Bob’s Journal for 9/5

Even with the Labor Day break, there were many interesting developments in the markets and economy over the last week.

I told you last week about the strong bull market in U.S. Treasury bonds in 2019 and especially in August 2019. But not all bond investors are participating fully.

The three biggest names in bond funds are trailing the indexes and their peers, according to a report from Reuters.

The three are Jeffrey Gundlach of DoubleLine, Dan Ivascyn of PIMCO and Scott Minerd of Guggenheim. They have great long-term records, but 2019 has been an off year for all three so far.

They gave the same two reasons for trailing this year. In general, they’re being conservative.

One reason they trailed is their lack of appetite for corporate bonds. Investors overall bought a lot of corporate bonds so far in 2019, pushing the return of the Bank of America Merrill Lynch Corporate Bond Index above 13% for the year to date.

All three fund managers say they’ve seen too much risk in corporate bonds all year. If the economy weakens, defaults will increase and investors will sell corporate bonds rapidly. They also believe corporate balance sheets are weaker than most investors perceive.

In addition, the fund managers have maintained relatively short durations in their portfolios. A portfolio with a long duration benefits greatly when interest rates fall (but loses a lot when rates rise). The three investors rarely take big bets on interest rate moves. That protects them when interest rates rise. But it causes them to lag indexes when interest rates decline significantly as they have this year.

Moving to the stock market, while headlines in August focused on the days of major declines, there also were a lot of significant increases during the month.

In August, we saw a number of offsetting significant gains and losses, according to Bespoke Investment Group. There were 10 rallies when the S&P 500 increased 1% or more before stalling, and there were nine periods when it declined 1% or more.

The index closed the month with a 1.67% loss. The month was saved by a rally exceeding 3% in the last three trading days.

The index essentially was in a trading range in August, and it really has been in a trading range for 12 months. Though it has returned more than 18% for the year to date, that mostly offsets the decline in the last quarter of 2018. The total return of the S&P 500 for the last 12 months is only 2.74%.

Utility stocks are one support of the S&P 500. Utilities often increase when interest rates are declining. Investors also can turn to utilities during periods of market turmoil. That’s why utilities increased 5.09% in August and are up 20.08% for the year to date.

In the economic data, Tuesday’s ISM Manufacturing Index drew a lot of headlines. The index declined below 50 to 49.1. A decline below 50 was unexpected and is an indication that the sector is contracting. The report spawned widespread speculation that a recession is developing.

But keep in mind that manufacturing is a relatively small sector of the U.S. economy. Also, the other recent manufacturing data has been mixed. As I’ve been reporting, some of the Fed regional bank surveys have been improving, as has some of the hard data.

We went through a similar downturn in manufacturing and broader economic measures in 2015 but avoided a recession. Right now, consumer spending is strong as is the job market. A lot of the decline in manufacturing is due to the trade conflicts along with lower growth outside the United States.

It is too soon to call a recession.

The Data

There was a significant drop in Consumer Sentiment as measured by the University of Michigan. It fell to 89.8 from 92.1. This is the lowest level since October 2016. Both expectations and current conditions declined, though expectations declined more.

This differs from The Conference Board’s Consumer Confidence survey, which I reported last week. The two surveys have been differing significantly since 2016. The University of Michigan report has been in a narrow range since 2015 while The Conference Board survey has risen significantly.

Yet, the Personal Income and Outlays report for July indicated that consumers are confident. Consumer spending increased 0.6%, following a 0.3% increase in June. Spending was strong across the board.

Wages and salaries increased 0.2% for the month, and supplements to wages and salaries increased 0.3%. Overall personal income increased only 0.1%, largely because of a sharp decline in interest income.

Inflation, as measured by the PCE Price Index, remains low. It increased 0.2% for the month as measured by both the headline index and the Core PCE Price Index (which excludes food and energy). Over 12 months, the headline index increased 1.4% and the core index rose 1.6%.

As mentioned above, the ISM Manufacturing Index declined to 49.1 from 51.2. The survey was weak almost across the board. The U.S. report now matches a number of recent global manufacturing surveys that came in below 50. There appears to be a global contraction in manufacturing.

The less widely followed PMI Manufacturing Index declined slightly to 50.3 from 50.4. This is close to a 10-year low in the index, though it still indicates that manufacturing is growing. Significant declines in the survey were in exports and optimism about the next six months.

To further complicate the picture, the Chicago PMI rose to 50.4 from 44.4. Last month’s number was the lowest in four and one-half years and indicated business in the Chicago area was contracting. New orders were a major reason for the significant increase.

Factory Orders increased by 1.4% in July, following a 0.5% increase in June. That’s the largest increase in almost a year. But excluding the volatile transportation sector, orders increased only 0.3%, compared to a 0.1% decline in June. Orders for non-defense capital goods, a measure of business spending on equipment, increased 0.2% in July following a 0.9% increase in June.

The service sector continues to do well despite the troubles in manufacturing. The ISM Non-Manufacturing Index rose to 56.4 from 53.7. That was well above expectations for a modest increase in the index and the highest level since May. New orders jumped significantly, but job creation and export orders were lower.

The PMI Services Index, on the other hand, declined to 50.7 from 53.0. The last time the index was this low was early 2016. New orders were at a three-year low, largely due to a decline in foreign orders. The survey did find that demand from U.S. consumers remains strong.

The latest employment market reports indicate tomorrow’s Employment Situation reports are likely to be strong.

The ADP Employment Report said 195,000 private sector jobs were created in August. That was well above expectations and July’s revised 142,000 number.

New unemployment claims increased by only 1,000 to 217,000. Once again, the numbers are near historic lows.

The Markets

The S&P 500 rose 1.78% for the week that ended with Wednesday’s close. The Dow Jones Industrial Average increased 1.36%. The Russell 2000 added 0.89%. The All-Country World Index (excluding U.S. stocks) gained 2.12%. Emerging market equities improved by 2.97%.

Long-term treasuries declined 0.07% for the week. Investment-grade bonds fell 0.14%. Treasury Inflation-Protected Securities (TIPS) lost 0.20%. High-yield bonds decreased 0.07%.

In the currency arena, the U.S. dollar increased 0.22%.

Energy-based commodities rose 0.80%. Broader-based commodities climbed 1.86%, while gold gained 1.02%.

Bob’s News & Updates

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