U.S., Global Economic Expansion Helps Boost Stock, Commodity Prices in July
The U.S. economy continued to grow at a moderate pace in the second quarter thanks to strong consumer spending, business investment and healthy exports of goods and services. While residential construction’s contribution to second-quarter gross domestic product (GDP) declined year-on-year, home prices and less available inventory have led to significant home price appreciation.
Global economic conditions continue to improve as more economies are in the earlier stages of business-cycle expansion compared to the U.S. That is benefiting global stock markets as well. Recent concerns of a potential slowdown in economic growth in China were allayed this past month with reports of mostly positive manufacturing and construction activity, while second-quarter GDP was slightly above expectations.
Consumer, Business Spending Contribute to Pick Up in U.S. Second-Quarter Economic Growth
Advance estimates for second-quarter gross domestic product (GDP) showed that the economy grew at an annual rate of 2.6%, according to the Commerce Department’s report released July 28. That marked an acceleration in economic growth from a downwardly revised 1.2% growth rate in the first quarter.
Personal consumption expenditures, the biggest component of GDP, rose 2.8% compared to a year ago. Fixed investment by business rose by 5.2% with spending by business on equipment up 8.2%. Exports of goods and services also outpaced imports of foreign products, according to the report.
A dim component of the GDP report was housing. Residential investment declined by 6.8% compared to a year ago. Builders have been experiencing lot and labor shortages as well as building materials price increases, the National Association of Home Builders, the leading trade organization has been saying recently (see below for more on the real estate housing market).
Consumer interest in the housing market remains strong; however, available inventory continues to tighten while affordability is also becoming an issue. On a broader note, the U.S. consumer remains optimistic. The University of Michigan’s consumer surveys show that its Index of Consumer Sentiment posted a final result of 93.4 in July. The sentiment index has been declining since hitting a 12-year high in January, but is still at its highest level since 2004 through the first seven months of 2017.
Improvements in consumer finances have led to record-favorable views of Current Economic Conditions, which at 113.4, rose to its highest level since July 2005. Meanwhile, the Conference Board’s Consumer Confidence Index improved to 121.1 in July, up from 117.3 in June. Consumers’ assessments of current conditions remain at a 16-year high, but they weren’t as bullish about future prospects.
Although advance estimates of retail and food service sales declined by 0.2% in June from the previous month, they were 2.8% higher compared to the same month a year ago.
Economic activity in the management sector also expanded in July. The Institute for Supply Management (ISM) reported that its purchasing managers index (PMI) declined slightly to 56.3 compared to the June reading of 57.8. A reading above 50 indicates that the manufacturing economy is expanding and ISM noted that July’s reading shows growth in manufacturing for the 11th consecutive month and is the fourth highest reading in the last 12 months.
Fed to Unwind Securities Portfolio
What’s been missing from these generally positive economic numbers has been a corresponding increase in the rate of inflation. That led, in part, to the Federal Reserve leaving short-term interest rates unchanged in a range between 1% and 1.25% at the conclusion of its two-day policy meeting on July 26.
The Federal Open Market Committee (FOMC), which sets monetary policy, expects to begin unwinding its portfolio of bonds “relatively soon.” The Fed’s more than $4 trillion in balance-sheet holdings were purchased as part of its efforts to inject liquidity into financial markets and spur economic activity following the financial crisis in 2008.
Reducing its portfolio of Treasury and mortgage securities would likely pressure prices, leading to higher yields. If done too rapidly it could lead to a spike in market interest rates used to price mortgages and other consumer loans.
While the FOMC said in its statement that near-term risks to the economic outlook appear roughly balanced, it continues to monitor inflation developments closely. The Fed is considering the tapering of its balance sheet just as inflation remains below its 2.0% objective and is expected to remain so on a 12-month basis.
Inflation measures such as those reported in the Consumer Price Index (CPI) have been below the Fed’s 2% target since January. Core CPI, which excludes food and energy prices, was up by 1.7% compared to June 2016.
The FOMC also said in its statement that market-based measures of inflation compensation remain low. While the current unemployment rate remains low at 4.4%, real wages grew by only 2.5% in June compared to a year ago.
Real Estate – Mixed Readings in Housing-Market Stats Steady
U.S. home prices are approaching levels not seen since the peak of the housing bubble a decade or so earlier. Construction activity, however, remains tepid. That has partly led to higher prices with less inventory available for eager buyers, while affordability is becoming more of an issue in some local markets.
Privately-owned housing starts were 2.1% higher in June compared to a year ago. At a seasonally-adjusted annual rate of 1.22 million, June’s figure was also 8.3% higher than the revised estimate for May, according to the Commerce Department. Permits, an indicator of building activity ahead, were up 5.1% year-on-year at an annualized rate of 1.25 million, and 7.4% compared to May’s revised figures.
While June’s starts were the highest since February, quarter-over-quarter growth declined (although June’s numbers are still preliminary), and was partially evident in the contraction in residential construction activity noted above in second-quarter GDP.
