Patience

by Ralph Cole, CFA Executive Vice President of Research

Patience

It’s been a strange week in “Euroland.” After a resounding “no” vote on the Greek debt bailout referendum last Sunday, it appeared that Greece was on its way out of the Eurozone. Capital markets promptly sold off early in the week.

Today it appears that Greece has delivered a reasonable response. “The program they are presenting is serious and credible,” said French President François Hollande.

We must admit that we have a tad bit of Greek fatigue in recent weeks, but it is clear that Greece is on everyone’s mind these days. The country has presented a 3-year plan, which is better than some of the temporary schemes that have been floating around the past few months. If it is accepted over the weekend, markets should continue to move higher along with yields. The removal of this distraction will allow the ECB to continue focusing on the nascent European recovery.

We continue to have our doubts for the long-term sustainability of Greece within the Eurozone. It doesn’t appear to us that the Greek people are committed to the structural changes that need to take place in order to pay their debts and make their economy more competitive in the future. This will not be the last time we talk about Greece’s debt, economy and leadership.

Roller Coaster

Compounding the volatility induced by Greece was the roller coaster known as the Chinese A-share market. As China tries to open its capital markets, they also must learn how to govern them.  Much like holding water in your hands, the tighter you grip, the more water that slips through your fingers. Confidence in the system is the most important element to a successful exchange. The more China tries to prop up their market the less confidence investors have in their system.

We are more concerned with underlying growth in China’s economy than we are with the volatility in their A-share market. It is clear that China’s growth is slowing and it is nowhere near the 7 percent reported by the Chinese government. Growth around the world is challenged and China’s growth is needed until the stimulus by other countries gets their economies growing.

We will continue to monitor their real economy closely in the coming months. We expect growth to pick up around the world in the second half of the year, but that forecast has come into question in recent weeks.

Our Takeaways for the Week

• Proper investment patience kept prudent investors from overreacting in a week packed with news flow
• Growth in the second half of the year should propel markets modestly higher

Disclosures

Supreme Summer

by Shawn Narancich, CFAExecutive Vice President of Research

While Chinese stocks endured more losses in a week that now puts the A-Shares Index into correction territory, U.S. investors continue to preside over a range-bound market domestically. With U.S. equity indices near record levels and late quarter news flow reduced to a trickle, all eyes were focused on the U.S. Supreme Court decision this week regarding the legality of federal tax subsidies for states not running their own insurance exchanges. A high court ruling upholding a key tenet of the Affordable Care Act (ACA) was greeted with a sigh of relief by investors who own hospital stocks, while sending speculators short names such as HCA Holdings running for cover. While minor tweaks to the ACA are still possible, such as the repeal of the medical device tax, this week’s key ruling all but assures that the key structure of the national healthcare law will remain intact at least until the Obama administration leaves office.

Gathering Pace

As healthcare stocks reacted to the Supreme Court drama, investors with more cyclical leanings received the latest confirmation that moribund first quarter consumption and weak retail sales were transitory. U.S. consumption spending in May rose at the fastest month-to-month rate in nearly six years, and the 0.9 percent surge easily outpaced a smaller increase in consumer income. Indeed, the U.S. consumer has not forgotten how to spend! Coupled with a strong job market confirmed by a surge in May hiring and an upbeat retail sales reported for the same month, we are left to conclude that the U.S. economy has picked up considerable pace from the slight contraction it experienced during the first quarter. Our best guess is that the Federal Reserve will exit zero interest rate policy sometime later this year, and it will most likely be in September.

