconductors 5.36% Financials 0.10%
Technology 3.96% Broker Dealers -0.13%
Materials 3.66% Financial Services -0.24%
Oil & Gas Exploration 3.18% Regional Banks -0.69%
Software 2.93% Telecommunications -0.98%

 

Semiconductors took top honors in terms of sector performance last week after Taiwan Semiconductor released worse than expected earnings, but upheld a bright future for the sector over the remaining two quarters of 2017.  The outsized gain in the semiconductors sector helped drive technology overall higher, as the group came in second place in terms of performance. Materials as well as Oil and Gas Exploration took the third and fourth positions last week as oil and commodity prices increased. Software moved higher by almost 3 percent last week on the backs of Twitter, which gained almost 9 percent, and Microsoft, which added 4.5 percent, with both companies being very heavily weighted in the index. On the negative side of performance last week, financial related stocks took 4 of the 5 spots as hopes for a rate hike later in 2017 were dashed by several economic data points. Telecommunications saw the worst performance of any of the major sectors last week as AT&T and CenturyLink were down and are both weighted heavily on the index.

 

Fixed income investments in the US moved higher last week as the odds of a rate hike later this year by the Fed declined:

 

Fixed Income Change
Long (20+ years) 0.50%
Middle (7-10 years) 0.60%
Short (less than 1 year) 0.05%
TIPS 0.52%

Global currency trading volume was average last week as traders around the world shuffled some of their positions following both chair Yellen’s testimony and the rate hike by the Canadian central bank. Overall, the US dollar decreased 0.89 percent against a basket of international currencies. The weakness emerged almost entirely during Chair Yellen’s testimony. The best performing of the global currencies last week was the Brazilian real, as it gained 3.1 percent against the value of the US dollar. The worst performance among the global currencies was the Kazakhstan tenge, which declined 1 percent against the US dollar. The decline in the tenge was primarily due to a default and bankruptcy in neighboring Azerbaijan by the largest bank in the country, a bank that Kazakhstan had put a significant amount of money into over the past several years.

Commodities were mixed last week as Oil moved higher, while several of the soft commodities pushed lower:

Metals Change Commodities Change
Gold 1.29% Oil 5.38%
Silver 2.38% Livestock 0.65%
Copper 1.97% Grains -3.39%
Agriculture -0.15%

The overall Goldman Sachs Commodity Index advanced 2.55 percent last week, driven by the movement in the price of oil. Oil has been on a pretty wild ride over the past three weeks, with each week seeing movement of more than 4 percent. Last week it was the bull’s turn on oil, pushing it higher by more than 5 percent as supply concerns crept into the market. Metals were positive last week with Gold, Silver and Copper advancing 1.29, 2.38 and 1.97 percent, respectively. Soft commodities were mixed last week with Grains posting a 3.39 percent loss, while Livestock gained 0.65 percent and Agriculture overall decreased 0.15 percent.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
BIST 100 Turkey 5.09% Merval Argentina -0.67%
Sao Paulo Bovespa Brazil 5.00% KSE 100 Pakistan -1.96%

Last week was a good week for global financial markets, with 93 percent of the global markets posting gains. The best performing index last week was found in Turkey, and was the BIST 100 Index, which turned in a gain of 5.09 percent for the week. The worst performing index last week was found in Pakistan for the second week in a row and was the KSE 100 Index, which turned in a loss of 1.96 percent for the week.

The VIX continued to push lower last week, falling by 14.4 percent as it closed the week at 9.51. The 9.51 reading is the second lowest reading on the VIX since the index was created in the early 1990’s; the lowest reading ever at closing was 9.31 (12/2/1993). If the trend continues, we could easily see the VIX close below this point and make a new all-time low. The current reading of 9.51 implies that a move of 2.75 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week a typical week for economic news releases, but it was a bifurcated week with all releases for the week coming out on Thursday and Friday:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 7/13/2017 PPI June 2017 0.10% -0.10%
Neutral 7/13/2017 Core PPI June 2017 0.10% 0.20%
Negative 7/14/2017 Retail Sales June 2017 -0.20% 0.10%
Negative 7/14/2017 Retail Sales ex-auto June 2017 -0.20% 0.20%
Neutral 7/14/2017 CPI June 2017 0.00% 0.00%
Neutral 7/14/2017 Core CPI June 2017 0.10% 0.20%
Slightly Negative 7/14/2017 University of Michigan Consumer Sentiment Index July 2017 93.10 95.10

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

 

Last week, the economic news releases started on Thursday with the release of the Producer Price Index (PPI), both overall and core for the month of June. The data was mixed on the PPI. Overall PPI came in better than expected at 0.1 percent, while the market had been expecting a -0.1 percent reading. However, enthusiasm over the positive reading was short lived as core PPI missed expectations, coming in at 0.1 versus the expected 0.2 percent. On Friday, retail sales kicked off the releases with the June data being reported, which was negative all the way around. Retail sales, both including and excluding auto sales, were shown to have declined by 0.2 percent. This is a significant development, but not an entirely surprising one. We have been seeing weak consumer spending now for the past several months, so seeing it finally manifest itself in the retail sales number was a foregone conclusion. However, with retail sales having now declined, we will have to see if there is a noticeable impact on consumer confidence, which has been one data set that bulls have been pointing to for several months now as very positive. Also released on Friday was the latest reading from the Consumer Price Index (CPI), both overall and core. The CPI numbers came in at or slightly below market expectations, which, combined with the PPI data earlier in the week, signaled that inflation is not currently in the US economy in any meaningful way. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of July (first estimate). We saw a slight drop in sentiment as the index declined by 2 points, but this could be a trend if sentiment starts to roll over and catch up with the spending and retail sales numbers that have been coming out over the past few months.

 

This week is light on the number of economic news releases, leaving the markets with plenty of time to thoroughly go over corporate earnings released during the week:

 

Date Release Release Range Market Expectation
7/17/2017 Empire Manufacturing July 2017 13.0
7/19/2017 Building Permits June 2017 1210K
7/19/2017 Housing Starts June 2017 1150K
7/20/2017 Philadelphia Fed July 2017 23.0

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

 

This week, the economic news releases start on Monday with the release of the Empire Manufacturing index for the month of July, which is expected to show weaker growth than was experienced in June, but growth nonetheless. On Wednesday, the first of the US housing related data points for the month of June are set to be released, those being the building permits and housing starts figures for the month. As is normally the case, housing starts will be more important to the markets than building permits. Wrapping up the week this week is the release of the Philadelphia Fed index for the month of July, which is expected to show slower than expected, but still growing, business conditions in the greater Philly area. It is a slow week for Fed officials this week as well as there are no scheduled Fed officials making any speeches this week.

 

Interesting Fact — The anticipated speed of Japan’s population decline is astonishing

 

Japan’s population is currently 128 million people. It has largely remained stable over the past decade, but is predicted to decline gradually, reaching 87 million people by 2060—that is a huge 32 percent decline. A decline of 32 percent will cause decades of hardship within the Japanese economy if Japan is unable to come up with a way to boost its economy.

 

Source: http://asiancenturyinstitute.com

For a PDF version of the below commentary please click here Weekly Letter 7-10-2017

Commentary quick take:

 

  • Major developments:
    • Federal Reserve data released
    • Oil declined
    • Bond market rout

 

  • US:
    • Congress not in session
    • Tax reform is coming
    • Fed stress test results boosted financials
    • Q2 2017 earnings season about to start

 

  • Global:
    • French bond auction
    • Oil declined more than 4 percent
    • G20 meeting

 

  • Technical market view:
    • All three US indexes moved higher
    • NASDAQ remained in trading range
    • VIX had volatile week, but ended flat

 

  • Hybrid investments strategy update:
    • No changes to the models

 

  • This week for the markets:
    • Congress is back in session
    • Reaction to the G20
    • Q2 2017 earnings season kicks off

 

  • Interesting Fact: How much extra would you volunteer to pay in taxes?

 

Major theme of the markets last week: The US Federal Reserve

The focus of the US markets last week was on the Fed, as the semiannual Monetary Policy Report (MPR) by the Fed was released, as well as the meeting minutes from the June FOMC meeting. While the market focused on both of these releases, a result of the holiday-shortened week and very little else going on in the US financial markets, there was virtually no new information in either of the releases. There are parts of the MPR that make the Fed seem hawkish and other parts that make the Fed seem dovish, which is likely the goal. They Fed currently wants to keep all options on the table and going too far in one direction or the other, in terms of being hawkish or dovish, would corner the Fed into various actions. This is not something Chair Yellen would be comfortable with as the nimbleness of the Fed is one of the main keys enabling it to fulfill its dual mandate of full employment and price stability.

 

US news impacting the financial markets:

 

With both houses of Congress in recess for the Fourth of July holiday week last week, there was very little movement on the political front in Washington DC. There were, however, some interesting comments from administration officials and several releases by the Federal Reserve that the markets took note of during the week. US Treasury Secretary Steve Mnuchin spoke last week about tax reform, saying the administration would absolutely get something done by the end of 2017. He said the administration is currently aiming to release the “fully-blown” plan by the end of September, in time for Congress to get it passed by the end of the year. Secretary Mnuchin also said there would not be an increase in the top tax rate to 40 percent, a rumor that was circulating in the media, supposedly coming from Steve Bannon. Investors seem to be rightly concerned about the upcoming tax overhaul as the language from the administration now is that there will not be an increase in middle class taxes. This is very different language from the “tax cuts for everyone” statements heard not too many months ago. Secretary Mnuchin also pointed out that he and the administration are aware of high tax states that could have residents see their taxes increase as the number of deductions will likely be drastically lowered under any newly devised tax plan. The Fed also made several headlines last week after releasing its MPR and minutes from the June FOMC meeting, at which the Fed increased interest rates.

 

The above mentioned MPR is a semiannual report the Fed puts out in July and January, in which it outlines its current thinking about the economy through different data points it watches and bases decisions on. The report mostly used data through May, with a small amount of data about June as well. In the report, the Fed continued forecasting a gradual increase in interest rates and the imminent wind down of its balance sheet. The Fed also kept its target rate of inflation and unemployment targets unchanged. The Fed continues to see the US economy expanding at a slow pace, but noted that business spending and investment had been increasing. Much of this increase, however, was due to increased spending in the oil and gas drilling sector, which has been ramping up, thanks to increased fracking production in the US. The report called out valuations as being on the rise, but that upward pressures are not currently cause for alarm. The Fed also continues to see support for the US economy coming from income and spending, despite both being significantly slower than the Fed would like. The FOMC meeting minutes released on Wednesday held no new information. Both of these releases will likely be elaborated upon later this week when Chair Yellen testifies before Congress on Wednesday and Thursday.

 

This week marks the start of the second quarter 2017 earnings reporting season as there are several well known companies that will report. WD-40 will be the first to go, followed by several of the very large financial institutions. The table below shows the companies that have the greatest potential to move the markets highlighted in green:

 

Citigroup Helen Of Troy Taiwan Semiconductor
Delta Air Lines J P Morgan Chase WD-40 Company
Fastenal Pepsico Wells Fargo

 

With this being the very first of the companies to report earnings, they are unlikely to cause much market movement. The exception would be JP Morgan Chase and Wells Fargo, as either of these two companies could cause waves in the financial sector of the markets. Delta Airlines could also provide a little insight into how the airlines industry is doing with falling fuel costs and we could see trading in other airlines stocks as a result of Delta’s results.

 

Global news impacting the markets:

 

Global news last week that impacted the financial markets mainly focused on the fixed income markets, as bond yields spiked higher while bond prices declined. There were two potential catalysts for the movement in bonds last week. The first was weak excess demand for 30-year government bonds being sold by France. Demand was not so weak that France could not sell all of the bonds it wanted to sell at auction; there was just less demand than has been seen over the past 18 months. The results of the French auction immediately caused the German bund to see its yield spike upward, hitting an 18 month high. For some investors, the ECB meeting minutes added fuel to the fire, seeming  to carry a more hawkish tone with more talk about ending easing, rather than continuing or expanding it. Some traders also pointed to ECB President Draghi’s comments two weeks ago as being more hawkish as well. Much like the releases from the US Federal Reserve, the language can easily be read as either hawkish or dovish, depending on your perspective. One thing that currently seems very clear is that global central banks are all in agreement that the time of quantitative easing and ultra easy money has come to an end and the slow and potentially painful normalization of monetary policy is under way. The ECB went as far as cautioning that even small and incremental changes in communications could be misperceived as signaling a more fundamental change in policy direction, stating, “This could trigger unwarranted movements in financial conditions, which could put the prospects of a sustained adjustment of inflation at risk.”

 

Other global headlines last week had to do with the G20 meeting that took place in Germany. The world seemed to be watching and waiting for mistakes to be made by US President Donald Trump and while some mistakes were made, it seemed the meeting was as successful as any other G20 normally is.

 

Technical market review:

 

There were no changes to the technical trading ranges on the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

There were not many changes in the technical charts above last week. The Dow (upper right pane above) remains the strongest of the three major US indexes as it is still significantly above its most recent trading range. The S&P 500 (upper left pane above) is currently in second place after briefly touching and bouncing off of the upper end of its trading range on Thursday and Friday. The NASDAQ remains solidly in third place, as the index seems to be moving in a sideways fashion, going down the middle of the trading range. The VIX had an interesting week, starting and ending the week with very little movement. On Thursday, however, the index spiked upward and very briefly touched the one-year average level of the VIX, something it has not done since the middle of May. We are seeing some clustering in large single day movements on the VIX, starting back at the end of June and continuing into July. This type of spike clustering shows just how fast the markets and the VIX move during low trading volume.

