summit financial resources, inc. · investment newsletter by noreen johnston, cfa (director of...
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20171011-1140
Summit Financial Resources, Inc. Investment Newsletter By Noreen Johnston, CFA (Director of Research) Third Quarter 2017 And Daniel Cohen, CFA (Investment Analyst)
EXECUTIVE SUMMARY
The global economy is expanding at the fastest pace in years, propelled by a resurgence in trade and manufacturing. Consumer and business confidence are at peak levels, boding well for future activity. Many countries, including the U.S. and China, have experienced positive data surprises suggesting worries of a slowdown earlier in the year may have been overdone. The breadth and pace of the economic gains have created a positive environment for the capital markets and all major asset classes delivered positive results during the third quarter.
Stocks markets benefited from another healthy earnings season as well as a steady flow of positive economic data. Uncertainty over government policy and reduced expectations for rate increases continued to weigh on the U.S. dollar, boosting investments outside the U.S. Emerging markets surged past developed countries both for the quarter and year to date, due to a rise in exports and strong investment flows.
U.S. stock market volatility fell to a new low, restrained by investor optimism and declining correlations among stocks. Growth stocks, notably in the technology and health care sectors, continued to far outpace value stocks. After underperforming for much of the year, small cap stocks rallied on renewed prospects for corporate tax reform, which would favor domestically focused companies.
A resurgence in commodity prices during the quarter was a boon for both energy and industrial metals. The price of copper, a proxy for global economic health due to its widespread use in manufacturing, rose 9%.
Fixed income markets provided modest returns for the quarter. Credit risk was rewarded with high yield and emerging market debt posting the highest returns. Fixed income prices traded within a very tight range. U.S. Treasuries had the lowest volatility since 1965. Despite higher leverage and lower liquidity, credit spreads are approaching levels last seen before the financial crisis.
Global politics continued to impact the capital markets. Investors closely followed the conflict between the U.S. and North Korea and the popularity of populist, anti-trade candidates in upcoming European elections. In the U.S., government turmoil has put a broad range of policy changes on hold.
Another wildcard is the path of interest rates and inflation. The markets seem to be taking central bank leadership changes and balance sheet tapering in stride. Although inflation is below the desired level in many countries, a pick-up in wages and tightening capacity suggest it is rising or at least stable in many countries.
By many measures valuations are high across the major asset classes. Given the strength of the global economy and investor enthusiasm, the bull market for higher risk assets may continue for some time. Historically speaking, however, high valuations have consistently led to lower returns down the road. The elevated level of geopolitical risks and the impact of aging populations on savings and spending patterns could lead to unexpected outcomes in the investment markets.
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ECONOMIC REVIEW AND OUTLOOK
Key Economic Fundamentals
0
1
2
3
4
An
nu
aliz
ed
Gro
wth
(%)
Quarterly GDP Growth
Data Source: U.S. Department of Commerce
-2
-1
0
1
2
3
2016-I 2016-II 2016-III 2016-IV 2017-I 2017-II
An
nu
aliz
ed
GD
P G
row
th (%
)
Contributions to GDP
Personal Consumption Investment Spending
Net Exports Government
Data Source: U.S. Department of Commerce
-100-80-60-40-20
020406080
100
Citigroup Economic Surprise Index
United States Eurozone
Positive values = Data above expectations, and vice versa
Data Source: Citigroup
Q2 GDP showed the U.S. economy grew 3.1%. This is the fastest pace of growth since the first quarter of 2015. Most recent International Monetary Fund forecasts call for full-year 2017 growth of 2.3%, followed by 2.5% growth in 2018. Given the difficulty in predicting the impact of Hurricanes Harvey and Irma, heightened uncertainty is inherent in near-term economic forecasts. Consumer spending was the largest contributor to GDP growth for the 15th consecutive quarter. Investment spending showed modest strength compared to recent history, while net exports were a slight positive on the heels of a weak dollar. Government spending was a negligible detractor, and has not added more than 0.1% to GDP since Q1 of 2016.
In the United States, economic data weakness (relative to expectations) moderated as Q2 progressed, with the Citigroup U.S. Economic Surprise Index rallying 65 points to close out the quarter at -7.9. Meanwhile, in Europe, data was favorable against expectations throughout the quarter, showing particular strength in the back half of September.
