Week in Review: December 5, 2016

What's Important

Positive U.S. economic news and a new OPEC accord favored cyclical stocks at the expense of bonds


Investors are acting as if faster U.S. economic growth and inflation are a fait accompli, but much policy and execution work is still ahead



Economic reports for the week confirmed the positive trajectory for the U.S. economy and the high likelihood the Fed will raise rates in mid-December. Third quarter GDP was revised higher with stronger consumer spending more than offsetting weaker fixed investment and inventories. Now estimated at 3.2%, growth in the third quarter of 2016 was the fastest since the third quarter of 2014.


The broad equity market slipped a bit last week after a string of significant gains following the elections. Beneath the surface, however, sector performance sharply diverged with energy stocks on top and the tech sector left behind.


Other reports showed that quickening economic momentum continued through November as employment, consumer confidence, manufacturing and construction showed good conditions. In response, investors bought stocks expected to benefit the most from a cyclical upturn - for example energy, materials and bank stocks. Technology stocks fell since valuations were less attractive in contrast to the brighter prospects in the cyclical sectors.

OPEC stole the show mid-week with its surprise agreement to cut oil production by 1.2 million barrels per day (bpd), significantly larger than expected. Most analysts had either dismissed the prospect of an agreement at all, or expected a cut of around only 750 thousand bpd. Further, non-OPEC producers (such as Russia) may announce additional cuts. The OPEC agreement drove U.S. crude futures up 12.2%, the largest weekly percentage gain since 2009. The energy sector shot up on the news and is the best performing sector for the year, up 25%.

Both the improving U.S. economy and progress towards balance in oil demand/supply are in line with our investment views. We have held a defensive tilt towards U.S. investments since we believe the U.S. has the best prospects for earnings growth. We also believe the oil market will slowly rebalance through higher demand and lower supply. However, we remain cautious on the OPEC agreement. Details around enforcement mechanisms are thin and individual cartel members have an incentive to “cheat” by exceeding their production ceilings. Therefore, we will be watching the actions of the OPEC-members before adjusting our thesis.

Faster economic growth and higher oil prices also raised the specter of inflation. Consequently, longer-term bonds sold-off briskly with the yield the 10-year Treasury bond ending the week at 2.4%. Since Election Day, the 10-year Treasury yield has skyrocketed over 0.5% on the belief that inflation will be higher under the Trump administration. Higher interest rates also took a toll on stocks such as utilities, telecom and real estate.    

Hopes are high that the Trump Administration will quickly accomplish many of its stated objectives. The combination of fiscal spending, tax reform and reduced regulation are intended to spur U.S. economic growth. President-elect Trump nominated several members of his Cabinet during the week who are seen as strong advocates for tax cuts and deregulation. So far, Trump’s actions are mostly in-line with the campaign rhetoric on these points.
    
However, many unknowns are ahead including the willingness of Congress to expand the federal deficit, the particulars on trade policies and the impact of the strong U.S. dollar. Further, very slow private investment and the aging population hold back growth. Therefore, we are reluctant to take significant investment moves away from strategic targets at this point.

Uncertainty continues overseas as well. In Italy, voters rejected a package of constitutional reforms intended to make the country more competitive. The early market reaction has been muted, implying the market had largely expected the outcome. Since the reforms focused on domestic issues, we expect the fallout from the election to be contained within Italy. Indeed, Prime Minister Renzi is reported to have offered his resignation. Nonetheless, Europe is facing a momentous political year including elections in Germany and France. We see significant policy uncertainty in Europe in addition to the Brexit negotiations. This is one reason we are lukewarm on non-U.S. developed market equities.




Market Returns (USD)

1-Week

Quarter-to-Date

Year-to-Date

1-Year

Global Equities

MSCI All Country World

-0.6%

-1.2%

5.3%

3.2%

S&P 500

-0.9%

1.5%

9.5%

7.7%

Dow Jones Industrial Average

0.2%

5.3%

12.9%

11.1%

NASDAQ

-2.6%

-0.8%

6.2%

3.9%

Russell 2000

-2.4%

5.2%

17.3%

12.0%

MSCI EAFE

-0.2%

-3.9%

-2.3%

-4.0%

MSCI Emerging Markets

-0.3%

-5.5%

9.7%

6.3%

Hard Assets

MSCI US REIT

-0.2%

-7.9%

2.0%

4.4%

Alerlan MLP

-1.2%

-3.7%

11.7%

12.4%

Bloomberg Commodity Index

2.4%

2.1%

11.1%

8.6%

Fixed Income

BofA Merrill Lynch 1-12 Municipal Bond

-0.7%

-3.3%

-0.8%

-0.6%

Barclays Intermediate Government/Credit

0.1%

-2.1%

2.0%

1.6%

Barclays High Yield Bond

0.4%

0.0%

15.1%

11.8%

JPMorgan GBI Emerging Markets Global Diversified

0.3%

-8.4%

7.2%

4.4%

Market Levels

Friday

Week Ago

Year End

Year Ago

S&P 500

2,181.90

2,164

2,044

2,081

Dow Jones Industrial Average

18,867

18,848

17,425

17,733

10-Year U.S. Treasury Yield (Constant Maturity)

2.34%

2.15%

2.27%

2.24%

Gold ($/oz)

$1,208

$1,228

$1,061

$1,082

Crude Oil ($/barrel)

$46

$43

$44

$48

U.S. Dollar / Euro ($/)

1.06

1.09

1.09

1.07

U.S Dollar / British Pound ($/£)

1.23

1.26

1.47

1.53

Japanese Yen / U.S. Dollar (¥/$)

110.9

106.7

120.2

122.9