 

Hybrid model performance and update

For the shortened trading week ending on 7/7/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.32% 6.64% 12.41%
Aggressive Benchmark -0.22% 8.99% 8.78%
Growth Model 0.14% 5.68% 10.46%
Growth Benchmark -0.17% 7.01% 7.17%
Moderate Model -0.07% 4.34% 8.15%
Moderate Benchmark -0.12% 5.06% 5.45%
Income Model -0.23% 3.77% 7.36%
Income Benchmark -0.05% 2.67% 3.15%
Quant Model 0.65% 11.15%
S&P 500 0.07% 8.32% 17.55%

*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. The positive performance in the higher risk hybrid models was driven primarily by the models’ allocation to financials and industrials. The underperformance by the lower risk hybrid models was driven by the fixed income leaning positions. Overall, the stock positions in each model continue to perform as expected and it looks like earnings for the second quarter for the stocks in the models will be strong. The quant model last week moved very quickly to take advantage of the decline in the markets seen on Thursday, moving to a nearly fully invested position for Friday.

 

Market Statistics:

 

During the holiday-shortened trading week last week, all three of the major US indexes managed to move higher, despite some large movements during the week:

 

Index Change Volume
Dow 0.30% Below Average
NASDAQ 0.21% Below Average
S&P 500 0.07% Below Average

 

Volume, when compared to a full 5-day trading week, was expectedly very low last week as Tuesday was a holiday and Monday saw an early close to trading. Even when looking at the daily volume across the remaining trading days, trading volume was still below average. It could be because the fourth of July is the unofficial start of summer in the US, a time when many large institutional money managers typically see fewer staff at work (with many going on vacation), resulting in less trading.

 

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
Semiconductors 2.42% Energy -1.52%
Aerospace & Defense 1.96% Natural Resources -1.61%
Transportation 1.45% Real Estate -1.66%
Financial Services 1.37% Telecommunications -1.89%
Regional Banks 1.34% Oil & Gas Exploration -2.71%

 

The top five sectors last week in terms of performance comprised a very mixed group, with Semiconductors taking the top spot as market timing investors tried to pick a good entry point into the sector after it declined by more than 5 percent two weeks ago. The sector could be one of the big movers this coming week as Taiwan Semiconductors releases its latest earnings report, a release that can easily move the relatively small (low number of companies) sector of the market. The Aerospace and Defense sector came in second as the sector typically sees positive performance when there are provocative actions being taken by North Korea, which launched an ICBM this past week. Transportation came in third last week as the continued decline in the cost of fuel is starting to positively impact the fuel intensive sector. Financials made up the final two spots on the positive performance list last week as Financial Services and Regional Banking both saw nice gains following the release of the FOMC June meeting minutes. On the negative side, the decline in the price of oil took down three sectors last week: Oil and Gas Exploration, Natural Resources and Energy. These are the same three sectors that typically feel the most pressure when oil prices decline and are also the three sectors that stand to gain the most if prices turn around. Telecommunications and Real Estate also made the list of poor performers last week as there was some profit taking pressure in the sectors.

 

Fixed income investments in the US were mixed over the course of the past week as there was a lot of selling mid-week on bonds, but they recovered partly during the last two days of trading:

 

Fixed Income Change
Long (20+ years) -1.72%
Middle (7-10 years) -0.64%
Short (less than 1 year) 0.01%
TIPS -0.60%

Global currency trading volume was below average last week with the US holiday. Overall, the US dollar increased 0.36 percent against a basket of international currencies. The best performing of the global currencies last week was the Egyptian Pound, as it gained 1.4 percent against the value of the US dollar. The worst performance among the global currencies was the Turkish Lira, which declined 2.7 percent against the US dollar.

Commodities were mixed last week as Oil fell back, while Agriculture moved higher:

Metals Change Commodities Change
Gold -2.32% Oil -4.21%
Silver -6.24% Livestock -1.39%
Copper -2.53% Grains 3.93%
Agriculture 1.26%

The overall Goldman Sachs Commodity Index declined 2.14 percent last week, driven once again by the movement in the price of oil. After gaining more than 7 percent two weeks ago, last week Oil resumed its downward trend, declining by more than 4 percent with the absence of positive news for oil prices regarding US oil and gasoline inventories. Metals were negative last week with Gold, Silver and Copper declining 2.32, 6.24 and 2.53 percent, respectively. Soft commodities were mixed last week with Grains posting a 3.93 percent gain, making the two week gain for the group more than 10 percent, while Livestock declined 1.39 percent and Agriculture overall increased 1.26 percent.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Santiago IPSA Chile 2.27% Hang Seng Hong Kong -1.64%
FTSE MIB Italy 2.09% KSE 100 Pakistan -2.88%

Last week was a mixed week for global financial markets, with 53 percent of the global markets posting gains. The best performing index last week was found in Chile, and was the Santiago IPSA Index, which turned in a gain of 2.27 percent for the week. The worst performing index last week was found in Pakistan, the KSE 100 Index, which turned in a loss of 2.88 percent for the week.

Volatility remained in the VIX last week, but by the end of the week the index had barely moved at all. In fact, the gain of 0.09 percent was the smallest movement that we have seen on the VIX since a move of 0.04 percent back in January of 2016. Overall, the VIX advanced by 0.09 percent for the week, but this does not tell the whole story of the movement for the week. On Thursday, as the US markets moved lower, the VIX jumped by more than 20 percent intraday and closed the day more than 13 percent higher. The VIX fell back on Friday, giving up more than 10 percent. The current reading of 11.19 implies that a move of 3.23 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a slow holiday week for economic news releases, but US employment data was released so there were a few impactful releases:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Positive 7/3/2017 ISM Index June 2017 57.8 55.0
Neutral 7/5/2017 FOMC Minutes June Meeting NA NA
Neutral 7/6/2017 ADP Employment Change June 2017 158K 185K
Neutral 7/6/2017 ISM Services June 2017 57.4 56.6
Positive 7/7/2017 Nonfarm Payrolls June 2017 222K 173K
Slightly Positive 7/7/2017 Nonfarm Private Payrolls June 2017 187K 175K
Slightly Negative 7/7/2017 Unemployment Rate June 2017 4.40% 4.30%

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

Last week, the economic news releases started on Monday with the release of the overall ISM index for the month of June, which came in slightly better than expected at 57.8 versus expectations of 55.0. This is a continued positive development of the manufacturing industries in the US, as expansion seems to continue to move forward. On Wednesday, the June FOMC meeting minutes were released by the Fed with the market reacting to a section of the minutes that held a little more detail about a discussion between Fed officials regarding asset bubbles. On Thursday, the first of the employment related figures for the week was released with the ADP employment change index for the month of June, which came in slightly lower than expected. Later during the day on Thursday, the service side of the ISM index was released, but much like the overall ISM released on Monday, the figure came in very close to market expectations and did not impact the overall markets. On Friday, the focus of the economic news releases was on the US labor market. The overall unemployment rate for the month of June ticked up one tenth of a percent from 4.3 to 4.4 percent, which was not a large enough move for the markets to react to. Nonfarm payrolls came in significantly higher than anticipated, while nonfarm private payroll figures came in very close to market expectations. Wage growth remained relatively stagnant, gaining 0.15 percent during the month, continuing the downward trend that we have been seeing in wage growth for the past 18 months.

 

This week is a little light on the number of economic news releases, but it will seem like a lot at the end of the week since all of the week’s releases are crammed into Thursday and Friday:

 

Date Release Release Range Market Expectation
7/13/2017 PPI June 2017 -0.10%
7/13/2017 Core PPI June 2017 0.20%
7/14/2017 Retail Sales June 2017 0.10%
7/14/2017 Retail Sales ex-auto June 2017 0.20%
7/14/2017 CPI June 2017 0.00%
7/14/2017 Core CPI June 2017 0.20%
7/14/2017 University of Michigan Consumer Sentiment Index July 2017 95.1

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

 

This week, the economic news releases start on Thursday with the release of the Producer Price Index (PPI), both overall and core for the month of June. Expectations are for overall prices at the producer level to have declined by one tenth of a percent, while core prices at the producer level are expected to have increased by 0.2 percent. The primary difference between the two figures is the price of energy, and fuel in particular, which declined in excess of 5 percent during the month and is the single largest contributor to the overall PPI decline. Energy price movements are typically seen by the Fed as  transitory, so unless there are several months of broad price declines on both the PPI and the CPI, it is unlike that we will see any statements from the Fed regarding changes in inflation expectations. On Friday, retail sales kick off the releases with the June data being reported. Expectations are for a very small gain of 0.1 percent overall and 0.2 percent when looking at retail sales excluding transportation. Both of these figures seem very optimistic given the poor spending figures that we have already seen for June and the decline in consumer confidence seen for the same time. Also released on Friday is the latest reading from the Consumer Price Index (CPI), both overall and core. Much like the PPI released on Thursday, expectations are for a very low reading; in the case of overall CPI, a zero reading. This data, combined with the PPI data, will likely show that inflation has all but stalled at the end of the second quarter. 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). There is an expectation of no change when compared to the end of June reading, so this release should have minimal impact on the overall markets. In addition to the scheduled economic news releases, there are nine speeches by Fed officials this week. The most important Fed official speaking this week will be Chair Yellen as she provides Congress with an economic update on Wednesday and Thursday. The market will be listening very closely to her, as is always the case.

 

Interesting Fact — Would you voluntarily pay the government more in taxes than you owe?

 

In June, the right leaning government in Norway started an interesting new voluntary tax program in which citizens who feel they should pay more in taxes have the opportunity to do so. So far, the program has collected a grand total of $1,325.

 

Source: Bloomberg.com

For a PDF version of the below commentary please click here Second Quarter 2017 in Review

Second Quarter 2017 in Review:

The second quarter of 2017 was a very interesting quarter, with many occurrences in geopolitics and on Capitol Hill in the US. Q2 2017 started with the world focused on Europe with the Brexit being formally triggered at the end of March and with the elections in France. At the time, the snap elections held in the UK during the quarter were unanticipated. The global financial markets moved into the second quarter riding high as hope for changes coming from the new US administration combined with continued global growth pushed many of the global stock indexes to their highest points ever. Meanwhile, under the surface, tension seemed to be building during the quarter as warning signs started to appear in many of the key global economies around the world. The US experienced an interesting second quarter as well.

 

It was still a quarter of learning for President Trump regarding his relationship with the US financial markets. Throughout the quarter, some of the largest moves in the financial markets were caused by non-financial headlines. When President Trump fired FBI director James Comey, the Dow fell by its largest single day amount in 2017. When a special prosecutor was announced to look into President Trump’s dealings with Russia, and communications that may have occurred between Trump’s people and Russia, the US financial markets also declined. There were also many individual shots fired by President Trump on Twitter, targeting individual companies that were bad by his estimation and praising others that were supporting some of his ideas. Almost every time, the mention of a company during the quarter by President Trump caused entire sectors of the markets to move. Healthcare reform was a political football during the quarter, sending healthcare related stocks jumping higher or plunging lower at random points. The Republicans managed to pass a healthcare reform bill in the House, but it was dead on arrival at the Senate. The Senate tried to draw up and pass its own version of healthcare reform, but there was such a lack of consensus among even Republicans that they were forced to pull the bill from a vote just before the Fourth of July holiday break. From a political standpoint, very little, if anything, of meaning was accomplished in Washington DC during the quarter that impacted the financial markets. Though very little was moving in Congress, the Federal Reserve was quite active.

 

During the second quarter of 2017, Fed Chair Yellen managed to increase the Fed funds rate from a range of 0.75 to 1 percent up to a range of 1 to 1.25 percent. This was done at the June meeting and was widely anticipated by the global financial markets. One interesting aspect to the Fed raising rates during the quarter is that although the employment market in the US did improve during the quarter, the inflation targets remained well out of range and consumer spending declined during much of the quarter. This split in the data associated with the Fed’s dual mandate presents an interesting problem for the Fed moving forward. One unexpected item released by the Fed during the quarter was the Fed’s plan being considered to decrease the size of its balance sheet, which swelled during the bond buying binge following the Great Recession. The outline, comprised of buying fewer bonds with repayments on a monthly basis, was well received by the markets, but was also perceived to have little impact relative to the overwhelming size of the Fed’s balance sheet.

 

One bright spot driving positive market performance during the quarter was the earnings season for the first quarter of 2017. Overall earnings for the S&P 500 increased by 13.9 percent on a year–over-year basis (the strongest earnings growth since 2011) with the Energy sector providing much of the boost. It was not so much the price of oil that helped energy earnings, but rather the year-over-year comparisons with the dismal results from the first quarter of 2016. Oil, for its part during the second quarter of 2017, was a major detractor, as the black gold fell by more than 10 percent during the quarter. Another bright spot during the second quarter was the VIX, which consistently moved lower during the quarter despite an uptick the last week of the quarter. At the start of June, the VIX recorded the second lowest reading of the last 24 years for the index (9.75); complacency seemed to be fully in the markets. This was somewhat debunked late in the quarter when the VIX started to move higher, but it still closed out the quarter very low by historical standards. While most of the world was watching the US administration throughout the second quarter, there were key developments in other countries as well.