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114
116
118
120
122
124
126
128
130
Relative Value of the U.S. $
Vs. a TradeWtd. Basket
Q1: -3.0% Q2: -2.3% Q3: -1.7%
Data Source: U.S. Federal Reserve
-1.0%
0.0%
1.0%
2.0%
3.0%
4.0%
Ye
ar O
ver
Ye
ar C
han
ge
OECD Leading Economic Indicators
Data Source: Organization for Economic Cooperation and Development
Global Growth Rates1 (%)
Q2
2017 Q3
2017 Q4
2017 2016 2017 2018
Advanced 2.2 2.2 2.1 1.7 2.0 2.0
Euro 2.3 2.3 2.3 1.6 1.9 1.8
U.S.2 3.1 2.5 1.8 1.6 2.3 2.5
Japan2 2.5 1.5 1.0 1.0 1.2 0.6
U.K.2 1.2 1.2 1.2 1.8 2.0 1.5
Canada2 4.5 2.1 1.9 1.5 1.9 2.0
Emerging 4.7 4.9 4.8 4.1 4.5 4.8
China 6.9 6.7 6.6 6.7 6.6 6.2
India 5.7 6.4 6.9 7.1 7.2 7.7
Russia 2.5 2.0 2.2 -0.2 1.4 1.4
Brazil 0.3 1.1 1.9 -3.6 0.2 1.7
World 3.2 3.3 3.2 3.1 3.5 3.6
Data Source: J.P. Morgan, International Monetary Fund, World Bank 1Q2 2017 and 2016 are actual, all others are forecasts 2Quarterly numbers are sequential annualized, others are year-over-year
The U.S. dollar troughed in early September, ending a nine-month slide. At its low, the dollar was down 8.8% on the year versus a trade weighted basket of foreign currencies. Though the downtrend reversed, the dollar still weakened by 1.7% in Q3 and closed out the quarter with a year-to-date decline of 6.8%.
Growth in leading economic indicators for the ten largest economies in the world showed widespread (albeit generally modest) improvement in economic prospects. Brazil experienced notable improvement as it continued to recover from a deep recession. Of the rest of the group, Germany and Canada were relatively strong, while India and Italy were weak.
Even with the tailwind of unprecedentedly easy monetary policy, advanced economies are expected to grow only 2.0% in both 2017 and 2018. This begs the question - how strong (or weak) would growth be without historic central bank support? Meanwhile, EM growth is expected to be 4.5% and 4.8% in 2017 and 2018, respectively, led by India and China.
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Employment September was the first time in 84 months that nonfarm payrolls were negative, showing a loss of 33K jobs. While ostensibly concerning, the weakness can be attributed to sharp (and likely transient) employment declines in industries affected by Hurricanes Harvey and Irma, such as food services. Expectedly, weekly jobless claims jumped following landfall of the hurricanes and remain somewhat elevated. While the payroll report showed job losses, the household survey painted a more sanguine picture. This survey showed a large decrease in the number of unemployed and a significant boost to the labor force level. The result? A new post-crisis low for the unemployment rate of 4.2%. Also notable, wage growth climbed to its highest level since June 2009. Importantly, investors should be wary of putting too much stock in any data release, as hurricane effects are likely to make U.S. data very volatile in the near term.
-50
0
50
100
150
200
250
300
350
(00
0's
)
Change in Non-farm Payrolls
Data Source: U.S. Department of Labor
62.2
62.4
62.6
62.8
63.0
63.2
% o
f A
du
lt C
ivil
ian
Po
pu
lati
on
Labor Force Participation RateHighest participation
rate since early 2014
Data Source: U.S. Department of Labor
1%
2%
3%
Year
Ove
r Ye
ar G
row
th
Wages
Data Source: U.S. Department of Labor
220
230
240
250
260
270
280
290
300
310
320
(000
's)
Weekly Initial Jobless Claims
Longest streak below 300K since 1970 - 135 weeks
Data Source: U.S. Department of Labor
4.2
4
5
6
Per
cen
t
Unemployment Rate
Lowest unemployment
rate since Feb 2001
Data Source: U.S. Department of Labor
6170
2000
3000
4000
5000
6000
7000
(000
's)
Job OpeningsMost recent reading
was highest on record
Data Source: U.S. Department of Labor
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ConsumerUndeterred by gridlock in Washington, elevated geopolitical risks, and uncertainty surrounding the Fed’s tightening campaign, the consumer remains resilient. Throughout the second quarter, consumer confidence was steady around the 120 mark and has remained above 115 for eight consecutive quarters. This is the third longest streak above 115 since the inception of the index, bested only by runs of 49 quarters and 12 quarters beginning in January 1997 and December 1988, respectively. Major stock market indices ended the quarter at record highs, which should further bolster household net worth. As of the most recent reading from Q2, household net worth was up 9.3% over the prior year to a record $96.2 trillion. The declining trend in auto sales (one of the potential warning signs relating to the consumer) abruptly reversed in September, as consumers began replacing an estimated 500,000 to 900,000 vehicles destroyed by Hurricanes Harvey and Irma. Growing student debt levels remain a concern, as do rising delinquency rates in student, auto, and credit card debt.