Sales of new single-family homes in June were 0.8% higher (at an annual rate of 610,000) compared with May’s revised figures, according to the Commerce Department. Sales were up 9.1% compared to the previous year.
The pace of existing home sales slowed somewhat in June even as tight inventory levels and strong buying interest have been contributing to further price strengthening. Existing home sales fell 1.8% in June from the previous month to a seasonally adjusted annual rate of 5.52 million, according to the National Association of Realtors. June’s sales pace is 0.7% above a year ago but the second slowest this year (5.47 million in February), the NAR said.
The median existing-home price for all home types in June was up by 6.5% compared to a year ago. At $263,800, June’s median sales price represents another new peak and is the 64th straight month of year-over-year gains.
Other measures of home prices are also posting strong gains. Prices for homes as measured by the S&P CoreLogic Case-Shiller U.S. National Home Price Index rose by 5.6% on an annualized basis in May, the most recent available figures show. That represented a new high for the National Home Price Index, which is now 3.2% higher than its July 2006 peak.
Mortgage rates remained low in July.
Global Markets Review – U.S. Benchmarks End the Month with Gains
U.S. benchmark stock market indexes ended July mostly higher, with the Dow Jones Industrial Average climbing to another record on the last day of the month. The S&P 500 and Nasdaq Composite also posted monthly gains. Commodity, energy and industrial shares received a boost late in the month as oil prices edged briefly over $50 a barrel and copper prices hit two-year highs.
For the month of July, the Dow was up 2.5%, while the S&P ended up 1.9% and the Nasdaq gained 3.4%, according to MarketWatch. The tech-heavy Nasdaq has posted gains eight out of the past nine months after declining in June. Technology shares have been the leader in U.S. markets for much of the year and continued to chug along, despite some bumps and bruises in recent weeks.
On a total-return basis, which includes capital gains and reinvested cash distributions such as dividends, the S&P 500 Information Technology Sector Index rose by 4.33%, bringing its year-to-date return to 22.31% through July, according to data from S&P Dow Jones Indices.
While the long-running U.S. economic expansion continues, weak inflation data has led to expectations that the Fed may hesitate to raise interest rates and that’s put some downward pressure on the U.S. dollar. The WSJ Dollar Index, which tracks the value of the dollar against 16 other currencies, is down by slightly more than 8.0% for the year through July.
The dollar has suffered recently, in part due to uncertainty over political tensions in Washington, and the U.S. presidential administration’s ability to move on pro-growth policies such as infrastructure spending and an overhaul of the tax code. The yield on 10-year Treasury securities, meanwhile, barely changed at 2.29%, down by 1 basis point (a basis point is one one-hundredth of a percentage point) from 2.30% at the end of June.
Overseas Equity Markets Buoyed by Economic Growth Synching Up with U.S. Expansion
International stocks have been playing catch-up with the bull run that U.S. equity markets have been experiencing since 2009. The prospect of continued support from the European Central Bank (ECB) for the eurozone economy, improving corporate profits in Japan, and lower valuations across the globe compared to U.S. stocks have contributed to rising share prices.
Preliminary reports of the eurozone’s economic growth remained positive with advance readings of second-quarter GDP up 2.1% compared to the same period a year ago. Economic growth in the eurozone has remained steady in the 1.8% to 2.0% range since 2015.
Accommodative monetary policies from the ECB are set to continue. In addition to very low interest rates, the ECB, like the U.S. Federal Reserve, has been injecting more liquidity into the financial markets through its bond-buying program. While that’s helped the region’s economy bounce back from contraction in 2012 and the first-half of 2013, inflation at 1.3% in June was below the ECB’s 2.0% target.
The ECB recently delayed talk of when it would wind down its bond buying program noting that inflation isn’t where it wants it to be or should be. The ECB said in a July 20 statement that the current monthly €60 billion pace of its net asset purchases “are intended to run” through December 2017, or beyond, if needed, until it sees a sustained adjustment in the path of inflation consistent with the ECB’s target. The central bank also left key interest rates unchanged in July.
Continued ECB support also helped stocks in the region bounce back from some selling pressure during July over uncertainty of when the central bank would begin tapering its bond-buying program. The MSCI Euro Index ended July up by 3.64% and has gained 18.66% this year through July. The broader MSCI Europe Index rose by 2.94% in July and has risen by 16.39% for the year through July.
Japanese Equities’ Low Valuations Attractive, BOJ to Continue Easy-Money Policies
In Japan, rising corporate profits, a more focused approach to shareholder returns following corporate governance changes (companies have added more outside directors in recent years, for example), and debt deleveraging have helped lift share prices for much of 2017.
Japan’s economic growth, though tepid when compared to other developed countries, has been consistent for the past few quarters. The Bank of Japan (BOJ), the country’s central bank, continues to seek a path out of the long-standing deflationary environment the country’s economy has been experiencing in recent years. Real GDP has risen for the past five quarters, and the Japanese economy grew by 1.3% in the first quarter on an annualized basis, according to data released by the BOJ in late July.