 

In the UK, the second quarter of 2017 represented the first steps forward following the Brexit being officially triggered at the end of March. Prime Minister Theresa May made the political error of a lifetime when she called for a snap election in the UK last quarter to try to strengthen her existing majority in Parliament. This political gamble backfired with PM May losing her outright majority. The election outcome was negative for the overall European financial markets, but seemed to have little impact on the rest of the world. Later during the quarter, Brexit negotiations officially started with the EU seemingly taking a hard-line stance on how and when certain items would be discussed and the UK having to agree to the negotiating outline. In France, political newbie Emmanuel Macron was elected President, beating Marine Le Pen in a second round of elections. This was the latest wave of defeat for the populist movement in Europe. Financial markets around the world seemed to welcome the French election outcome, which seemed to remove the chance of a political debacle resulting in the EU blowing apart for the time being. China’s only real news during the quarter that had an impact on the global markets was its inclusion in the MSCI emerging markets index, within the local A share stock index. This was a tip of the hat to China, a significant part of the emerging global economy that MSCI had avoided including for three years. Russia had a difficult quarter, failing to get out of its own way both in US politics and in Syria, which saw very difficult fighting during the quarter with the US seemingly against Russia, which is backing President Assad.

 

Looking to the future

 

The remainder of 2017 looks likely to be more difficult for stocks as we enter the third quarter close to all-time highs on all three of the major US indexes. Politics remains the biggest wild card currently in play. Investigations into President Trump will likely continue and be drawn out for months, if not years, to come. All of this will likely hinder Congress’s ability to get anything of substance done. Without tax reform, both on the individual and corporate level, it is difficult to see how the current valuations of the stock market are justified. Analysts seem to have already priced in a reduction in corporate tax rates of at least 15 percent. If this becomes more in doubt, we could see some major downward revisions to coming estimates for US based companies. If healthcare reform is not realized, it will remain the elephant in the room, overshadowing all future negotiations on Capitol Hill and potentially impacting negotiations surrounding the budget and debt ceiling, which will likely come to a head during the third quarter of 2017. Strictly looking at investments, it is very difficult to find value oriented investments that are trading at fair prices. Almost everything that pays a solid dividend and is less volatile than the S&P 500 is very richly valued. There are opportunities, however, in sectors of the markets such as financials and banking as well as materials and industrials that present interesting potential. Summer should be a relatively slow time for the markets this year, but as we have seen recently, even slow times can become exciting very quickly, which will likely be the case this year.

 

Peter Johnson

Callahan Capital Management

 

Second Quarter 2017 Numbers:

 

The following is a numerical representation of the second quarter of 2017. I will start with the three major US indexes and the VIX, which turned in performance as follows:

 

Index 2nd Quarter 2017
Dow 3.32%
S&P 500 2.57%
NASDAQ 3.87%
VIX -10.27%

 

All three of the major US indexes turned in positive performance for the quarter, thanks mostly to a strong month of May as earnings for the first quarter of 2017 were being reported. Not surprisingly, the VIX for the quarter moved lower, declining by more than 10 percent, even after gaining more than 10 percent during the final 5 trading days of the quarter.

 

Globally, the top three performing indexes for second quarter of 2017 were:

 

Country Index 2nd Quarter 2017
Venezuela Caracas General 181.1%
Turkey BIST 100 12.9%
Sri Lanka Colombo Stock Exchange 11.3%

Venezuela continues to have very wild performance figures, both in its currency and its markets, as the country tries to cope with hyperinflation. According to Reuters, Venezuela ended 2016 with an inflation rate of 800 percent and it was expected to reach as high as 1,500 percent during 2017. Residents that can afford to are putting money into the local stock market, which is made up of a very small number of companies, to try to keep up with inflation. Sadly, even this strategy is not working, but it did provide investors with a stunning 181 percent gain for the quarter if you had guts to hang on for some very wild swings. Turkey was the second best performing index on the world stage for the second quarter, thanks in large part to ISIS falling apart and becoming much less of a threat to the country. Sri Lanka rounded out the best performing stock exchanges for the quarter with a gain of 11.3 percent as the country has been steadily seeing increases in foreign investments and travel and tourism.

 

Globally, the bottom three performing indexes for the second quarter of 2017 were:

 

Country Index 2nd Quarter 2017
Brazil Sao Paulo Bovespa -3.2%
Pakistan KSE 100 -3.3%
Russia RTS Index -10.1%

 

 

It is not surprising to see that Russia was the worst performing country in terms of market performance during the second quarter. Every time its name was brought up by the US Congress it seemed the RTS index would drop by half a percent. Combine this with its relationships with countries the rest of the world would rather not talk with and it is not surprising to see a more than 10 percent decline. Pakistan came in second worst, with a decline of 3.3 percent, followed by Brazil dropping 3.2 percent, thanks to continued political corruption being found on a seemingly daily basis.

 

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 2017:

 

Style / Market Cap Value Blend Growth
Large Cap 1.30% 3.06% 4.59%
Mid Cap 1.33% 2.63% 4.15%
Small Cap 0.60% 2.50% 4.40%

Growth beat out value across the board during the quarter, while large caps were the favored market cap in most cases. Technology companies drove much of this performance as the very large Google, Amazon, Facebook and Apple companies of the world all experienced strong returns, while mid-sized and smaller companies lagged. As mentioned above, value investing was not in favor during the quarter as valuations were too elevated to see much significant buying during the quarter.

 

The following table gives the performances for the best sectors for the second quarter of 2017:

 

Sector Change
Healthcare Providers 10.87%
Medical Devices 10.07%
Software 8.20%
Healthcare 7.35%
Industrials 6.35%

 

 

 

 

 

 

 

With healthcare being a political football for much of the quarter, the sector was bound to either end up near the top or the bottom of the performance tables as so much is riding on the healthcare reform currently in the works. Healthcare Providers took top honors for the second quarter, while Medical Devices and Healthcare overall took the second and fourth spots, respectively. Software got a big jump from earnings during the quarter, especially those of Oracle, which beat analyst estimates and moved more than 10 percent higher in just a single day. Industrials took the fifth and final spot of top performing sectors, as industrials remain a key part of President Trump’s plan to make American great again.

 

 

The bottom-performing sectors for the second quarter of 2017 were as follows:

 

Sector Change
Telecommunications 0.05%
Semiconductors 0.02%
Natural Resources -7.18%
Energy -7.34%
Oil & Gas Exploration -10.22%

 

With oil down in excess of 10 percent for the quarter, it was not surprising to see that Oil and Gas Exploration took the bottom spot, also declining by more than 10 percent during the quarter. Energy and Natural Resources were also largely taken down by oil during the quarter and occupied the second and third worst performing sectors. Semiconductors and Telecommunications rounded out the bottom five as these two sectors seemed to have many headwinds during the quarter, including relatively poor earnings and uncertainty following the finalization of several large mergers and acquisitions.

 

Commodities saw mixed results during the second quarter of 2017; returns were as follows:

 

Commodity Change Commodity Change
GS Commodity Index -5.40% Oil -10.71%
Gold -0.59% Livestock 12.46%
Silver -8.93% Grains 4.85%
Copper 1.18% Agriculture 0.35%

 

Oil declined by more than 10 percent during the quarter and officially entered a bear market two weeks prior to the end of the second quarter after falling more than 20 percent during 2017. Global supply and demand imbalance combined with increasing US oil production were the primary factors behind the negative price movements in oil. Gold declined 0.59 percent, while Silver fell 8.93 percent and the more industrially used Copper moved up by 1.18 percent. For the quarter, all the soft commodities moved higher, with Grains advancing 4.85 percent, while Livestock jumped 12.46 percent and Agriculture overall posted a small 0.35 percent gain.

 

Without missing a beat, the Fed has now increased rates each of the last three quarters, something that has not occurred for many years. In doing so, one would normally expect rates to rise and bond prices to fall, but both rates and bond prices rose this quarter:

 

Fixed Income Change
Long (20+ years) 4.31%
Middle (7-10 years) 1.42%
Short (less than 1 year) 0.13%
TIPS -0.46%
Long US Dollar -4.62%

 

These bond market movements reflect bond traders making bets that the Fed will not be able to increase rates again in 2017, that the hike in June was the last for a long time to come. This could turn out to be correct, despite Fed officials continuing to insist that a rate hike later this year is still on the table. There was one fixed income investment that declined during the quarter and that was the TIP bonds, which are inflation protected bonds. This was because we saw deflation at several points during the second quarter, which hurts inflation protected bonds. With President Trump being so vocal about “America first,” the US dollar was a very popular trade at the start of the second quarter, but as time went on and investors saw President Trump have less impact on things in Washington DC, they sold the hopes of a stronger US dollar. The decline in the price of oil also helped push the US dollar downward during the quarter as oil is denominated in US dollars, so falling prices mean less demand for dollars in the oil trade.

For a PDF version of the below commentary please click here Weekly Letter 7-3-2017

Commentary quick take:

 

  • Major developments:
    • Slow week for the markets
    • Oil rebounded
    • ECB President Draghi turning hawkish?

 

  • US:
    • Fed officials warn of asset bubbles
    • Republicans pulled healthcare bill off the table
    • Fed stress test results boosted financials

 

  • Global:
    • ECB President Draghi scared the markets
    • Oil jumped more than 7 percent

 

  • Technical market view:
    • All three US indexes moved lower
    • NASDAQ back down in trading range
    • VIX increased more than 10 percent

 

  • Hybrid investments strategy update:
    • No changes to the models
    • Nike has a deal with Amazon

 

  • This week for the markets:
    • Holiday shortened trading week in the US

 

  • Interesting Fact: Australia quietly goes about its business

 

Major theme of the markets last week: Volatile times lead to thoughts of bears

The US financial markets had two intraday declines of more than two percent during the week last week, bringing the thought that there could be a bear lurking around the corner. While the overall daily volume was average and there were no volume spikes on the large market movements, seeing such large movements in the markets gave some investors pause. The general lack of volume was indicative of non-institutional money managers making the changes, individual investors adjusting their portfolio positions ahead of the Fourth of July holiday in the US. Volatility in the financial markets was also confirmed by the movements in the VIX, which saw spikes of more than 20 percent on an intraday basis twice during the week. While there were no individual items to point toward for the reasoning behind the volatility, weaker than expected economic releases combined with uncertainty over the future movements of the Fed and congressional politics in Washington DC likely all played some role in the movements.

 

US news impacting the financial markets:

 

There were several topics that made headlines in the US financial news last week that had a notable impact on the overall markets: Fed Chair Yellen’s speech, the Republican’s failure to get a healthcare bill to the Senate floor and the results of the Fed’s banking and financial institutions stress test for 2017. Tuesday was a big day for Fed officials as there were three members of the Fed who spoke about the same topics all on the same day. Fed Chair Yellen received the most media coverage, as is common, and was speaking in London. Markets headed lower following her prepared remarks and even lower during the question and answer portion of the meeting when she discussed asset prices. Chair Yellen made a few waves when she described asset valuations as “somewhat rich if you use some traditional metrics like price earnings ratios.” This sentence, out of all the sentences from her speech, was taken as a “shot across the bow” warning that financial markets in the US have come too far too fast. This sentiment was echoed by Fed vice chair Stanley Fisher on Tuesday when he said, “The general rise in valuation pressures may be partly explained by a generally brighter economic outlook, but there are signs that risk appetite increased as well. So far, the evidently high-risk appetite has not led to increased leverage across the financial system, but close monitoring is warranted.” The third Fed official that seemed to be warning about US financial prices on Tuesday was San Francisco Fed President John Williams in an interview with an Australian media outlet when he said, “the stock market still seems to be running very much on fumes.” Any time a Fed official alludes to the stock market being overvalued it is typically a bad day for the US markets, but when three Fed officials all said the same thing in different ways on the same day, the market really seemed to pay a lot of attention. Despite the Fed officials not saying what the markets wanted to hear, the Fed did say something, unlike the Republicans in the Senate with their ongoing healthcare bill.

 

Last week, Senate Majority leader Mitch McConnell was forced to pull the Senate healthcare reform bill that he was initially trying to get voted on before the Fourth of July holiday. The delay of such an important bill by the Republicans shows how hard they have to work, even within their own party, to pass this bill. Senator McConnell can only afford to have two Senate republicans vote against the bill or it will not be passed. With some counts having as many as 4 republicans staunchly against the bill, there was no way for a vote to be called, knowing the bill would be defeated. Senator McConnell announced that the bill would be reworked and get another score from the Congressional Budget Office (CBO), with hopes for a vote on the bill following the one week recess for the Fourth of July. The bar has been set low for improvement from the CBO score of the bill since the first draft of the bill left an estimated 22 million Americans that currently have coverage under The Affordable Care Act (Obamacare) without coverage under the new plan. President Trump did not seem to help the situation when he jumped into the debate saying that a bill was very close to getting done. Healthcare stocks and medical providers were hardest hit on the announcement of the bill being pulled as their future payment streams are once again in question.

 

The final topic of the week in the US financial media had to do with the results of the Fed’s banking stress test for 2017. The financial score cards were released last week and all the major US financial institutions passed with flying colors. The secondary financial institutions also performed very well, with only a single institution getting a provisional passage with a “changes being needed” score. This positive news for the financial sector set the group moving significantly higher for the week. With the thumbs up from the Fed, the large financial institutions in the US are now able to increase the dividends they are paying out to shareholders and increase the amount of the share buyback programs, both of which are normally positive for investors. With the Fed starting to raise rates with some regularity, the latest banking health check-up being complete and valuations below the broad markets, the financial sector looks ripe for strong performance going forward.