80
85
90
95
100
105
110
115
120
125
130
Consumer Confidence Index
Data Source: The Conference Board
-7.5%
-5.0%
-2.5%
0.0%
2.5%
5.0%
7.5%
12
13
14
15
16
17
18
19
Year
ove
r Ye
ar G
row
th
Mill
ion
s o
f V
eh
icle
s
Monthly Auto SalesSeasonally Adjusted Annual Rate
Data Sources: Bloomberg
0%
5%
10%
15%
Year
Ove
r Ye
ar G
row
th
Household Net Worth
Data Source: U.S. Federal Reserve
3%
4%
5%
6%
7%
8%Student Debt as a % of GDP
Data Sources: U.S. BEA and U.S. Federal Reserve
Business Activity Business strength accelerated as the second quarter progressed. Factory activity surged to a 13-year high in September as the ISM manufacturing index reached 60.8. The service sector, which accounts for 86% of employment in the U.S., was also extremely strong in Q2. In fact, September’s ISM non-manufacturing index registered its strongest reading since August 2005. This was the 92nd straight month of expansion. While industrial production exhibited growth in Q2, the most recent reading was relatively weak due to disruption from Hurricane Harvey. Sectors impacted most by the Hurricane were mining, refining, organic chemicals, and plastics. Harvey was also likely to blame for a rather sharp fall in capacity utilization.
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46
48
50
52
54
56
58
60
62In
de
x Le
vel
U.S. ISM Indexes
Non-Manufacturing Manufacturing Expansion
Data Source: Institute for Supply Management
74
75
76
77
78
79
80
-4
-3
-2
-1
0
1
2
3
4
5
Cap
acit
y U
tiliz
atio
n (%
)
Ind
. P
rod
. YO
Y G
row
th (%
)
Industrial Growth and Utilization
Data Source: U.S. Federal Reserve
Real Estate On the surface, the housing market appears strong. Existing home sales remain near post-crisis highs, the NAHB Index indicates strength, and price gauges show consistent growth. Underneath the surface, however, the market is suffering from a mismatch of supply and demand. Demand is very strong on the low-end, but supply is tight and prices are too high for many would-be buyers. Builders are reluctant to break ground on cheaper homes due to prohibitively high building costs. Meanwhile, demand for high-end homes is tepid. High-end homes spend a historically long time on the market and those that sell often do so at steep discounts. Evidence of a softening housing market is observable in the Pending Home Sales Index, which has been negative for five out of the past six months. Also, new home sales have been trending lower since March and August’s figure was the weakest reading in nine months. To be sure, the housing market bears watching, as its health is important to the U.S. economy.
3
4
5
6
7
8
9
10
11
12
13
3.0
3.5
4.0
4.5
5.0
5.5
6.0
Mo
nth
s o
f Su
pp
ly
An
nu
aliz
ed
Sal
es in
MM
's
Existing Home Sales and Inventory
Data Source: National Association of Realtors
-4%
-2%
0%
2%
4%
6%
Mo
nth
ove
r M
on
th G
row
th
Pending Home Sales IndexSeasonally Adjusted
Data Source: National Association of Realtors
0
10
20
30
40
50
60
70
80
Ind
ex
Leve
l
National Association of Home BuildersHousing Market Index
Data Source: National Association of Homebuilders
400
450
500
550
600
650
An
nu
aliz
ed
Sal
es in
000
's
New Home Sales
Data Source: U.S. Census Bureau
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CAPITAL MARKETS REVIEW Returns
3rd Qtr 2017
YTD 2017
Cash and Fixed Income
U.S. Treasury Bills 0.3% 0.6% Barclays U.S. Aggregate Bond 0.8% 3.1% Barclays Municipal Bond 1.1% 4.7% Barclays Global Agg. ex. U.S. 2.5% 8.7%
Hedge Funds and Alternatives
Bloomberg Commodity 2.5% -2.9% DJ US Real Estate 1.1% 7.1% HFRI FOF Composite 2.2% 5.5%
Data Sources: Morningstar & Hedge Fund Research, Inc.
