May 2016
Hiking Horizon
US employment disappoints
Fed minutes reveal hawks in ascendency
Britain ramps up scare tactics ahead of Brexit vote
France gridlocked by strikes
Markets in May continued in recovery mode, with US stocks performing better than other major asset classes. International developed countries' markets were flat for the month, while emerging markets were down nearly 4% in May. Bonds were also flat as investors weighed the possibility of a potential interest rate hike by the Federal Reserve. Commodities were generally higher on the month by 1%, with gold being an exception, losing 6% in May, but still leading all major assets so far this year:
Longer term returns still favor US assets, as the chart below highlights. US stocks have outperformed materially over the last 3 and 5 year periods. Momentum has clearly favored the US, as international developed markets are only slightly higher over the last 5 years, and emerging market stocks are down considerably over the period. Commodities are attempting to stage a comeback after their second double-digit sell-off in the last decade. If momentum continues to be a good indicator for commodities, the rally we've seen this year may have only just begun. You've likely noticed this change in commodities momentum most directly by your recent visits to the gas pump. During 2015 gas seemed to be getting cheaper by the day, and now it has reversed course and has moved higher since the beginning of the year.  
In U.S. economic news released on May 6, the U.S. economy added a weaker-than-expected 160,000 jobs in April as the unemployment rate held steady at 5% according to the Labor Department.  It was the smallest gain since last September.  However, a positive detail in the report is that hiring in high-paying sectors appears to have broadened out, helping to raise average hourly earnings by +0.3% on the month and +2.5% from a year earlier.  In a separate report from payroll processor ADP, private sector employers added 156,000 jobs last month, down from 200,000 in March - the smallest ADP gain in 2 years.  Both the Labor Department's and ADP's reports missed analyst expectations widely.
Another way to gauge the state of the job market (perhaps more reliably) is to measure the amount of taxes withheld from paychecks for federal income and employment taxes. An analysis of daily Treasury statement funds by Investors Business Daily (IBD) revealed that the job market apparently grew +4.5% from a year ago.  It was the fastest pace in 6 months, and supports the view that the economy is strengthening after 2 weak quarters.  The tax data, which doesn't rely on statistical samples and seasonal adjustments, had previously been signaling weaker wage gains in contrast to the monthly employment reports, which painted a rosier picture.  The improvement in tax-receipt growth since last month could indicate another strong employment report is coming and, along with a further rise in wage growth, may open the door soon to an interest rate hike by the Fed.
On May 18, the minutes from the Fed's April policy committee meeting were released and they surprised many traders.  In March, Fed Chair Janet Yellen gave a speech in which she stated that "caution is especially warranted" when it comes to raising rates with global risks so high and policymakers so low on conventional ammunition to counteract a downturn.  But the minutes revealed a much more hawkish consensus within the Fed.  Most participants agreed that an interest-rate increase would be appropriate in June if the economy continued to improve.  From the minutes: "Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen and inflation making progress toward the committee's 2% objective, then it likely would be appropriate for the committee to increase the target range for the federal funds rate in June."  On May 18, New York Fed President William Dudley reinforced that notion, saying at a press briefing that "a tightening in the summer, the June, July timeframe is a reasonable expectation."
Then on May 27, Federal Reserve Chair Janet Yellen said that ongoing improvement in the U.S. economy would warrant another rate increase "in the coming months," stopping short of giving a definite timeline of when the central bank might act.  "It's appropriate-and I've said this in the past-for the Fed to gradually and cautiously increase our overnight interest rate over time," Yellen said during remarks at Harvard University.  "Probably in the coming months such a move would be appropriate." 
The next Federal Open Market Committee meeting will be held June 14-15, when the Fed will deliberate over a second interest-rate increase following 7 years of near-zero borrowing costs following the Great Recession.  Yellen's comments and those of several regional Fed Presidents hint that the hiking horizon just got a lot shorter in May. Investors are taking them at their word: according to the fed funds futures markets, investors place a 23% probability on a vote to raise rates at the June meeting; but that rises to 58% by July:
 Source: CME Group
At month end, the Commerce Department reported that the U.S. economy expanded at a slightly better pace in Q1 than originally reported.  GDP in the first quarter rose +0.8%, up from the +0.5% initially reported, but still missing the +0.9% expected.  Q1 consumer spending rose at a +1.9% pace, slightly missing expectations, while business investment fell sharply. 