 

Global news impacting the markets:

 

There were two main topics last week in the global financial media that had notable market impacts, the first being ECB President Draghi’s statement sounding very hawkish and the second being the movement in the price of oil. ECB President Mario Draghi spoke on Tuesday in Sintra, Portugal and from his speech and the Q&A session there were two key lines the market took as very hawkish when compared to his previous speeches. He said, “We need prudence. As the economy picks up we will need to be gradual when adjusting our policy parameters, so as to ensure that our stimulus accompanies the recovery amid the lingering uncertainties. As the economy continues to recover, a constant policy stance will become more accommodative, and the central bank can accompany the recovery by adjusting the parameters of its policy instruments — not in order to tighten the policy stance, but to keep it broadly unchanged.” The word “adjusting” is what made the markets think the stimulus programs currently being run by the ECB could be coming to an end and that in doing so there could be an increased amount of volatility in the European markets. Because of the speech, bond yields in the Euro area spiked higher, especially in Germany, and the value of the Euro also jumped upward. This spike shows how sensitive the global financial markets have become to central banks following the Great Recession of 2008. Even very slight deviations from the norm are magnified and much is read between the lines of everything every central banker says. This will likely remain the way it is for the foreseeable future. The media headlines last week on the global front dealt with the price of oil.

Oil prices last week jumped higher by more than 7 percent after officially moving into bear market territory just two weeks ago, having declined by more than 20 percent so far during 2017. However, the reason for the jump in oil prices had less to do with the global oversupply of oil relative to global demand and more to do with other, relatively unimportant, figures. Gasoline stockpiles last week in the US were shown to have decreased by 894,000 barrels, when expectations had been for a decline of 583,000 barrels. While the data is just for one week, it was the first week that US demand for gasoline was higher than anticipated. Adding further to the bullish movement in the price of oil last week was the fact that US oil production last week declined by 100,000 barrels per day, down to 9.3 million barrels of oil per day. While this may seem like a relatively slight change, the fact that US production declined at all is what got oil traders excited about the potential for oil to move higher. Most analysts think the usage from the gasoline reserves in the US and the decline in production of oil are very temporary and will correct over the course of the next two weeks, likely pushing oil right back down by 7 percent or more.

Technical market review:

 

There were no changes to the technical trading ranges on the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

The Dow (upper right pane above) is currently the strongest of the three major US indexes after all three indexes entered last week virtually tied. The Dow, while it did decline slightly last week, managed to stay the most above its current trading range. The S&P 500 (upper left pane above) moved into second place with a lack luster week in terms of performance that kept the index just above its most recent trading range. The NASDAQ (lower left pane above) failed to stay above its most recent trading range last week as the large declines in a few of the very heavily weighted stocks in the index brought down the whole index. The NASDAQ also closed out the week last week in a very interesting spot as it is almost the same level the index has closed the last three times it has bounced down. Will it bounce right back off this support level as it has the past three times? Only time will tell. The VIX (lower right pane above) had a very volatile week, as alluded to above, but ended the week with a relatively tame increase of a little more than 10 percent, still way below the 52-week average level for the VIX.

 

Hybrid model performance and update

For the trading week ending on 6/30/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.09% 6.30% 12.03%
Aggressive Benchmark -0.36% 9.23% 9.02%
Growth Model -0.17% 5.53% 10.31%
Growth Benchmark -0.28% 7.19% 7.35%
Moderate Model -0.41% 4.40% 8.21%
Moderate Benchmark -0.19% 5.19% 5.57%
Income Model -0.62% 4.01% 7.61%
Income Benchmark -0.08% 2.73% 3.21%
Quant Model 0.11% 10.42%
S&P 500 -0.61% 8.24% 17.46%

*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. There was, however, a substantial change in the price of Nike stock during the week. There had been rumors over the past few weeks that Nike would begin a partnership with Amazon to sell its products. Nike had long been one of the last major brands to hold out on officially selling its products on Amazon’s platform, but on Friday a deal was confirmed. The reaction was an immediate gain of almost 10 percent in Nike stock, while other foot ware and athletic apparel companies saw meaningful declines. It will be interesting to see how pricing works for Nike products on Amazon, if Amazon forces Nike to lower its prices on some products or if Nike will be allowed to sell at the same prices it sells its products in big box stores. This agreement should more than pick up any slack that Nike has experienced with the closure of Sports Authority and several other outdoor sporting good chains over the last 18 months.

 

Market Statistics:

 

Last week, the bears seemed to oversee the US financial markets going into the Fourth of July holiday week in the US, as all three indexes closed lower for the week:

 

Index Change Volume
Dow -0.21% Average
S&P 500 -0.61% Below Average
NASDAQ -1.99% Average

 

After being the best performing index two weeks ago, the NASDAQ had a difficult week as selling pressure was great on the large technology stocks that have been driving much of the positive performance of the index so far this year. The NASDAQ declined 1.99 percent for the week, giving up all of the index’s gains from two weeks ago and a little more. The S&P 500 saw below average volume during a week in which it posted modest declines. The Dow was the top performing index as it experienced average trading volume as investors seemed to be moving toward the large cap Dow component companies as a way to avoid some of the recent volatility seen in other indexes such as the NASDAQ.

 

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
Commodities 5.49% Multimedia Networking -3.04%
Regional Banks 4.07% Software -3.12%
Financial Services 3.33% Technology -3.16%
Financials 2.97% Biotechnology -3.27%
Broker Dealers 2.61% Semiconductors -5.16%

 

The top five performing sectors of the markets last week were made up of two primary sectors, the first being Commodities that jumped on oil gaining more than 7 percent for the week (the largest weekly move in the past several months) and the second being Financials. Financials moved higher last week because of the latest round of Federal Reserve stress test results. With all the major banks and nearly all the secondary banks and financial institutions passing the Fed’s latest stress tests, investors jumped back into the stocks. Having passed the stress tests, the banks are now allowed to increase both the payouts and their share buyback programs. On the flip side, Technology broadly pushed lower last week with technology related sectors taking all five of the bottom performing sectors. Semiconductors and Biotechnology took the bottom two spots as they are the riskiest of the high technology sectors and typically the most negatively impacted to the downside when the NASDAQ moves lower. Technology overall took third from the bottom last week, while Software and Multimedia Network rounded out the bottom performers.

 

Fixed income investments in the US were mixed over the course of the past week as the markets continued to defy what the Fed is saying about future rate hikes in 2017:

 

Fixed Income Change
Long (20+ years) -2.08%
Middle (7-10 years) -1.10%
Short (less than 1 year) 0.01%
TIPS -0.77%

Global currency trading volume was average last week as traders adjusted their positioning for the more hawkish tone ECB President Draghi used in his speech, discussed in more detail above in the international section. Overall, the US dollar decreased 1.59 percent against a basket of international currencies. Much of the decline in the value of the dollar was due to strength coming from the Euro and from the British pound, both of which moved higher on the hawkish ECB. The best performing of the global currencies last week was the Swedish Krona, as it gained 3.4 percent against the value of the US dollar. The worst performance among the global currencies was the Argentinean Peso, which declined 2.6 percent against the US dollar.

Commodities were mixed last week as Oil jumped higher, while the precious metals moved lower:

Metals Change Commodities Change
Gold -1.18% Oil 7.22%
Silver -0.51% Livestock 3.76%
Copper 3.36% Grains 6.70%
Agriculture 4.20%

The overall Goldman Sachs Commodity Index advanced 5.49 percent last week, making back approximately half of the decline experienced in the last half of May. As is normally the case, oil was the primary driving force behind the positive performance seen on the overall commodity index as it gained 7.22 percent for the week. The jump in oil was due to a significantly smaller increase in oil stock piles in the US as well as a slowdown of 100,000 barrels per day in total US production. Analysts, however, warn that these two factors, which contributed to nearly all the gains last week, are likely to be very temporary. Metals were mixed last week, with Gold and Silver declining 1.18 and 0.51 percent, respectively. The more industrially used Copper turned in a solid gain of 3.36 percent for the week as industrial demand for the metal looks to be increasing. Soft commodities were all positive last week with Grains posting a 6.7 percent jump, while Livestock gained 3.76 percent and Agriculture overall increased 4.20 percent.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Merval Argentina 4.02% OMX Helsinki Finland -2.96%
Sao Paulo Bovespa Brazil 2.97% DAX Germany -3.21%

Last week was a mixed week for global financial markets, with 41 percent of the global markets posting gains. The best performing index last week was found in Argentina, and was the Merval Index, which turned in a gain of 4.02 percent for the week. However, the gain on the stock exchange in Argentina was almost entirely due to the decline in the peso, which was the worst performing currency of all the global currencies, as mentioned above. The worst performing index last week was found in Germany, the DAX Index, which turned in a loss of 3.21 percent for the week, as the end of quantitative easing alluded to by the ECB could have adverse effects on the German economy.

Unlike two weeks ago, last week the VIX had several intra-week moves that were significant in size as the market moved up and down in a wide trading range. Overall, the VIX advanced by 10.78 percent for the week. Even with the gain of more than 10 percent, the index just barely managed to move over 11, which means complacency still seems to be the signal being given off by the markets’ fear gauge. The current reading of 11.10 implies that a move of 3.20 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a typical slow week for economic news releases with several important releases, but only a single release that came in significantly different than the market was expecting:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Slightly Negative 6/26/2017 Durable Goods –ex transportation May 2017 0.1% 0.5%
Slightly Negative 6/26/2017 Durable Orders May 2017 -1.1% -1.0%
Slightly Positive 6/27/2017 Consumer Confidence June 2017 118.9 116.0
Neutral 6/29/2017 GDP – Third Estimate Q1 2017 1.4% 1.2%
Neutral 6/30/2017 Personal Income May 2017 0.4% 0.3%
Neutral 6/30/2017 Personal Spending May 2017 0.1% 0.1%
Neutral 6/30/2017 PCE Prices – Core May 2017 0.1% 0.1%
Positive 6/30/2017 Chicago PMI June 2017 65.7 56.0
Neutral 6/30/2017 University of Michigan Consumer Sentiment Index June 2017 95.1 94.7

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

 

Last week, the economic news releases started on Monday with the release of the durable goods orders, both including and excluding transportation for the month of May. Both overall orders and orders excluding transportation came in slightly below market expectations. This is a cause for some concern from economists as soft consumer spending, as indicated by these figures, could spell trouble for second quarter 2017 GDP here in the US. On Tuesday, consumer confidence as measured by the government, was released slightly better than expectations, which is the opposite of what one would expect if they looked at the spending figures from the same time. On Thursday, the third estimate for first quarter GDP in the US was released and posted a 0.2 percent increase over the second estimate of 1.2 percent. This was a positive development, but first quarter (even after this latest revision) was still an extremely slow growth quarter and second quarter looks like it could be a bit more difficult in terms of growth. Friday was a busy day for economic news releases as personal income and spending for the month of May were released first, with both figures coming in very close to market expectations and having little market impact. Core PCE prices for the month of May were released a little later on Friday and showed a dismal amount of inflation in the US with a reading of only 0.1 percent on a month-over-month basis. Overall, PCE prices increased 0.07 percent, which is near the slowest inflation rate of the past 17 years. Both inflation indicators and consumer spending look like it will be increasingly difficult for the Fed to manage to raise rates even one more time in 2017. The Chicago area PMI for the month of June was released on Friday as well, and easily beat market expectations with the largest upside surprise of the week of any of the economic news releases. With manufacturing being a significant part of the US economy, an increase in this indicator gave some economists a breath of fresh air after such a poor showing on many of the other economic new releases this week. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment Index for the month of June (end of month reading), which came in very close to market expectations and had no noticeable impact on the overall markets.

 

This week is a normal week for economic news releases with the primary focus of the releases being on the US labor market:

 

Date Release Release Range Market Expectation
7/3/2017 ISM Index June 2017 55.0
7/5/2017 FOMC Minutes June Meeting NA
7/6/2017 ADP Employment Change June 2017 185K
7/6/2017 ISM Services June 2017 56.6
7/7/2017 Nonfarm Payrolls June 2017 173K
7/7/2017 Nonfarm Private Payrolls June 2017 175K
7/7/2017 Unemployment Rate June 2017 4.30%

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

 

This week the economic news releases start on Monday with the release of the overall ISM index for the month of June, which is expected to be very little changed when compared to the May reading of 54.9. On Wednesday, the June FOMC meeting minutes will be released by the Fed and could hold more detail about the fear of asset bubbles, discussed earlier in this commentary. It would make sense for the Fed officials to try to get out ahead of the minutes being released if information about a discussion about asset valuations was held at the meeting and will be divulged in the minutes. On Thursday, the first of the employment related figures for the week is set to be released with the ADP employment change index for the month of June, which is expected to show a modest 185,000 new jobs having been created during the month. Later during the day on Thursday, the service side of the ISM index will be released, but much like the overall ISM released earlier during the week, there is not expected to be much change between May and June on this release. On Friday, the focus of the economic news releases will be on the US labor market. The overall unemployment rate for the month of June will be released, in addition to the payroll figures and many other data points related to employment in the US. Overall, the unemployment rate in the US is expected to be unchanged from the May level of 4.3 percent. Payroll figures are expected to be slightly lower than the May figures, which would be a relief given the very poor reading seen on the May payroll figures. While we are likely a few months away from a realistic chance of a Fed rate hike, the data for June’s labor market will likely be closely watched to see if the declines in the unemployment rate and the stagnant wage growth really are “transitory” or not.

