Markets Recovering from the Winter Gloom

Do you remember the markets of last January and February? Did you think at the time that at the end of July almost all markets would have very solid positive returns for the year? That’s what the markets delivered.

The S&P 500 as of the end of July had returned 3.65% for the month, 5.78% for the last three months, and 7.61% for 2016. The Dow Jones Industrial average fared not quite as well, returning 2.94%, 4.33%, and 7.25%, respectively. The Russell 2000 was the best of the major domestic indexes. It returned 5.87% for July, 8.22% for the last three months, and 8.42% for 2016.

Even the international markets recovered despite all the worries about China, Brexit, and Europe. The All-Country World Index gained 3.77% for July, 4.07% for the last three months, and 5.91% so far in 2016. Emerging markets gained 5.37% in July, 6.1% in the last three months, and 13.35% for 2016.

In the bond markets, long-term treasuries continued their strong gains as interest rates collapsed. Long-term treasuries returned 2.10% for July, 10.06% for the last three months, and 18.79% for 2016. Investment-grade bonds returned 1.29%, 3.89%, and 10.61%, respectively. Treasury Inflation-Protected Securities (TIPS) lagged but still did well. They returned 0.64% for July, 2.24% for the last three months, and 7.08% for the year to date.

High-yield bonds also recovered, despite the pessimism directed at them early in the year. They returned 1.31% in July, 3.30% in the last three months, and 9.10% for the year.

The dollar ended its rally. It is down 0.68% in July, up 2.37% for the last three months, but down 3.82% for 2016.

Commodities had a strong recovery from their lows but still are lagging other assets. Energy-based commodities gave back some of the gains recently. They lost 10.05% for July, 8.28% for the last three months and 1.90% for 2016. Broad-based commodities lost 6.35% in July and 1.99% for the last three months but gained 7.87% for 2016. Gold continues to roll. It gained 2.04% in July, 4.33% for the last three months, and 27.27% so far in 2016.

There are investment lessons to be learned, but they aren’t new ones. It’s important not to project recent experience indefinitely into the future. Trends can change quickly, and emotions can capture markets for a while. Also, when there seems to be a strong consensus, especially one tinged with emotion, it probably is already reflected in market prices. The markets change direction before the consensus does. It’s also important to ignore the media headlines and other short-term market noise. Focus on fundamentals, data, and the things that really matter to the markets over more than the short-term.

Finally, it rarely pays to underestimate the power of central banks. When markets were declining early in the year and headlines were scaring people, central banks pumped a lot of liquidity into the markets and also publicly stated that they would provide as much support to the markets and economies as they believed was needed. Those moves overwhelmed the deflationary trends then in place and pushed markets higher.

The Data

Let’s start with the overhyped gross domestic product (GDP) report from last Friday. As longtime readers know, I don’t put much stock in this report. It’s frequently revised, and it is backward-looking. It also doesn’t do a good job of capturing the full measure of the economy. The report was considered disappointing because economists expected the first estimate of second-quarter GDP to be around 2.6%, while the actual report was 1.2%.

A big part of this disappointment was a decline in inventories. Inventories have too much weight in the GDP calculation, and a rise in inventories isn’t as bearish for the economy as is reflected in the GDP equation. Another reason to de-emphasize the GDP report is that the regular data issued for the last few months revealed that the economy improved through the second quarter. So, currently, the economy is doing better than the GDP report for the second quarter indicates.

Now, let’s look at more current data.

The Chicago PMI on business activity in the Chicago area declined a little and still indicates solid growth at 55.8.

There also continue to be indications that manufacturing is finding a bottom. That’s not surprising. Most of the headwinds to manufacturing of the last couple of years are reduced: a strong dollar, weak foreign growth (especially in emerging markets), and collapsing commodity prices).

The PMI Manufacturing Index increased to 52.9. The export component had its best reading in two years. The index level indicates solid but unspectacular growth.

The ISM Manufacturing Index declined a little to 52.6. That still indicates solid growth, plus the new orders and exports components of the index improved.

Factory Orders, on the other hand, don’t show manufacturing to be stabilizing. They declined 1.5%, and last month’s number was revised down to a 1.2% decline. Vehicle orders were the only bright spot in the report.

The non-manfacturing sector of the economy continues to perk along.

The PMI Services Index remained steady at 51.4. That indicates modest growth. But the ISM Non-Manufacturing Index came in at 55.5. That’s down only a little from last month and indicates strong growth. The ISM Index has been stronger than the PMI Index throughout this year and is considered a broader measure of economic activity.

Consumer Sentiment as measured by the University of Michigan declined a bit, largely a result of the Brexit vote, but still is solidly positive and around the average of the last two years.

The Personal Income and Outlays report also indicates households are doing well. Personal Income increased 0.2%, though wages and salaries were up 0.3%. Spending increased faster than income for the second consecutive month at a 0.4% rate. The extra spending was financed through reduced saving, indicating that households have some confidence about the future.

In that report, prices as measured by the Fed’s preferred PCE Price index barely increased in the last month. But over 12 months, the core PCE Price Index increased 1.6%. That’s approaching the Fed’s target of 2% or higher.

The Employment Cost Index is one of several measures that show the deflationary trends might be behind us and markets could be underestimating future inflation. The ECI says labor costs increased 0.6% in the latest quarter and are up 2.3% for 12 months.

The other overhyped data, the Employment Situation reports, are due tomorrow morning. The data leading up to them indicate employment should continue to be reasonably strong. The ADP Employment report said 179,000 new private sector jobs were created last month. That’s more than last month and above expectations.

Also, new unemployment claims rose only 3,000. That keeps both the weekly number and the four-week average near historic lows.

The Markets

U.S. stocks had a second week of modest declines, and international stocks joined them this week.

Emerging market stocks lost 0.03% for the week ended with Wednesday’s close. The All-Country World Index lost 0.22%. The S&P 500 was down 0.16%. The Dow Jones Industrial Average lost 0.66%. The Russell 2000 declined 0.57%.

Long-term bonds gave up a lot of last week’s gains, losing 1.41%. Investment-grade bonds lost 0.73%. Treasury Inflation-Protected Securities (TIPS) declined 0.44%. High-yield bonds dropped 0.58%.

The dollar lost 1.24%.

Energy-based commodities lost another 0.36% (but they gained 1.68% on Wednesday). Broad-based commodities gained 0.44%. Gold gained another 1.24%.

Bob’s News & Updates

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Some Reading for You

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I comment and link to these and other items on my public blog at http://www.bobcarlson.net.