Covenant Weekly Market Synopsis as of September 16, 2016

September 19, 2016

Following a rough end to the previous week (when equity markets declined by more than 2% on Friday, Sep 9th) risk assets staged a strong recovery on Monday, but ended the week mixed. Domestic equities rose by 0.6%, while developed international markets declined by 1.8% and emerging markets fell 2.6%. Month-to-date, broad equity indices are in the red, down an average of 1.5%, though the oft watched NASDAQ is up 0.6% after its largest constituent Apple gained more than 11% last week. The yield on US Treasury bonds, ended the week relatively unchanged. Precious metals declined (gold: -1.3%, silver: -1.4%) and crude oil fell 5.8% to $43.24 per barrel as a report from the Energy Information Administration showed a rise in crude inventories. The US Dollar rose by 0.7% (against a basket of its major international trade partners), while the VIX Index (a measure of expected S&P volatility) fell 12% to 15.37.

For a more detailed view of weekly, month-to-date and year-to-date asset class performance, please click here.

Rock and a Hard Place: This week the Federal Open Market Committee (aka FOMC and loosely referred to as “the Fed”) will meet to determine whether to raise interest rates. There are three FOMC meetings remaining this year, but with the next one falling only one week before the Presidential Election in November, most believe that if no action is taken this week then the most likely timing of the next potential interest rate hike would be December. Odds are that the Fed will not raise rates this week (Bloomberg data indicates a 20% probability). Although we believe that based on the available economic data there is not an economic reason for increasing interest rates, the Fed is concerned about normalizing rates as quickly as practicable so they have the ability to reduce rates to stimulate growth in the next recession. The Fed is in a Catch-22 with massive implications as raising rates now threatens to choke-off the modicum of growth that the economy is experiencing (over the last three quarters the economy has expanded at an annualized real rate of only 0.9%, 0.8% and 1.1%). A move to increase rates this week would represent a departure from the Fed’s policy over the last 20+ years of increased transparency, including telegraphing interest rate changes well in advance. The market reaction to such a move this week would be dramatic. Less than 10 days ago equity markets declined by more than 2% when rumors circulated that a dovish member of the FOMC might give a hawkish speech. The market is clearly on edge as low interest rates are supporting lofty stock valuations. Although the Fed is unlikely to raise rates this week, should they draw a line in the sand and announce a 0.25% increase on Wednesday, look for markets to react extremely negatively (unless the Fed softens the blow by announcing that they will not raise rates again for another three to six months). Being a FOMC member is never easy, but in this environment, the job is about as thankless as it gets.

Income, a step in the right direction: The median household inflation-adjusted income for U.S. families rose by 5.2% in 2015, the largest single-year increase since records began in 1967. The increase now puts the median annual income at $56,516. While a welcome change from years of declining earnings, it is worth noting that real median incomes are still 2.4% below the all-time high reached way back in 1999 (see the green line in the chart below). In other words, more than 50% of Americans have less income than they did 16 years ago. This unfortunate data point is surely influencing the rise of political populism because after nearly two decades average Joe’s and Jane’s have lost faith in the ability of traditional politicians to improve their standard of living.

image

Sources: Census Bureau and FTN Financial.                  * Dotted line reflects change in survey methodology in 2013.

Economic Wrap-up: In general it was not a good week for economic data. Retail Sales fell 0.3% in August (vs. expectations of -0.1%). The “control group” of products sold (which is the figure that goes into the GDP calculation) declined by 0.1%, versus an expected 0.4% increase. Industrial Production also declined by 0.4% (vs expectations of -0.2%). The core Producer Price Index (PPI) increased by 1.2% in August, which was above expectations, but the underlying data indicate the inflation increase may be short-lived and does not appear to be the beginning of a higher inflationary trend in the supply chain. That being said, the core Consumer Price Index (CPI), ex-food and energy, rose 0.3% (vs. expectations of +0.2%), primarily related to increases in medical care and housing costs. However, the Fed focuses on a different inflation measurement called Personal Consumption Expenditures (PCE). Medical care and housing costs have lower weightings in the PCE calculation and on this measure inflation is running closer to 1.5% year-over-year (well below the Fed’s 2% target).

Be well and Godspeed,

Jp.