 

Interesting Fact —Australia has a very stable economy.

 

Two weeks ago, Australia announced its first quarter 2017 GDP Growth rate, which was 0.3 percent. This is significant because it has now been 103 consecutive quarters that Australia has gone without a technical recession (two consecutive quarters of GDP declines). Twenty-six years is a very long expansion for an already rich and developed country.

 

Source: http://www.telegraph.co.uk

For a PDF version of the below commentary please click here Weekly Letter 6-26-2017

Commentary quick take:

 

  • Major developments:
    • Slow summer trading
    • Healthcare jumped higher
    • Oil continued to move lower

 

  • US:
    • Republican healthcare bill on the table
    • US housing market rebound

 

  • Global:
    • Brexit negotiations moving forward
    • Oil continues to tank
    • China A share index now included in the MSCI Emerging Market Index

 

  • Technical market view:
    • NASDAQ made up some lost ground
    • All three US indexes tied
    • VIX pushed lower for the week

 

  • Hybrid investments strategy update:
    • No changes to the models
    • Models remain almost fully invested

 

  • This week for the markets:
    • Summer trading
    • Brexit negotiations ongoing
    • Healthcare reform bill potentially on Capitol Hill

 

  • Interesting Fact: Buyer beware in the Chinese A share index

 

Major theme of the markets last week: Healthcare reform back on the table?

 

The major theme of the US financial markets last week was strength in the US healthcare sector. This strength was based on the thought that Republicans would successfully revive the healthcare reform bill that miserably failed the first time around about 3 months ago. While details about the new plan remain elusive, there was renewed hope that a bill reforming the Affordable Care Act would be able to come up for a vote and pass both the House and the Senate. If a bill were to pass on Capitol Hill and be signed by President Trump, it would represent the first major piece of legislation the administration has achieved. While gains were primarily seen among stocks that had declined the most following the first round of the healthcare reform debate, seeing Republicans come together for healthcare reform reinvigorated the idea that Congress may be able to start passing additional meaningful legislation.

 

US news impacting the financial markets:

 

There were two main themes that moved the overall US markets last week and both were positive. As mentioned above, healthcare reform had a significant impact on the NASDAQ and the markets in general. The spillover from the healthcare reform movement was also seen in the pharmaceuticals industry, which moved higher last week. The rumor surrounding the healthcare reform dropping any language about capping drug prices was enough to push the drug manufacturers significantly higher during the week, though no one from the administration explicitly said the administration will cease going after high drug prices. Additionally, there were several FDA drug approvals last week that pushed a few mid-sized drug companies up by more than 40 percent, further adding fuel to the rally in the Pharmaceutical and Biotechnology sectors.

 

The second major theme during the slow week last week was reversal in the US housing market, which had been looking soft compared to previous years. Last week, existing home sales and new home sales were released with both posting better than expected figures for the month of May. Prices on home sales also increased at the fastest year-over-year rate since mid 2014, as depicted in the chart to the right. This development provided some hope that spending for the second quarter will be positively impacted by the housing market. Consumer spending remains the wildcard for the overall health of the US economy as recent data points show spending is slowing. Slowing consumer spending was also one of the points addressed in speeches made last week by several Fed officials.

Federal Reserve Bank of New York President William Dudley had one of the more interesting speeches of the seven Fed officials who spoke last week, outlining some very unusual logic about why the Fed needs to keep raising interest rates. His thinking is not universal among the FOMC members. He said that “if we were not to withdraw accommodation, the risk would be that the economy would crash to a very, very low unemployment rate, and generate inflation, then the risk would be that we would have to slam on the brakes and the next stop would be a recession.” This line of thinking is concerning to some economists because the Fed is supposed to have a dual mandate of full employment and price stability, not manipulating the Fed funds rate so they can just manipulate it again in the opposite direction. Inflation remains stubbornly below the Fed’s target inflation rate (but this has been the case for the past several years), while the US employment market has moved all the way down to target. The Fed must delicately balance future rate movements in order to avoid tipping the US economy back to slower or even negative growth, which is a risk when raising rates while inflation is lacking. Right now, the fixed income markets in the US are not really considering any further rate hikes during 2017, while the Fed language is still pointing toward at least one more hike during the calendar year. We will have to see who ends up being correct, the bond market or the Fed.

 

Global news impacting the markets:

 

There were two primary themes in international news last week: the commencement of the Brexit negotiations between the UK and the EU and the continued decline in the price of oil. Brexit negotiations started in Brussels on Monday with UK Brexit secretary David Davis and EU Chief Brexit negotiator Michael Barnier holding a first meeting and exchanging gifts as assign of good will. While Davis sounded optimistic in his remarks about the first round of discussions, it was clear the EU is in the driver seat and not in the mood to negotiate much on many of the sticking points surrounding the Brexit. This is evident in Barnier’s statement, “I am not in a frame of mind to make concessions, or ask for concessions,” adding, “It’s not about punishment. It is not about revenge. Basically, we are implementing the decision taken by the United Kingdom to leave the European Union, and unravel 43 years of patiently-built relations.” The positive aspect easing Brexit fears is that the negotiations have started. When the snap election was called for by PM May, there were some fears that the negotiations may never actually start, so with the talks commenced and not seeming to go badly for the UK last week, there was a bit of an upbeat mood surrounding the Brexit. One area of the global markets that experienced no upbeat mood was the oil market.

Oil continued to slide last week, falling more than 4 percent and officially seeing all types of oil traded around the world enter into bear market territory (a decline of more than 20 percent from a top). Oil traders around the world are starting to feel the pinch and there are rumblings of the potential negative impact the energy sector could have on overall earnings should the decline in oil prices persist through the remainder of 2017. The global oversupply of oil, and in turn the oversupply of gasoline, seems to be very persistent and thus far everything that OPEC and other oil producing countries have done to try to boost the price of oil has failed, mainly due to US fracking production. US fracking has become the swing producer that is not beholden to the wishes of OPEC and is fully capable and willing to take any and all market share the cartel is will to give up via production cuts and freezes.

 

A quick note last week out of Asia is that the Chinese A share stock index is now included in the MSCI Emerging Market Index for the first time ever. The change has been three years in the making with MSCI having rejected the addition of the local currency stock index to its main emerging market index for three years running. This inclusion adds some volatility to the overall MSCI emerging market index as the Chinese A share index is notoriously volatile around the movements of the Chinese government, both in currency and with outright trading controls. It is a big win for China, but could also become a concern for emerging market investors that passively invest in the big MSCI index.

 

Technical market review:

 

There were no changes to the technical trading ranges on the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

At this point, it is becoming increasingly difficult to discern which of the three major indexes is in the lead in terms of short term relative strength. Obviously, the NASDAQ (lower left pane above) recovered the most last week, but it started the week from a very weakened position compared to the other two indexes. The Dow (upper right pane above) started last week well, but finished the week with technical weakness. The S&P 500 (upper left pane above) started the week weaker than the Dow, but finished stronger. With all of that being taken into consideration, last week resulted in all three of the major US indexes being tied in terms of technical strength. Even the VIX (lower right pane above) had a tough time making up its mind and doing much of anything over the course of the previous week.

 

Hybrid model performance and update

For the trading week ending on 6/23/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model -0.19% 6.20% 11.93%
Aggressive Benchmark 0.16% 9.62% 9.41%
Growth Model -0.21% 5.71% 10.50%
Growth Benchmark 0.13% 7.49% 7.64%
Moderate Model -0.22% 4.83% 8.66%
Moderate Benchmark 0.10% 5.39% 5.77%
Income Model -0.19% 4.66% 8.29%
Income Benchmark 0.05% 2.81% 3.29%
Quant Model 0.25% 10.29%
S&P 500 0.21% 8.91% 18.19%

*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. With the primary driver of market performance last week being the healthcare sector and the hybrid models’ general underweight to the sector, due to its volatile nature, the models generally lagged last week. Overall, the hybrid models remain close to fully invested, with one focus of the investments being low volatility areas of the markets, while a secondary focus is more on investments that should perform well in the current political climate, such as materials and infrastructure, something both Republicans and Democrats can agree needs to be improved.

 

Market Statistics:

 

Last week was the first positive week in several weeks for all three of the major US indexes; the Dow just barely managed to eke out a gain for the week:

 

Index Change Volume
NASDAQ 1.84% Above Average
S&P 500 0.21% Average
Dow 0.05% Average

 

NASDAQ took top honors on above average volume last week after being the worst performing index for the past several weeks. The index turned around in a big way thanks to the large increases seen in Biotechnology and Pharmaceuticals. The S&P 500 posted a small gain for the week on average volume, while the Dow finally took a breather after running so hard for the past few weeks.

 

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 9.57% Oil & Gas Exploration -1.91%
Pharmaceuticals 5.51% Insurance -2.41%
Software 3.99% Energy -2.76%
Healthcare 3.71% Telecommunications -3.01%
Healthcare Providers 2.42% Regional Banks -3.51%

 

With the Republican healthcare bill potentially back on the table, all things related to healthcare seemed to take a positive bounce last week. Biotechnology and Pharmaceuticals took the top two spots last week, as is normally the case with healthcare jumping higher. Performance in these two sectors was driven primarily by FDA drug approvals and the failure of the Trump administration to reign in drug prices so far. Healthcare overall and Healthcare Providers took the fourth and fifth best performing spots for the week. Sitting in third place last week in terms of best performing sectors was the Software sector, thanks almost entirely to a large jump by Oracle (one of the heaviest weighted stocks in the relatively small sector) after the company significantly beat earnings expectations on Tuesday. On the negative side of sector performance last week, regional banking struggled with potentially increasing regulations and the latest Fed rate hike. Telecommunications came in second worst as the Verizon deal to buy Yahoo finally closed after more than a year of speculation about whether the deal would ever get done. Yahoo’s CEO Marissa Mayer resigned shortly after the deal closed, leaving the company with the honorary title of “least likable” CEO in Technology. Energy took the third from bottom position and Oil took the fifth as oil prices continued to decline around the world, as mentioned above in the international news section. Insurance took a hit last week and made the bottom five performing sectors thanks to the Republican healthcare bill potentially having far reaching negative effects on the insurance industry overall.

 

Fixed income investments in the US all increased over the course of the past week as the markets continued to defy what the Fed is saying about future rate hikes in 2017:

 

Fixed Income Change
Long (20+ years) 1.13%
Middle (7-10 years) 0.08%
Short (less than 1 year) 0.03%
TIPS 0.55%

Global currency trading volume was below average last week as there were almost no major events or data points released around the world that warranted adjusting the very large currency contracts. Overall, the US dollar increased 0.12 percent against a basket of international currencies. The best performing of the global currencies last week was the Romanian Leu, as it gained 0.6 percent against the value of the US dollar. The worst performance among the global currencies was the Russian Ruble, which declined 2.9 percent against the US dollar as the situation in Syria continued to heat up with the US shooting down a Syrian air force fighter plane.

Commodities were mixed last week as Oil continued to decline, while the metals turned in positive performance:

Metals Change Commodities Change
Gold 0.08% Oil -4.11%
Silver 0.00% Livestock -1.87%
Copper 1.99% Grains -5.00%
Agriculture -3.54%

The overall Goldman Sachs Commodity Index declined 2.78 percent last week and is now down almost 11 percent since May 22nd. Oil has contributed to most of the decline, including last week when Oil fell 4.11 percent. With the decline seen last week in Oil, more and more pundits are jumping on the bear market band wagon, which officially started rolling two weeks ago when Oil was more than 20 percent lower than it started the year. Supply and US production numbers keep adding pressure to the price of oil. Last week, we saw Brent crude oil break down below $45 per barrel for the first time this year, a sign that the bear market in oil is not just limited to the West Texas Intermediary (WTI) type of crude oil. Metals were positive or flat last week with Gold and Copper advancing 0.08 and 1.99 percent, respectively. Silver turned in a zero change for the week when looking at point to point performance. Soft commodities were all negative last week with Grains posting a 5 percent decline, while Livestock fell 1.87 percent and Agriculture overall declined 3.54 percent.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Dow Jones China 88 China 3.95% Santiago IPSA Chile -1.45%
Weighted Taiwan Index Taiwan 2.18% Bel-20 Belgium -1.65%

Last week was a very mixed week for global financial markets, with exactly 50 percent of the markets posting gains, while 50 percent moved lower. The best performing index last week was found in China, and was the Dow Jones China 88 Index, which turned in a gain of 3.95 percent for the week. It was nice to finally not seen Venezuela in the top spot in terms of performance. The worst performing index last week was found in Belgium, the Bel-20 Index, which turned in a loss of 1.65 percent for the week.