Good news in May came from the real estate market. Purchases of new homes in the U.S. surged last month to the highest level since the beginning of 2008.  Sales jumped +16.6% to an annualized pace of 619,000 and purchases for the first 3 months of the year were revised higher, according to the Commerce Department.  The sales rate exceeded even the most optimistic forecast in a Bloomberg survey.  In addition, the median sales price reached a new record of $321,100, up +9.7% from April 2015, reflecting a pickup in signed contacts on more expensive properties (although, oddly, sales of mega-mansions in the multi-million dollar category are reportedly stagnating).
The number of homes sold and not yet under construction also climbed to its highest level since May of 2007.  The gain in demand was led by the South where sales climbed +15.8% to a 352,000 annualized rate-the strongest in the South since December of 2007.  The supply of homes on the market fell to 4.7 months from 5.5 months in March. Also, the National Association of Realtors reported that the Pending Home Sales Index surged +5.1% last month to the highest level since February 2006.  Economists had only expected a +0.8% rise.  The index suggests that actual existing-home sale closings should have strong readings in May and June as these pending contracts are finalized. All in all, years of pent up demand seems to be emerging, and housing is a major contributor to GDP. Better times ahead?
In the United Kingdom, with less than a month to go before Britain votes on leaving the European Union (yes, the infamous "Brexit"), the U.K. Treasury issued a report that warned that the British economy could dive into a year-long recession should Britain leave the E.U.  Analysts at the U.K. Treasury claim that the economy could slide more than -3.5% in the two years following a British exit from the E.U. All the stops are being pulled out by the government and their compliant media allies to scare the voters into staying in the EU. June 24th will be a red letter day for the markets, with the future of British sovereignty and the entire EU project probably hanging in the balance. Stay tuned.
As if to underscore the conflict between domestic and Eurozone priorities, France was convulsed in May by nationwide strikes over proposed labor reforms. Tear gas filled the air in Paris as authorities struggled with a groundswell of public anger in response to a labor bill that would give employers more flexibility and weakens the power of unions. The labor law, tagged the "El Khomri Law" (referring to French Labor Minister Myriam El Khomri) relaxes stifling labor rules regarding the 35-hour work week and lowers protections for workers from layoffs that employers maintain make them uncompetitive on the world market. Gas stations were short on petrol, and train and airline travel were disrupted. Even the electric grid was threatened as nuclear plant operators joined the fray. The French are being buffeted by terrorism, rising nationalist sentiment, and now, yet again, by paralyzing national strikes. If this is the future of the EU, the British may want to opt out! June 24th gives them a chance.
Finally, we take a look at the continuing devastation occurring in the energy industry following oil's 13-year low earlier this year.  Although oil has recently recovered in price, the industry itself has been pummeled. On May 1, Houston-based Linn Energy filed for bankruptcy, becoming the biggest U.S. casualty of the collapse in oil prices.  Linn sought to restructure debts of $9.2 billion to "provide a platform for future growth", according to the CEO.  At last check, some 69 North American oil and gas producers have filed since the beginning of 2015 according to a recent report from law firm Haynes and Boone.  Last month was the worst so far, with 11 new Chapter 11 bankruptcy filings.  The website Visual Capitalist created the following "infographic" to demonstrate the worsening carnage in the oil sector - and how truly big players are now joining the crowd on the courthouse steps.
As the infographic depicts, earlier bankruptcies were confined to the smaller players in the space with total debt load below $100 million. However, last month the situation deteriorated to the point where 4 firms with greater than a billion dollars in debt sought bankruptcy protection.  And there are more to go, according to consulting and accounting firm Deloitte, which concluded that about 175 companies in total are at risk of insolvency.  
This is good news, counterintuitively, as it represents the "wash-out" phase of the commodities bust of the past several years. Energy stocks have already begun a recovery, and now the junk bond market can hopefully also start to normalize. Time heals all, as the saying goes.
We hope you have a terrific month in June. Vacations are underway, and weddings, as always, are in the air. Enjoy!
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