Financial Markets Updates

Monday, June 26th 2017

Stocks were mixed last week, although the S&P 500 Index and Dow Jones Industrial Average were able to reach new highs. The healthcare and technology sectors rallied sharply while REITs (real estate investment trusts) posted a small gain. Energy shares weighed on the major indexes for much of the week, but this was offset somewhat by periodic strength in health care, financials, and technology stocks with the technology giving a particular boost to the Nasdaq Composite Index. Amazon’s plans to acquire Whole Foods Market, announced the prior week, continued to reverberate among retail stocks. For example, shares in Bed Bath & Beyond tumbled Friday with some observers pointing to worries about competition from Amazon as exacerbating the drag from a disappointing earnings report. For the week, the Dow and S&P 500 finished higher by a hair, but the Nasdaq continued to power ahead gaining 1.8% for the week! Gold finished out the week up a few dollars a troy ounce higher at $1257.80 and up about 9% year-to-date.

When considering the overall economy, there did seem to be more debates surrounding some high-profile issues related to monetary policy, particularly inflation and the signaling effect of a flatter yield curve (shorter and longer maturing debt having similar yields). There were also a number of interesting developments somewhat below the surface. Oil entered into bear market territory with the usual supply side suspects in focus from America’s advances in bringing on new oil supplies to the global energy markets. Healthcare stocks saw their biggest gain since just after the election with biotech leading the way on continued speculation about an industry friendly executive order on drug pricing. On the political front, policy headlines largely revolved around the uncertain fate of Republicans' Obamacare repeal and replace effort in the Senate.

Over in the bond market, longer-term Treasury yields were largely unchanged for the week with the ten year U.S. Treasury closing-out the week with a 2.14% yield. On last Thursday, the Federal Reserve performed its annual Comprehensive Capital Analysis and Review (CCAR), also known as the bank “stress test.”  All thirty four of the largest U.S. banks passed the examination. In one test, a “severely adverse” scenario, featured a global recession with U.S. unemployment rates jumping to 10% along with distressed commercial real estate market conditions. The positive results evidence the improved condition, post the 2008/9 financial crisis, of America’s largest banks. This significant progress raises the possibility that the Fed may relax some of its capital rules, hopefully leading to increased lending activity, especially to potential borrowers that had been neglected due to the strict capital requirements.

With regard to global Central Banks, the cumulative balance sheets of the Fed, European Central Bank and Bank of Japan have exploded higher over the last 17 years as noted in the chart below. With increases of this magnitude, stocks have rallied. The trillion dollar question is “what happens to stocks when all the “fiat money” created out of thin air is sanitized” and how will it be done in a fashion not to disrupt the worldwide financial markets. Buckle-up!

As noted earlier, energy stocks fell as oil prices declined for a fifth consecutive week.  Brent crude oil, the international benchmark, has retreated more than 15% since OPEC’s agreement in May to extend production cuts. Increased output from Nigeria and Libya (both of which are exempt from the OPEC deal) is putting additional pressure on oil prices along with a growing number of active drilling rigs in the U.S. However, the Energy Information Administration’s weekly inventory report showed that U.S. stockpiles, while still elevated, are receding and Iran’s oil minister stated that OPEC is contemplating deeper cuts to reduce the global inventory overhang. However, due to labor and equipment shortages, many of the recently-drilled shale wells are unlikely to be brought online in the near-term. These drilled-but-uncompleted wells (DUCs, in industry parlance) hit an all-time high in May 2017. The current economics of shale oil point to a break-even price range from $40 to $60 per barrel in contrast to prior years while most shale producers have not locked in higher prices for their production. Accordingly, as oil prices are near the low end of the break-even range, companies will likely respond by curtailing activity until oil prices recover. Thus, oil prices themselves may be the catalyst to bring the global oil supplies into balance.

In Overseas markets, the sharp 3.5% decline in oil prices last week dominated European stock market activity during the week. The oil and gas sector led stocks lower, dropping around 2%, along with a decline in basic materials stocks. Bank, consumer goods, and health care stocks also suffered from the knock-on effects of mixed signals about the health of the eurozone economy. The pan-European benchmark Stoxx 600 index ended the week slightly lower. However, Japanese equities posted gains and the Nikkei 225 Stock Average now stands near a seventeen year high in U.S. dollar terms. The Nikkei advanced 0.9% (189 points) for the week, closing at 20,132.67. Year to date, the Nikkei is up 5.3%, the TOPIX Index is ahead 6.1%, and the TOPIX Small Index advanced 10.4%.

"We always wanted a big two story house." George Jones and Tammy Wynette. Families are finding homebuying success even with limited inventory. May Existing Home Sales edged higher 1.1 percent from April to an annual rate of 5.62 million units, above the 5.52 million expected. Sales were up 2.7 percent from May 2016. Despite the increase, low inventories continue to be a problem with supply at a 4.2-month level. May New Home Sales surged. The Commerce Department reported that New Home Sales in May jumped nearly 3 percent from April to an annual rate of 610,000, above the 599,000 expected. From May 2016 to May 2017, sales were up almost 9 percent with May being the second highest tally of 2017. Tight inventories of just a 4.6-month supply pushed the median price to a record $345,800. For both new and existing homes sales, a healthier inventory level is a six-month supply. Whether you are looking to purchase a first home, downsize or move into a dream home at this time, home loan rates remain near historic lows.

Weak economic news normally causes money to flow out of Stocks and into Bonds, helping Bonds and home loan rates improve. In contrast, strong economic news normally has the opposite result. The chart below shows Mortgage Backed Securities (MBS), which are the type of Bond on which home loan rates are based. When you see these Bond prices moving higher, it means home loan rates are improving. When Bond prices are moving lower, home loan rates are getting worse. To go one step further, a red "candle" means that MBS worsened during the day, while a green "candle" means MBS improved during the day. As you can see in the chart below, Mortgage Bonds have been trading in a sideways holding pattern.

Chart: Fannie Mae 3.5%% Mortgage Bond (Friday Jun 23, 2017)

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On a personal note: Al Procaccino is happily married, has two wonderful daughters and resides in Rumson, NJ. He loves his pets, enjoys music, reading, swimming, golf, college sports, biking, cooking, model railroading and chess. Al supports many charities also serving on the Board of Room in Our Hearts at  Room in Our Hearts is a nonprofit organization dedicated to helping families whose homes have been affected by crisis.

Economic Calendar for the Week of June 26th to June 30th

Information contained herein is obtained from industry sources believed to be reliable. The information presented comes from different sources on a weekly basis and is intended to provide a commentary related to market events and is not intended to be used as investment advice or represent any specific product or service. Market information and performance information is provided from different industry sources including, but not limited to TD Ameritrade;  MMG; Barron’s; BBC; NPR; Reuters; MFS Research; CNBC; CME; The Wall Street Journal Online; Bloomberg News; Financial Times; Forbes; CNNMoney; J.D. Power Valuation Services; The Economic Times; USA Today; stockcharts; CotSignals; Bespoke; Manheim; The Fed; Econoday; U.S Bureau of Economic Analysis; World Development Indicators database from the World Bank and the Internet.