Last week was a surprising week for the VIX; it traded in the tightest weekly trading range seen for more than the past year. The VIX remained flat almost the entire time. There were no intraweek or intraday spikes on Trump tweets or random news out the UK about the Brexit; nothing seemed to budge the VIX. Overall, the VIX declined by 3.47 percent for the week. Complacency still seems to be the rule, given the low level of the VIX. The current reading of 10.02 implies that a move of 3.89 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a very slow week for economic news releases with only two releases, neither of which the market paid any attention to at all:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/21/2017 Existing Home Sales May 2017 5.62M 5.52M
Neutral 6/23/2017 New Home Sales May 2017 610K 599K

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

 

Last week, the economic news releases started on Wednesday with the release of the existing home sales figure for the month of May, which came in very close to expectations and had no impact on the markets. On Friday, new home sales, also for the month of May, were released and while they beat expectations, they did not do so by enough for the market to react. In aggregate, the two data points about the US housing market pointed to a housing market that is mature in age and market cycle, but not currently at risk of moving meaningfully lower. If we start to see the housing sales figures decline by several percentage points, it could be a warning flag about the overall health of the US economy, but that is currently not the case.

 

This week is a normal week for economic news releases with the primary focus of the releases this week being the US consumer:

 

Date Release Release Range Market Expectation
6/26/2017 Durable Goods –ex transportation May 2017 -1.0%
6/26/2017 Durable Orders May 2017 0.5%
6/27/2017 Consumer Confidence June 2017 116.0
6/29/2017 GDP – Third Estimate Q1 2017 1.2%
6/30/2017 Personal Income May 2017 0.3%
6/30/2017 Personal Spending May 2017 0.1%
6/30/2017 PCE Prices – Core May 2017 0.1%
6/30/2017 Chicago PMI June 2017 56.0
6/30/2017 University of Michigan Consumer Sentiment Index June 2017 94.7

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

 

This week the economic news releases start on Monday with the release of the durable goods orders, both including and excluding transportation for the month of May. Expectations are for overall orders to have increased by 0.5 percent, which seems a little too optimistic given the poor consumer spending figures previously announced for the month of May and the slip in consumer confidence we’ve seen. Durable goods orders excluding transportation are expected to post a decline of 1 percent during the month of May, which seems about right given the other data points for the month. A slowdown and decline in durable goods orders is normally a very early warning flag for the overall health of the US economy. April was a negative month on both durable goods orders calculations and we could easily make it two months in a row of declines. That would be a troubling development for the economy. On Tuesday, consumer confidence as measured by the government is set to be released with expectations of a slight decline being seen during the month of June, following the previously released negative movements in other consumer sentiment indicators. On Thursday, perhaps the most potentially impactful release of the week is set to be released, that being the third estimate for first quarter GDP in the US, which is expected to post no change from the 1.2 percent printed for the second estimate. While not impossible, it would be unusual for the figure to be meaningfully adjusted on the third estimate, leaving open the possibility for a large market reaction if the figure changes by a significant amount. Friday is a busy day for economic news releases as personal income and spending for the month of May are set to be released first, with both figures expecting to post very low positive fractions of a percent growth for the month. We need to see spending tick up by something in the range of 0.4 percent, not the expected 0.1 percent, for the US economy to really start moving forward. Inflation has also been running abnormally low over the past few years and we get the latest in a long line of inflation indicators on Friday when the change in PCE prices for the month of May is released. Expectations are very low for this release, at 0.1 percent, so it is unlikely the market will be disappointed to the downside. The Chicago area PMI for the month of June is set to be released on Friday as well, with expectations of the rate expansion in manufacturing seen in May slowing down slightly, but still growing well above the inflection point of 50. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment Index for the month of June (end of month reading), which is expected to show almost no change when compared to the middle of the month reading. If this release does pan out and not show a further decline in sentiment, it will probably be taken as a positive development for the markets as a downward trend will not be seen as developing. In addition to the scheduled economic news releases this week, there are seven speeches being given by Fed officials, all of which will be watched by the markets, but none more closely than Fed Chair Yellen’s speech on Tuesday morning.

 

Interesting Fact — Chinese A share index is the wild west for investing

 

With the Chinese A share market now included in the MSCI emerging market index, some facts about the index could be entertaining:

 

Six percent of new equity investors in the A share index are illiterate, Deutsche Bank said in a note about the “Chinese share frenzy.”

 

About two-thirds of new equity investors left school before the age of 15, according to data from the China Household Finance Survey carried in a recent Bloomberg report. About a third left at age 12 or younger.

 

Median earnings multiples for Chinese technology stocks are twice U.S. peer valuations at their dot.com peak, Deutsche Bank said. More worrying perhaps, the note added, is a price to earnings ratio for health-goods-from-deer-antlers producer at 70 times, the seamless underwear manufacturer at 90 times or school uniform and ketchup makers at 330 times. (For reference, the average price to earnings ratio in the United States is close to 25 times on the S&P 500.)

 

Watch Out!

 

Source: Forbes.com, WSJ.com

For a PDF version of the below commentary please click here Weekly Letter 6-19-2017

Commentary quick take:

 

  • Major developments:
    • US Federal Reserve raised rates
    • Oil continued to tumble, officially hitting a bear market last week
    • Amazon makes offer to buy Whole Foods

 

  • US:
    • June rate hike by FOMC
      • Fed Funds rate now 1 to 1.25 percent
      • Forecast shows one more rate hike in 2017
      • Plan to wind down balance sheet was outlined
    • Attorney General Sessions testified

 

  • Global:
    • Central bank meetings
    • UK EU negotiations to commence
    • Oil continues to move lower

 

  • Technical market view:
    • NASDAQ fell back into trading range
    • Dow showed continued strength
    • VIX pushed lower for the week

 

  • Hybrid investments strategy update:
    • No changes to the models
    • Interesting reactions to Amazon and Whole Foods

 

  • This week for the markets:
    • Summer trading
    • Potentially more M&A news

 

  • Interesting Fact: Chocolate milk perceptions

 

Major theme of the markets last week: Amazon—Whole Foods

On Friday, Amazon’s surprise announcement that it is trying to buy Whole Foods for $14 billion in cash made waves throughout the US financial markets. Grocery stores such as Kroger, Safeway and Sprouts all booked large declines, while Whole Foods increased by almost 30 percent over its closing price on Thursday. The move by Amazon to move into grocery retailing is an interesting one. The cost to run brick and mortar stores is something Amazon has always criticized its competitors for. However, the company has been trying its own hand at retail outlets over the past few years with a grocery store and a book store up and running in the Seattle area. This buyout seems to be more of a real estate play than anything else, as Whole foods has a nationwide presence, yet not so many locations that the chain would be a logistical headache for Amazon. Wal-Mart appears to be one of the main targets of the deal if analysts are correct; its stock moved down about 4.5 percent on Friday following the announcement. In the Hybrid model section below, I briefly discuss why this seems like an overreaction on the markets’ part regarding Wal-Mart.  As of early trading on Monday, Whole Foods is currently trading above the takeover price that Amazon announced. It would be very ironic if Wal-Mart outbid Amazon for Whole Foods and was able to close the deal.

 

US news impacting the financial markets:

 

The Federal Reserve here in the US grabbed most of the headlines early last week as it held its June FOMC meeting on Tuesday and Wednesday. The outcome of the meeting was a rate increase of 0.25 percent, taking the target range from 0.75-1 percent up to 1-1.25 percent. This increase was already accounted for in the markets, both on the equity side and the fixed income side of investing, so there was little direct market movement from the release of the statement. The increase comes as the economic data the Fed has said it is looking at to determine the correct time to raise rates has been showing signals that would counter this move.

 

On the labor market front, the unemployment rate has largely continued to push lower in 2017 and is meaningfully below the Fed’s full employment target. Inflation, on the other hand, continues to be the primary problem for the Fed as it is just not present in most of the US. The Fed has a target inflation rate of 2 percent, but the most recent CPI and PPI data puts the rate closer to 1.7 percent and moving lower. In fact, the CPI data point for the month of May posted a decline of 0.1 percent, which signals deflation, something the Fed absolutely does not want to see picking up. Deflation is something all central bankers fear as it is very difficult to break the deflationary cycle once it gets going in earnest.  Other than cutting rates and throwing money at the economy, central bankers have little else to combat deflation. Retail sales, while not explicitly part of the Fed formula in determining when to move rates and by how much, could also come into play in the psychology of the Fed as we saw in May the first decline in sales in 16 months. These above-mentioned factors seemed to be taken into account by one FOMC member, Minneapolis Fed President Neel Kashkari, as he dissented against the decision to raise rates and voted to keep them unchanged at the June meeting. The Fed’s current balance sheet plan was another area of focus for the markets last week as Chair Yellen provided more detail.

 

The Fed plans on shrinking its balance sheet over the next several years, but the details of the process remained elusive until last week’s FOMC statement addendum and Chair Yellen’s press conference. The plan to lower the Fed’s balance sheet deals with the Fed not reinvesting all the principal payments it receives during a month. There will be caps in place that will allow for reinvestment only after a certain amount of payments have been received and not reinvested. We now know that the first set of caps will be $6 billion per month for treasuries and $4 billion for agency debt. This $10 billion in aggregate caps is a little higher than many Fed watchers had been expecting, but will need to be substantially increased if the Fed is going to work $2.5 trillion off the current $4.5 trillion balance sheet in any reasonable amount of time.

 

The only other major news last week in the US surrounded the media’s continued infatuation with President Trump. Last week, it was Attorney General Jeff Session’s turn to be in the hot seat, answering questions before Congress. One could tell, if they watched any of the testimony at all, that Sessions is a very practiced attorney as he said next to nothing and got around answering the most direct questions Congress wanted answered. Thankfully, the markets have largely stopped paying attention to the proceedings in Washington DC as they relate to going after President Trump. However, the markets are still closely watching the proceedings for tax reform and infrastructure spending. The more time spent on going after the President means less time to get meaningful legislation done before the August recess. At some point, the market could surmise that meaningful legislation is highly unlikely in the current political environment in DC, which would likely push the markets notably lower as a corporate tax rate cut in 2017 and personal tax rate declines have already been accounted for in the current lofty earnings expectations for 2017 and 2018.

 

Global news impacting the markets:

 

The main theme last week in the global financial media was central bank meetings. Over the past two weeks, nearly all the most powerful central banks around the world held meetings. Two weeks ago, it was the Bank of India, Reserve Bank of Australia and the ECB—the meetings resulted in no change in any of their central bank target rates. Last week, the US Federal Reserve, the Bank of England, Bank of Japan and the Swiss National Bank all held meetings. Out of the meetings held last week, only the US took any action in moving rates, as explained above in the national news section. The central theme of the various meetings over the past two weeks is that inflation, for the most part, remains elusive to the most powerful bankers in the world. The US Fed, the Bank of England and the Bank of Japan all called out this potential problem. Overall, the global economic data released came in worse than expected with data out of Germany, Italy and the UK all signaling slowdowns or stalled growth within each economy. One bright spot last week was Greece, which managed to fulfill the creditors’ requirements to gain access to the next tranche of bailout funds, which is needed so they can continue to make loan payments on their current outstanding tranches of debt.

 

Other news in the global financial media last week included the ongoing uncertainty over the UK’s Brexit negotiations, which are scheduled to start this week. PM Theresa May has a plan that would be very beneficial to the UK, but is completely untenable to the EU, and the EU cannot look weak in the negotiations or other member countries will follow the UK’s lead. In the end, the EU can drag out the negotiations and move as slowly as they want as the clock is ticking down on the two years until a deal is either reached or the UK is given the boot without a deal. The negotiations will likely come down to the wire, as is typical for political negotiations, so we will not know much about anything for at least 18 more months.

 

Oil also made a few headlines last week in the global markets as US production and rig count numbers continue to rise, while OPEC production cuts look to remain in place. US oil and gasoline inventories continue to build, despite this time of year being the peak driving/consumption time here in the US. All of this continued to push oil lower and officially into a bear market, marked by the liquid gold being down more than 20 percent during 2017. There do not appear to be any major changes in supply and demand coming over the next several months.

 

Technical market review:

 

There were no changes to the technical trading ranges on the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

The Dow (upper right pane above) has taken over in terms of relative strength as the previous two weeks have seen the other two major US indexes decline, while the Dow has managed to push higher. The S&P 500 (upper left pane above) is currently in second place in terms of relative technical strength as the index has managed to remain significantly above its most recent trading channel. The NASDAQ (lower left pane above), which had been the best performing of the three major indexes for much of 2017 so far, is now in last place as the index has broken down and is back within its most recent trading range. This breakdown could be temporary, however, as the reasons for the breakdown remain unclear. Investors could have just been taking profits from the FAANG (Facebook, Apple, Amazon, Netflix and Google) stocks, only to see that the stocks still look good relative to other areas of the market and return to them. As far as I can tell, there was nothing on a fundamental basis that warranted the drastic change in sentiment on the stocks—so a snap back rally is not unexpected. While not at the lowest point that we have seen so far in 2017, the current level of the VIX is still very low by historical standards.

 

Hybrid model performance and update

For the trading week ending on 6/16/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.33% 6.41% 12.15%
Aggressive Benchmark -0.13% 9.45% 9.24%
Growth Model 0.24% 5.94% 10.73%
Growth Benchmark -0.10% 7.35% 7.51%
Moderate Model 0.14% 5.06% 8.90%
Moderate Benchmark -0.07% 5.28% 5.67%
Income Model 0.10% 4.86% 8.50%
Income Benchmark -0.03% 2.75% 3.24%
Quant Model -0.28% 10.06%
S&P 500 0.06% 8.68% 17.94%

*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. The defensive nature of the current holdings played well in the risk-off trade seen early on during the week. The announcement of Amazon wanting to purchase Whole Foods had a noticeable negative impact on several of the hybrid model holdings on Friday as Wal-Mart seemed to bear most of the brunt. This deal is far from finalized and while it would represent Amazon moving into the brick and mortar business, the average customers who shop at Wal-Mart are not the same people who frequent Whole Foods. Unless Amazon is going to drastically change the very reasons people shop at Whole Foods, it doesn’t seem to present a significant amount of direct competition in the short term.