Greece Ad Nauseum

The melodrama of Greece failed to find a resolution this week, but European stocks seem to have found their footing nonetheless. Regardless of whether ongoing talks with Greece are successful in retaining the country as a solvent member of the Eurozone economy, the European Central Bank (ECB) has demonstrated its commitment to do, as chief Mario Draghi famously observed several year ago, “whatever it takes,” to keep the Eurozone and its currency viable. Exhibit A of this commitment is the ECB’s ongoing program to enhance the European monetary base by purchasing $60 billion of European bonds every month until at least the fall of next year. Exhibit B, key in the latest Greek crisis, is the central bank’s commitment to fund Greek banks with loans to accommodate ongoing deposit flight from these institutions. Our main observation here is that if no acceptable resolution is reached and Greece ends up leaving the common currency, then Europe and its central bank will do what is necessary to keep the region’s banking system and economies liquid, thus preventing any lasting type of contagion from Greece’s exit.

Our Takeaways from the Week

• The U.S. economy is perking up after a slow start to the year
• Global capital markets are unlikely to suffer any lasting repercussions from Greece, regardless of how the melodrama concludes

Multifamily Living Multiplies

by Brad Houle, CFA Executive Vice President

Demand for commercial real estate from investors has been robust for the past few years. In a world of low interest rates, the relative yield advantage of owning commercial real estate is attractive to investors. In addition, trophy commercial properties in gateway cities like New York and San Francisco are seen as a “store-of-value” to foreign investors. When international investors are faced with a volatile home currency or an unstable government, the thought of owning a landmark building in an American city is a relatively prudent investment. As a result, real estate transactions in coastal cities have occurred at price levels that imply a very meager return for the buyer.

While most categories of commercial real estate have performed well, one of the most robust has been apartment buildings. Home prices have rebounded sharply since the Great Recession, particularly in the “cool” cities that millennials prefer to call home. One would think that the millennial generation is the demographic driving new household formation and should be in their prime first-time home buying years. However, a cultural shift has taken place whereby millennials are waiting longer to get married, start families and often prefer to rent for a number of reasons.

According to the U.S. Census Bureau, home ownership as a percentage of households has declined nationally from nearly 70 percent in 2004 and 2005 to 63.8 percent in 2015. A one-percentage-point change in home ownership rates equates to 1.3 million households, according to Bloomberg data. Lending requirements for first-time home building have been tightened dramatically since the financial crisis and the 20-percent down payment requirement disqualifies many millennial prospective homebuyers.

Home Ownership as a Percentage of Total Households

 Source: Bloomberg 

According to Bloomberg, apartment construction nationally has been rising since 2009. Apartment construction permits, a leading indicator of multifamily construction, was at an all-time high of 557,000 units in May. Permits last approached this level in June 2008.

Broadly speaking, real estate development moves in cycles. Whether it’s the unsold condos following the 2009 financial crisis or the now ubiquitous “selfie stick,” we have seen firsthand that whatever the hot trend happens to be is, it has the potential to … cool down.

Greekspeak

This week there continued to be directionless news flow regarding the continued debt crisis in Greece. While it is impossible to determine what the outcome may be, one thing is certain: The market has a high level of Greece fatigue. Investors are weary of the issue and it appears that even the correspondents on CNBC are tired of reporting on it. We are closely monitoring the debt of neighboring southern European nations for any sign of contagion and thus far, the crisis does not seem to be spreading. July 20 is now viewed as a critical day, according to Bloomberg, as Greece owes the European Central Bank (ECB) 3.5 billion euros on that day. If there is a failure to pay, this would put Greece on the way to getting the boot by the EU. Interestingly, Greece will possibly delay payment to the International Monetary Fund (IMF) this month with no real consequences as liquidity will not be cut off to Greek banks. Evidently, not paying back the IMF is something akin to not paying back your in-laws with the only consequence being an awkward Thanksgiving dinner. The impact of not paying back the ECB is similar to not paying back the guy you borrowed money from at the racetrack.

In addition, the Federal Open Market Committee minutes were released this week. Parsing every word of the Fed minutes revealed that interest rates may rise in September and December of this year. This quote possibly has been the most over-analyzed and highly anticipated Fed rate hike of all time. Ultimately, this is good news: The Fed thinks the economy is robust enough that they need to tap the brakes to keep it from getting overheated.