While the ECB and Federal Reserve are at different stages of unwinding the quantitative easing programs they undertook in recent years, the BOJ remains committed to its ultra-easy monetary policy. The BOJ said on July 20 that it would keep interest rates on policy balances in accounts that banks have with the BOJ at -0.1%, and continue to purchase 10-year Japanese government bonds to keep longer-term rates at around zero percent.
Corporate profits have been on the rise since the second half of 2016 and rose by 26.6% in the three-month period through March 2017, the latest BOJ figures show. Rising export growth on the heels of the economic expansion across the globe is expected to bolster manufacturers’ profits. Another boost to share prices is that the BOJ is also purchasing exchange-traded funds and Japanese real-estate investment trusts (J-REITs) as part of its attempts to inject more liquidity into the economy.
For the year through July, the Tokyo Stock Price Index, or TOPIX, has gained 6.6% but has rallied by nearly 11.0% since mid-April, according to data from Bloomberg. The MSCI Japan Index rose 2.0% in July and has gained 11.07% since the beginning of the year.
Shell Preps for ‘Lower Forever’ Oil Prices, OPEC Seeks Production Caps
With oil prices trading roughly in a range between $45 and $55 for the past year, it’s no wonder that the oil and gas supermajors have been working diligently to figure out ways to deliver higher production with lower costs.
Exporting nations, for their part, have also sought to curtail output as they seek to offset the effects of higher production from countries such as Libya and Nigeria and the shale boom’s impact on prices. And at least one of the supermajors, Royal Dutch Shell, isn’t waiting for a sharp rebound in prices. It’s taking a conservative approach to the impact of oil prices on its future business by adopting what it calls a “lower forever mindset.”
Three years ago at this point in late July 2014, West Texas Intermediate (WTI) futures were trading above $100 a barrel, while Brent Crude futures remained above the $100 mark until that September. But oil prices were soon to begin a steady decline that would see both grades dip briefly below $30 a barrel in early 2016. WTI prices rose by nearly 9.0% in July, while Brent Crude increased by nearly 10.0%, according to data from Bloomberg.
Saudi Arabia’s energy minister said on July 24 that it would limit crude exports in August, while other members of the Organization of the Petroleum Exporting Nations (OPEC) as well as non-OPEC members discussed extending output cuts past March 2018. A larger-than-expected decline in U.S. crude inventories also helped lift prices.
Whether or not oil extends its recent gains and forges a path toward a higher trading range, Royal Dutch Shell continues to reshape its business with an eye toward operating in an environment of lower oil prices. In recent times, the world’s largest fuel retailer has worked toward delivering similar results to shareholders that it did when oil prices were around $100. It’s navigated the past 12-month period with a mindset of oil prices at below $50 a barrel, maintaining capital investment in projects that’ve led to growth, reducing debt and covering its cash dividends, the company noted in its July 27th conference call with analysts discussing its second-quarter results.
Shell is also positioning itself, not only for lower oil prices in the future, but also lower demand as more countries move to set limits on new gas or diesel-fueled car sales. Royal Dutch Shell’s CEO Ben van Buerden, who is switching to a plug-in vehicle for himself, expects fossil fuel demand to peak in the 2030s, thus the company’s long-term strategy of “fit for the forties.”
In late July the U.K’s environment and transport departments said the country would ban sales of new gas or diesel-fueled cars by 2040. The French government announced a similar measure earlier this month, while countries including Germany, India and Norway, among others, have set more aggressive targets.
Industrial Metals Prices Surge on Demand, Production Declines
Copper and iron ore prices, buoyed by expectations of continued demand from China, surged in late July. While China’s purchasing managers index (PMI) of manufacturing activity released July 28 was slightly below expectations, the sub-index for growth in the country’s construction sector reached its highest level since December 2013.
Copper prices have been climbing steadily since mid-2016 and reached two-year highs to close out July. In addition to demand from China, which represents about half of world consumption, potential policy changes by the Chinese government to limit or ban the import of copper scrap was viewed as a boost for demand for mined and refined copper.
Iron ore prices also ended the month at their highest level since early April. The Bloomberg Industrial Metals Total Return Index, a broad measure of industrial metals prices that tracks futures contracts on aluminum, copper, nickel and zinc, rose 9.8% for the month of July. And the S&P GSCI Energy Index was up 8.1% in July, the most for that month in 13 years.
China’s economy grew by 6.9% in the second quarter and quelled some concerns, for now, that the government’s attempts to rein in banking leverage and slow the pace of rising property prices would negatively impact growth. The government, though, is putting policies in place that could lead to a deceleration in economic activity for the second half of the year ahead of a Communist Party Congress in the autumn.
Debt has been fueling the Chinese economy and even outpaced economic growth for several years. It’s estimated that about one-third of 2016’s global economic expansion came in the form of demand from China.
In the U.S., second-quarter earnings of S&P 500 companies are expected to increase 11.6% from the second quarter of 2016. Of the 350 companies in the S&P 500 that have reported earnings through the beginning of August, 72.3% have reported earnings above analyst expectations. This is above the long-term average of 64% and above the prior four quarter average of 71%, according to Thomson Reuters I/B/E/S.
MSCI data as of July 31
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