 

Market Statistics:

 

Last week was a mixed week for the three major US indexes as heavy selling on the NASDAQ continued on Monday, just like we saw on the previous Friday:

 

Index Change Volume
Dow 0.53% Average
S&P 500 0.06% Below Average
NASDAQ -0.90% Average

 

Despite the tick in selling seen early in the week last week, the overall volume experienced was only average or slightly below average on a weekly basis. Much of this volume was due to the markets already pricing in the Fed rate hike that took place on Wednesday, which was the big event of the week for the markets.

 

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
Residential Real Estate 2.30% Consumer Service -0.75%
Home Construction 1.60% Technology -1.21%
Utilities 1.59% Oil & Gas Exploration -1.44%
Industrials 1.27% Materials -1.58%
Insurance 1.09% Semiconductors -3.75%

 

Real estate took the two top spots in terms of sector performance last week as a defensive, lower volatility trade was seen in the overall sector performance. Utilities and Insurance, both defensive leaning sectors of the markets, also made the top five. The odd ball in the top five performance table last week was Industrials, which most likely experienced positive performance due to the continued hope that political action in Washington DC would lead to increased infrastructure spending. On the negative side last week, the rout in technology continued with semiconductors seeing the largest negative move for the week. Semiconductors have now declined by more than 8 percent over the last 6 trading days. However, the sector remains one of the best performing for 2017 as it is still up more than 20 percent. With oil moving lower again last week, it was not surprising to see that Materials got lumped with oil and moved lower in a sympathy trade; Materials and Oil and Gas Exploration took the 2nd and 4th worst performance spots last week. Technology overall made it among the bottom five performing sectors, despite Amazon’s big announcement about buying Whole Foods on Friday, which caused a lot of buzz in the markets. Consumer Service took the fifth and final spot in the negative sector performance table last week as retail sales figures combined with falling consumer confidence seemed to adversely impact the sector more than others.

 

With the weak economic data released last week, fixed income traders seemed to push around yields in a manner that discounts another rate hike in 2017, despite the Fed raising rates last week and maintaining the outlook for one more rate hike in 2017. Bond yields moved lower overall last week, while bond pricing increased:

 

Fixed Income Change
Long (20+ years) 1.57%
Middle (7-10 years) 0.42%
Short (less than 1 year) 0.04%
TIPS -0.43%

Global currency trading volume was average last week. Traders had little to do last week in terms of reacting to the Fed rate hike on Wednesday, as the move was already nearly fully priced into the bond prices. Overall, the US dollar declined 0.12 percent against a basket of international currencies. The best performing of the global currencies last week was the Canadian Dollar, as it gained 1.9 percent against the value of the US dollar. The worst performance among the global currencies was the Icelandic Krona, which declined 2.1 percent against the US dollar.

Commodities were mixed last week as oil continued to decline:

Metals Change Commodities Change
Gold -1.00% Oil -2.63%
Silver -3.01% Livestock -4.57%
Copper -2.76% Grains 0.92%
Agriculture -1.94%

The overall Goldman Sachs Commodity Index declined 1.44 percent last week and is now down almost 8 percent since May 22nd. Oil has contributed to most of the decline, including last week when Oil fell 2.63 percent. Much of the decline last week was attributed to rising US gasoline and crude oil inventories and the increasing rig count figures released last week. The supply increase has officially pushed Oil into a bear market in terms of price, as it has declined by more than 20 percent so far in 2017, which is the marker for a bear market. Metals were negative last week with Gold, Silver and Copper all declining as they gave up 1, 3.01 and 2.76 percent, respectively. Soft commodities were mixed last week with Grains posting the only gain, advancing 0.92 percent, while Livestock and Agriculture overall declined 4.57 percent 1.94 percent, respectively.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Caracas General Venezuela 28.88% RTS Index Russia -4.52%
S & P/ASX 200 Australia 1.69% KSE 100 Pakistan -5.39%

Last week was a very difficult week for global financial markets, with only 28 percent of the markets posting gains. The best performing index last week was found in Venezuela, as the Caracas General Index turned in a gain of 28.88 percent for the week. As mentioned last week, this index seems to move randomly due to the political situation with President Maduro and the wild movements of the oil market. The index also happens to be one of the only places within the country to place money that has a remote chance of keeping up with the rampant inflation currently being experienced (741 percent annually at the January 2017 reading). The worst performing index last week was found in Pakistan, the KSE 100 Index, which turned in a loss of 5.39 percent for the week.

Last week saw the VIX meander lower on a weekly basis, falling 2.99 percent for the week, but remaining a bit higher than the lowest point seen so far in 2017. Complacency still seems to be the rule, given the low level of the VIX. The current reading of 10.38 implies that a move of 3.00 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was an average week for economic news releases with only three semi-meaningful releases:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/13/2017 PPI May 2017 0.00% 0.00%
Neutral 6/13/2017 Core PPI May 2017 0.30% 0.20%
Negative 6/14/2017 Retail Sales May 2017 -0.30% 0.10%
Negative 6/14/2017 Retail Sales ex-auto May 2017 -0.30% 0.20%
Slightly Negative 6/14/2017 CPI May 2017 -0.10% 0.00%
Neutral 6/14/2017 Core CPI May 2017 0.10% 0.20%
Neutral 6/14/2017 FOMC Rate Decision June 2017 Hike Hike
Neutral 6/15/2017 Philadelphia Fed June 2017 27.6 26
Positive 6/15/2017 Empire Manufacturing June 2017 19.8 6
Slightly Negative 6/16/2017 University of Michigan Consumer Sentiment June 2017 94.5 97

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

 

Last week, the economic news releases started on Tuesday with the release of the Producer Price Index (PPI) for the month of May, which came in very close to market expectations and had no noticeable impact on the overall markets. On Wednesday, Retail Sales for the month of May were released and turned in very poor readings. The decline of 0.3 percent, when looking at both overall retail sales and retail sales excluding auto sales, represents the worst monthly decline seen in the past 16 months. These figures fly directly in the face of the over confidence that we have been seeing in the confidence numbers from American consumers, but if they turn out to be correct, the economy could have a very difficult time growing much above 1 percent in 2017. The Consumer Price Index (CPI) was also released on Wednesday and printed a decline in overall consumer prices, which is the opposite of what the Fed was hoping to see. Core CPI, however, provided a little saving grace as it did not print a negative number, but rather zero, for the month of May. As mentioned above in the national news section, the Fed raised rates at the June FOMC meeting, which concluded on Wednesday afternoon. On Thursday, the two manufacturing figures released for the month of June both pointed toward an expansion in manufacturing during June, with the Empire figure handily beating market expectations. Wrapping up the week on Friday was the release of the University of Michigan’s Consumer Sentiment index for the month of June (first estimate) and it was shown to have unexpectedly declined from the 97 reading seen at the end of May down to 94.5 at the current mid-June reading. While this is only a very small decline, in the grand scheme of things it is a first sign in consumer sentiment declining and starting to match the trends we have been seeing in spending and retail sales for the past several months.

 

This week is a very slow week for economic news releases with only two releases on the docket, neither of which should have a notable market impact:

 

Date Release Release Range Market Expectation
6/21/2017 Existing Home Sales May 2017 5.52M
6/23/2017 New Home Sales May 2017 599K

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

 

This week, the economic news releases start on Wednesday with the release of the Existing Home Sales figure for the month of May, which is expected to show almost no change in volume when compared to the April reading. On Friday, new home sales, also for the month of May, are set to be released with expectations of a slight uptick over April as the full Spring selling season was under way during the data period. In addition to the two economic news releases, there will also be four different Fed officials giving speeches next week. The markets will be watching closely for any clues as to what the Fed may do next given the weakness seen recently in the data.

 

Interesting Fact —Where does chocolate milk come from?

Last week, the Innovation Center of US Dairy released the results of an online survey about US dairy, which held a very surprising figure. According to the results, a full 7 percent of American adults believe that Chocolate Milk comes from brown cows! Extrapolating the 7 percent against the entire US population yields that there are 16.4 million people who believe this, according to the survey. This is not the first time odd results have been reported, as a study in 2011 by UC Berkley found that among fourth-, fifth- and sixth-graders interviewed at an urban California school, more than half didn’t know pickles were cucumbers or that onions and lettuce were plants. Four in 10 didn’t know that hamburgers came from cows and 3 in 10 didn’t know that cheese is made from milk.

 

Source: Washington Post https://www.washingtonpost.com/news/wonk/wp/2017/06/15/seven-percent-of-americans-think-chocolate-milk-comes-from-brown-cows-and-thats-not-even-the-scary-part/?utm_term=.5a5059367761

For a PDF version of the below commentary please click here Weekly Letter 6-12-2017

Commentary quick take:

 

  • Major developments:
    • UK Vote has been counted
    • Comey testimony to Congress
    • Oil continued to tumble
    • Rate hike by the Fed this week is fully priced in

 

  • US:
    • Comey testimony—no smoking gun
    • Fed watch shows 100% chance of a rate hike
    • Infrastructure spending push from administration

 

  • Global:
    • UK Snap elections
      • PM May lost majority
      • Coalition government formed with DUP
      • Brexit negotiations start in 10 days, but May’s hand is weaker
    • US oil reserves dropped oil prices
    • Qatar exile is currently holding

 

  • Technical market view:
    • NASDAQ dove toward trading range Friday
    • All three indexes remain above trading ranges
    • VIX moved high, thanks to Friday

 

  • Hybrid investments strategy update:
    • No changes to the models

 

  • This week for the markets:
    • Fed June meeting and rate decision
    • UK Election fallout
    • OPEC action—if any
    • North Korea

 

  • Interesting Fact: James Comey cannot hide in plain sight

 

Major theme of the markets last week: Theresa May’s political gamble

Last week, the major focus of financial markets around the world was the UK snap election vote held on Thursday. The snap election was called for by Prime Minister Theresa May on April 18th. At the time she thought she could use an election to strengthen her hand in Parliament in order to make the Brexit negotiations easier. However, her plan quickly started to backfire as terrorist attacks and formidable political opponents quickly made it clear that there would be no easy victory for PM May. When all the votes were counted, PM May’s Conservative party ended up well short of the 326 seats needed for a majority, coming in at only 318 seats. Playing from a much weaker hand, PM May turned to a northern Irish party to form a very weak coalition government. With a weak coalition formed, the global market must now decide if it has the strength and votes to actually negotiate the Brexit from the EU or if they will struggle to work together and ultimately fail, ending in yet another election held in the UK in a very short amount of time. Theresa May took a huge political gamble and much like several other popular politicians in Europe in the recent past, she came up short, but at least it has not cost her the Prime Minster hat—yet.

 

US news impacting the financial markets:

 

There were two main story lines in the US media that impacted the financial markets last week: the Comey testimony on Thursday and speculation about the June FOMC meeting. On Thursday last week, former FBI director James Comey testified before Congress on his dealings with President Trump. With nothing new being said, his testimony did not amount to a smoking gun that could bring down the Trump administration. Several Congressmen asked numerous times about a loyalty pledge and whether President Trump told Comey to kill the Michael Flynn investigation. Ultimately, nothing was concrete enough to change most people’s thinking on the subject. The financial markets moved downward a little on Wednesday when the text of Comey’s prepared remarks were released, but moved very little during his actual testimony. The markets, however, seem to be increasingly concerned that the administration will not be able to distance itself from the allegations, consuming a lot of political time and willpower that could otherwise be going toward the administration’s agenda of making America great again. As we get further into 2017, if action is not being taken on things such as tax reform, healthcare reform and infrastructure spending, the market will likely start heavily discounting that these actions will ever happen. If this should happen, analysts’ expectations of earnings will likely be revised lower, putting downward pressure on the US financial markets, which have been banking on positive development from the administration for much of the gains that we have seen since election night. The White House dubbed last week “infrastructure spending week” as an attempt to move the spotlight on to something more positive than the proceedings on Capitol Hill, but this plan largely fell flat as any major spending would have to be appropriated by Congress and not done through executive order and Congress was much more interested in Comey’s testimony than anything else.

 

The second major story line last week in the US financial media is the fact that the odds of a rate hike at this week’s June FOMC meeting are 100 percent. While 100 percent on anything seems a little odd, it is very highly likely that the Fed will raise rates on Wednesday. If the Fed does not raise rates on Wednesday, it looks like the market will take a big step back and examine what it is the Fed is seeing that caused it to pause. The economic data has changed very little since the last meeting, with the unemployment rate having decreased slightly and inflation remaining stubbornly low. At the last meeting, the Fed identified several factors it deemed “transitory” in nature that are being closely watched. By my math, none of these factors have improved and in a few cases, they have continued to move further away from the Fed’s expectations. However, the June meeting seems to be more about saving face for the Fed than anything else. It is for this reason that the Fed will likely raise rates.