Our Takeaways for the Week

• Expect interest rates to make small movements upward in the fall
• The multifamily housing market is robust and is likely to peak this year

Disclosures

Friends in Low Places

by Ralph Cole, CFA Executive Vice President of Research

In a much anticipated move, the ECB joined the rest of the developed world by announcing a comprehensive quantitative easing package this week. Investors were worried that maybe the plan would not be big enough or long enough to satisfy global capital markets. Bond yields and equity indices gyrated as the official announcement was released but eventually stocks moved higher and European bond yields moved lower. Yields on 10-year bonds around the world remain shockingly low, and it appears they may remain low for some time. Here is a list of global 10-year yields:

U.S.	1.88%
UK	1.51%
Canada	1.42%
France	0.61%
Germany	0.38%
Italy	1.54%
Spain	1.41%
Switzerland	-0.20%

Source: Factset

The goal of quantitative easing is to lower longer-term borrowing costs in an attempt to incentivize businesses and individuals to borrow money and invest. Some of the excess liquidity in the system can also flow to equity markets, and drive prices higher. This acts to boost confidence and hopefully trigger investment and spending. This recipe worked well in the U.S. during QE3, and Europe is hoping to follow the same path.

Golden Years

Golden months may be a better term. Somewhat under the radar, gold has turned up in a strong performance in the last three months. It appears that a race to the bottom in currencies is finally starting to resonate with global investors. Gold is up 15 percent from recent lows to nearly $1,300 per ounce. Gold is viewed as a hard currency that can't be debased like fiat currencies. When we held gold in client portfolios several years ago it was for this very reason.

Takeaways for the week

• Despite a well telegraphed move, the QE announcement by Mario Draghi was celebrated by markets around the world
• Many developed economies are attempting to deflate their currencies in an effort to boost growth. This has led some investors to purchase gold as a store of value

Disclosures

A Pleasant Shade of Gray

by Jason Norris, CFA Executive Vice President of Research

Headline sales numbers from Black Friday looked disappointing with revenues falling 11 percent in 2014, which follows a negative year in 2013 as well. However, when we dig into the data, we see that sales have spread out over the entire week. Many stores have been starting their promotions earlier in the Thanksgiving week, meaning Black Friday is not the seminal event it once was. Coupled with an increasing amount of shoppers going online, the post-holiday shopathon is not the signal to the markets it once was.

Data from the entire weekend looked fine with sales rising approximately four percent, with a 15 percent clip coming from online sales. In forecasting the entire holiday season, industry analysts still expect low to mid-single digit growth. In light of gasoline prices down 35 percent from last year, we are comfortable with that growth forecast. In fact, this led us to increase our allocation to the consumer discretionary sector recently.

Quantitative Speaking

With the Fed wrapping up its quantitative easing last month, the European Central Bank has upped their rhetoric. This week, ECB president Mario Drahgi was more adamant that the ECB will be in the markets buying bonds. This put a small bid on the Euro; however, we are still waiting for the ECB to actually make meaningful purchases. Since 2012 when Drahgi stated the bank would do "whatever it takes" to prop up the Euro economy, there has been a lot of speaking, with little actual easing.

The economic data points coming out of Europe have been neutral at best. While the old adage of "don't fight the Fed" may be appropriate for the ECB and European equities, we would rather focus on large cap U.S. stocks due to a strong economy, falling commodity prices and low interest rates. One potential headwind for multinationals is going to be the strength of the U.S. dollar. The dollar has rallied 10 percent the past few months and this will start effecting overseas results this quarter. Due to this, recent portfolio additions have focused on the domestic economy, rather than the global economy.