3rd Qtr 2017
YTD 2017
Domestic Equities
Wilshire 5000 4.6% 13.7% S&P 500 4.5% 14.2% Russell 2000 5.7% 10.9%
International Equities
MSCI ACWI ex. U.S. 6.3% 21.5% MSCI EAFE (Developed) 5.4% 20.0% MSCI EM (Emerging) 7.9% 27.8%
Equity Markets
-5%
0%
5%
10%
15%
20%
25%
30%
35%
Domestic StocksPerformance by Capitalization
Russell 1000 (Large Caps) Russell Mid Cap (Mid Caps) Russell 2000 (Small Caps)
First Quarter Second Quarter Third Quarter
Data Source: Morningstar
1%
2%
3%
% o
f To
tal M
kt C
ap
U.S. Margin Debt
Data Source: Bloomberg and The New York Stock Exchange
-5%0%5%
10%15%20%25%30%35%
International Equity Markets(Price return only)
MSCI EAFE (Developed) MSCI EM (Emerging)
First Quarter Second Quarter
Third Quarter
Data Source: Morningstar
10.9
10
15
20
25
30
35
CBOE Volatility Index
Quarterly Average Long-term Average
Lowest on record
Data Source: Chicago Board Options Exchange
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Fixed Income Markets
2.0
2.2
2.4
2.6
2.8
U.S. 10 Year Treasury Yield (%)
Down 5 bps in Q1
Down 9 bps in Q2 Up 2 bps in Q3
Data Source: U.S. Department of the Treasury
3
4
5
6
7
8
9
10
Spre
ad
Ove
r Tr
easu
rys
(%)
High Yield Debt Spreads
Spread over Treasurys 15 Yr. Avg.
Spreads compressed 23 bps in
Q3 and are currently 2.2%below the 15-year average
Data Source: BofA Merrill Lynch
Alternatives
140
160
180
200
220
240
260
280
300
Ind
ex
Leve
l
Commodities(CRB Core Commodity Index)
Up 5.0% in Q3
Data Source: Thomson Reuters
42
44
46
48
50
52
54
56
U.S
. Do
llars
WTI Oil Price
Q1: -6.0%
Q2: -8.9% Q3: +12.3%
Data Source: US. Energy Information Administration
Disclaimers: This commentary was written by Noreen Johnston, CFA, Director of Research and Daniel Cohen, CFA, Investment Analyst at Summit Financial Resources, Inc. and Summit Equities, Inc., 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600, Fax: 973-285-3666. Securities and Investment Advisory Services offered through Summit Equities, Inc. Member FINRA/SIPC, and Financial Planning Services offered through Summit Equities, Inc.’s affiliate Summit Financial Resources, Inc. Sources of Performance: Morningstar®. Indices are unmanaged and cannot be invested into directly. The investment and market data contained in this newsletter is not an offer to sell or purchase any security or commodity. Standard & Poor's 500 Index (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Wilshire 5000 Index is a market capitalization-weighted index of the market value of all stocks actively traded in the United States. The index is intended to measure the performance of all U.S. traded public companies having readily available price data. The MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) that is designed to measure equity market performance in global emerging markets. Emerging markets are considered risky as they carry additional political, economic, and currency risks. Real Estate Investment Trusts, REITs, are securities that invest in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, however, have liquidity constraints. The Barclays Capital U.S. Aggregate Bond Index is a market capitalization-weighted index comprising Treasury securities, Government agency bond, Mortgage-backed bonds, corporate bonds, and some foreign bonds traded in the U.S. Fund Category Performance is not inclusive of possible fund sales or redemption fees. Investment grade bond analysis included bonds with ratings of AAA, AA, A, and BBB. Municipal and Corporate Bonds are backed by the claims paying abilities of the issuer. TIPS are inflation-indexed securities issued by the U.S. Treasury in an effort to widen the selection of government securities available to investors. Past performance does not guarantee future results. Information throughout this Newsletter, whether stock quotes, charts, articles, or any other statement or statements regarding market of other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the reader. Opinions expressed are subject to change without notice and are not intended as investment advice or a guarantee of future performance. Consult your financial professional before making any investment decision.