 

Global news impacting the markets:

The biggest news on the international front last week came out of the UK, as mentioned in the Major Theme section of this week’s commentary. Going into the snap elections, which were called for just a few weeks ago, Theresa May saw her outsized lead of more than 20 points dwindle to within the margin of error. In some cases, the polls were showing that she would lose her outright majority in Parliament. As soon as the exit poll numbers were released, the British pound went into a free fall, as depicted by the chart to the right from Bloomberg. For a market that typically moves in small fractions of a penny during any given trading day, the decline of nearly 3 full cents in the matter of a few seconds was a very meaningful change. This time around the polls turned out to be correct, unlike other polls in the recent past that have been completely off the mark. May’s Conservative Party managed to win only 318 seats when 326 are needed to claim a majority to avoid having to form a coalition government. Being several seats short of a majority, PM May almost immediately said a minority government would be formed with the Democratic Unionist Party of Northern Ireland (DUP), which won 10 seats in the election, pushing the two combined seat totals over the needed 326 mark. However, the Conservatives and the DUP form a very interesting marriage arrangement as the two groups have some very different views on a wide variety of topics. One item they have in common is the desire to move the Brexit forward, which is probably why PM May picked them as a partner. However, the DUP wants a few things from the Brexit that seem highly unlikely, such as tariff-free trade with Ireland and a “comprehensive free trade and customs agreement” with the rest of the EU. Both ideas have been shot down by members of the EU, saying that leaving must be fully negotiated prior to working on any trade deals that may exist after the Brexit is complete. If the EU holds to this line, which is in their best interest to do so, it could provide the relatively small DUP party in the UK with a lot more power than they have ever had in the past. Ultimately, the outcome of the election in the UK is likely to form a very weak coalition government, one that could fail an easy confidence vote and force yet another snap election. The Labor party has a vested interest in this type of an outcome as it picked up 40 percent of the vote on Thursday and gained more than 33 seats, giving the party momentum going into another election should one be held. In general, the global financial markets shrugged off the UK election results on Friday, which was surprising to many investors who thought a hung parliament in the UK could be a catalyst for increased market volatility around the world.

 

The other major story in the global media last week was the continued slide in the price of oil, which declined last week by 3.75 percent after an announcement from the US indicated that our commercial crude oil inventories increased by about 3.3 million barrels over the last week, while predictions had been for a 3.1-million-barrel decrease. It was interesting that such a relatively slight change in the number of barrels of oil in the US’s overall inventory had such a large impact on the price of oil around the world. However, this buildup in inventories clearly shows that there is still a large imbalance between supply and demand with demand being weaker than expected, while supply remains high and continues to grow. On Friday, we saw just how much a relatively small event can impact the price of oil, when an oil pipeline in Nigeria had to be shut down due to a leak the price of oil increased by 0.5%. Nigeria is not a member of OPEC, but it’s nearly 2 million barrels per day of production is closely watched by the global oil markets.

Technical market review:

 

There were no changes to the charts below this week. The green lines remain the daily index movements, while the yellow lines are the trading ranges that have been drawn based on the index movements of the past several weeks. The red line on the VIX chart remains the 52-week average level of the VIX.

The NASDAQ (lower left pane above) saw the most notable movements last week as the index dove toward the upper edge of its most recent trading range on Friday. Both the Dow (upper right pane above) and the S&P 500 (upper left pane above) are tied in terms of technical strength related to their most recent trading ranges.

 

Friday was a very interesting day for the NASDAQ as there seemed to be a very distinct technology sell-off. The largest technology names traded in the world were caught in the cross hairs for relatively unknown reasons as the index tumbled by as much as 3.8 percent at the low point on Friday. The movement was not a standard risk-off trade as the Russell 200 (the small cap index), which is typically the most impacted by a risk-off trade, turned in positive performance on Friday of nearly 1 percent. The selling on Friday seemed to be very deliberately technology focused and the reason remains unknown. We will have to wait and see if the sharp movement in the NASDAQ continues into this week or if Friday was just a one-off event with the top performing index of 2017 or if it is the start of a more substantial move downward of the broad US indexes.

 

The VIX (lower right pane above) ended the week at 10.70 after hitting 9.73 earlier in the day, the lowest point that we have seen on the VIX since December of 1993. More interesting, however, is the fact that there is only one day in the history of the VIX that the VIX was lower than this Friday low point; the VIX first started in early 1990. The lowest point ever for the VIX, as it is currently calculated, is 9.31. Even with the turnaround in the VIX late on Friday, the VIX is indicating that everything will work itself out rapidly and that a rate hike by the Fed this week will not have a meaningful impact on the markets.

 

Hybrid model performance and update

For the trading week ending on 6/9/2017, returns in the hybrid and quant hypothetical models* (net of a 1% annual management fee) were as follows:

 

Last Week 2017 YTD Since 6/30/2015
Aggressive Model 0.04% 6.03% 11.75%
Aggressive Benchmark -0.48% 9.59% 9.38%
Growth Model -0.07% 5.66% 10.44%
Growth Benchmark -0.37% 7.45% 7.61%
Moderate Model -0.16% 4.89% 8.73%
Moderate Benchmark -0.26% 5.35% 5.74%
Income Model -0.27% 4.74% 8.37%
Income Benchmark -0.12% 2.78% 3.27%
Quant Model 0.25% 10.35%
S&P 500 -0.30% 8.62% 17.87%

*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. The models remain heavily invested in low volatility areas of the markets with a concentration toward consumer products. The defensive nature of many of the holdings within the hybrid models did exactly what they should have done on Friday with the markets moving lower; the models were positive the entire day.

 

Market Statistics:

 

Last week was a mixed week for the three major US indexes as heavy selling on Friday afternoon in the NASDAQ solidified the index’s loss for the week:

 

Index Change Volume
Dow 0.31% Below Average
S&P 500 -0.30% Below Average
NASDAQ -1.55% Below Average

 

Volume overall last week was below the average level of the past year, but higher than it has been for several of the past weeks. Much of the volume was seen on Friday, during what turned out to be a very wild trading day. Looking at the main indexes, last week looks like a risk-off trading week, but with the small caps gaining more than 1 percent for the week, it was clearly not a classic risk-off trading week.

 

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 5.35% Consumer Staples -1.84%
Broker Dealers 4.69% Consumer Service -1.94%
Financial Services 3.89% Consumer Discretionary -2.25%
Financials 2.47% Technology -2.55%
Energy 1.99% Software -3.19%

 

Financial related sectors took the top four spots in terms of sector performance last week with the Fed increasing rates at the June meeting being a foregone conclusion, as mentioned above. Financials stand to benefit the most from higher interest rates as they can easily increase their spreads on margin products. Energy also made the list for top performing sectors as US based energy producers increased in value as they will likely be the largest benefactor from the continued OPEC production cuts. On the negative side, Software and Technology took the bottom two performing spots last week as the sell-off in the NASDAQ was the main culprit for the negative performance. Consumer related sectors took the remaining bottom performing spots as everything from discretionary items to services and staples took a hit with consumer spending continuing to be weaker than anticipated.

 

The US fixed income market last week moved in relation to the 100 percent chance of a rate hike at this week’s FOMC meeting:

Fixed Income Change
Long (20+ years) -0.97%
Middle (7-10 years) -0.29%
Short (less than 1 year) -0.02%
TIPS -0.57%

Global currency trading volume was above average last week. Traders had to adjust their positions to the UK election outcome and Comey testimony. Overall, the US dollar advanced 0.64 percent against a basket of international currencies. The best performing of the global currencies last week was the Mexican Peso, as it gained 2.8 percent against the value of the US dollar, largely on the thought that the Trump administration would not be able to enact any meaningful legislation that would impact the Mexican economy. The worst performance among the global currencies was the Brazilian Real, with a decline of 1.5 percent against the US dollar, as the corruption within Brazil seems to be even more pervasive and deep rooted than initially thought.

Commodities were mixed last week as oil continued to decline:

Metals Change Commodities Change
Gold -0.88% Oil -3.75%
Silver -1.87% Livestock -1.07%
Copper 2.77% Grains 4.08%
Agriculture 1.21%

The overall Goldman Sachs Commodity Index declined 1.77 percent last week and is now down almost 4.5 percent in just the past two weeks. Oil contributed to the majority of the decrease in the overall commodity index as it fell 3.75 percent. As mentioned above, commercial oil inventories in the US were a leading culprit for the decline seen in oil prices around the world last week. With the decline seen last week, oil is now down nearly 20 percent so far in 2017. Metals were mixed last week with Gold and Silver declining 0.88 and 1.87 percent, respectively, while the more industrially used Copper bucked the trend, increasing 2.77 percent for the week. Soft commodities were mixed last week with Agriculture gaining 1.21 percent, while Livestock declined 1.07 percent and Grains jumped by 4.08 percent.

Top 2 Indexes Country Change Bottom 2 Indexes Country Change
Caracas General Venezuela 18.07% Swiss Market Switzerland -2.19%
Dow Jones China 88 China 2.28% Merval Argentina -4.02%

Last week was a difficult week for global financial markets, with 43 percent of the markets posting gains. The best performing index last week was found in Venezuela, as the Caracas General Index turned in a gain of 18.07 percent for the week. This index seems to move randomly due to the political situation with President Maduro and the wild movements of the oil market. The index also happens to be one of the only places to put money within the country that has a remote chance of keeping up with the rampant inflation currently being experienced (741 percent annually at the January 2017 reading). The gains or losses have very little to do with member companies’ performance and more to do with existential events. The worst performing index last week was found in Argentina, the Merval Index, which turned in a loss of 4.02 percent for the week.

As mentioned above, the VIX last week briefly hit its second lowest point since its inception in 1990 before turning around and moving higher late in the day on Friday. The current reading of 10.70 implies that a move of 3.09 percent is likely to occur over the next 30 days. As always, the direction of the move over the next 30 days is unknown.

Economic Release Calendar:

 

Last week was a very slow week for economic news releases with only two semi meaningful releases:

 

Economic Impact Date Economic News Release Date Range Actual Expectation
Neutral 6/5/2017 ISM Services May 2017 56.9 57
Slightly Negative 6/7/2017 Consumer Credit April 2017 $8.1B $15.0B

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

 

Last week the economic news releases started on Monday with the release of the services side of the ISM index. The reading came in very close to market expectations, posting 56.9 rather than the expected 57.0. With the difference being so small, it was completely ignored by the markets, which focused instead on the Qatar situation with Saudi Arabia, which took most of the headlines on Monday. The economic news releases wrapped up on Wednesday with the release of consumer credit for the month of April, which came in at $8.1 billion, about half of the expected amount. This slowdown in lending in April was likely due to tightening lending standards on auto loans, which is an area of concern to the markets as overdue payments, non-payments and the overall loans outstanding are becoming an issue in the subprime section of auto loans.

 

After such a slow week last week, the economic calendar will seem very full this week. In reality, it is average in terms of the number of releases:

 

Date Release Release Range Market Expectation
6/13/2017 PPI May 2017 0.00%
6/13/2017 Core PPI May 2017 0.20%
6/14/2017 Retail Sales May 2017 0.10%
6/14/2017 Retail Sales ex-auto May 2017 0.20%
6/14/2017 CPI May 2017 0.00%
6/14/2017 Core CPI May 2017 0.20%
6/14/2017 FOMC Rate Decision June 2017 1.13%
6/15/2017 Philadelphia Fed June 2017 26
6/15/2017 Empire Manufacturing June 2017 6
6/16/2017 University of Michigan Consumer Sentiment Index June 2017 97

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

 

This week the economic news releases start on Tuesday with the release of the Producer Price Index (PPI) for the month of May, which is expected to be painfully close to zero overall and only slightly positive when looking at the core calculation. This very low level of inflation will end up being a problem for the Fed as rising rates increases the possibility of deflation—which is not something anyone at the Fed would like to see occur. On Wednesday, retail sales for the month of May are set to be released with very low expectations being seen on both versions of the figure. It seems possible that one or both figures could in fact post a negative reading on Wednesday, based on the spending patterns we have been seeing from the US consumer. The Consumer Price Index (CPI) is also set to be released on Wednesday and, much like the PPI released on Tuesday, expectations for the release are very low numbers near the zero percent mark. Negative prints on these figures would spell potential trouble in the future for the Fed policy. Both the CPI and retail sales figures on Wednesday will likely be overshadowed by the Fed as it concludes its June meeting with a rate decision. Chair Yellen will hold one of her press conferences following the statement release. With a rate hike out of this meeting a foregone conclusion, the press conference will be closely watched by the markets to see if there is any indication of future movements on rates by the Fed. On Thursday, two manufacturing figures will be released for the month of June, with lofty expectations on both. If we see a drastic difference between what is reported and what is expected, the markets could react, but it is unlikely to get much of a reaction. Wrapping up the week on Friday is the release of the University of Michigan’s Consumer Sentiment index for the month of June (first estimate) and it is not expected to have changed at all since the end of May reading.

 

Interesting Fact — Former FBI Director James Comey is 6’8” tall

 

When former FBI director James Comey walked into the hearing room on Thursday, he appeared much taller than anyone else in the room. After looking into it, I found that he is 6 feet 8 inches tall and that it has been an issue for him. According to an article on thehill.com, then FBI director Comey tried to blend in with the curtains of the Blue room to hide, per se, and avoid being approached by President Trump. His actions did not work as his cover was blown by his distinctive height, shown in the now famous video of him walking across the blue room at the President’s request to shake hands and get a pat on the back.

 

Source: http://thehill.com/homenews/administration/334173-comey-once-tried-to-hide-among-wh-curtains-to-avoid-trump-report