Our Takeaways for the Week: 

• Falling gas prices and an improving U.S. economy keeps us bullish on U.S. stocks
• Continued dollar strengthening will benefit U.S. stocks and bonds, while pressuring commodity prices, thus keeping inflation low

Disclosures

Slowdown?

by Jason Norris, CFA Executive Vice President of Research

The first couple weeks of trading in October have been volatile, primarily on the downside. While the U.S. economy continues to print positive data points, most other regions around the globe seem to be experiencing some headwinds. We continue to see deteriorating economic data coming out of the Eurozone. Germany had been stronger; however, recent data is pointing to the country possibly entering into recession. Industrial production and manufacturing orders came in weak, and this concern has pushed the yield on the 10-year German Bund to 0.84 percent.

China is a wildcard as well. Growth has been slowing moderately; however, Thursday evening technology investors were greeted with bad news from a key component supplier. Microchip Semiconductor, a supplier of chips that go into a broad array of consumer, household and industrial products, issued a warning citing weakness in China. The company believes this is a short-term issue, but demand just three months ago was strong. This resulted in a drubbing of the Philadelphia Semiconductor index and caused the industry to be down over 5 percent on Friday. Even though there may be some general hiccups in demand, we continue to play the semiconductor space through specific technologies and applications, primarily in the wireless space.

We don’t anticipate a slowdown here in the states. The U.S. economy should continue to exhibit solid growth and decouple itself from the rest of the globe. The most recent positive development has been the decline in energy prices over the last couple weeks, which will result in a nice increase of discretionary income for U.S. consumers.

When Doves Cry

The Fed released its meeting minutes earlier this week and the capital markets were pleasantly surprised. There had been some concern that the Fed may become more hawkish and looking to tighten. However, contents of the minutes showed the Fed to be focused on the data. They highlighted benign inflation, a strengthening U.S. dollar (which is positive for low inflation) as well as increased risks of a global slowdown due to Europe’s stalling growth. We still believe that the Fed will be looking to raise the funds rate in the second quarter of 2015. Even though inflation remains low, U.S. economic growth will support the beginning of a rate hike cycle.

European Central Bank President Mario Draghi also signaled his dovish intentions for the ECB earlier this week. At a speaking engagement in Washington D.C., he stated that the bank was willing and able to alter its current bond buying program which may eventually move from just asset-backed securities to actual sovereign debt. We believe the ECB will be active in the market and will attempt to push growth higher to fight any possibility of deflation.

Our Takeaways for the Week: 

• While the Eurozone looks to be slowing, U.S. economic growth remains healthy which is positive for both the U.S. dollar and equities
• The Fed will remain data dependent when determining when to increase rates, which probably won’t happen for another 6-9 months

Disclosures

A Little Less Conversation, a Little More Action

by Ralph Cole, CFA Executive Vice President of Research

A Little Less Conversation, a Little More Action

The European Central Bank (ECB) finally stopped jawboning the markets this week and put into place additional policies to get the European economy moving forward. Slow growth and disinflation continue to loom over the EU and spurred the ECB to take aggressive actions.

Specifically, the ECB announced the following policy actions¹; they are:

1)      Lowering the Eurosystem refinancing rate to .15 percent 2)      Lowering the interest rate on the marginal lending facility to .40 percent 3)      Lowering the deposit facility rate to negative 10 basis points (you have to pay the ECB 10 basis points to hold your money if you are a bank) 4)      They have outlined a new $400 billion long-term refinancing operation (LTRO) to aid bank lending

The ECB stopped short of QE but did not rule out the idea in the future. The central bank is hoping to stimulate bank lending which in turn should promote growth throughout the region. The EU is anticipating that some of this growth comes from a weakening Euro. A weaker currency would encourage tourism and make EU products cheaper abroad.

Working for the Weekend

We would be remiss if we didn’t at least mention the monthly jobs report that comes out the first Friday of the month. We have pointed out to readers that it is probably the most important report for understanding the durability of the recovery and the mood of the American consumer.

At this point in the cycle, we are also starting to look at the monthly jobs report for an additional source of insight about inflation. Wage inflation is a precursor to overall inflation in the economy. Wages in the U.S. have started to rise, albeit slowly. For the month of May average hourly earnings increased 2.4 percent year-over-year. While that is not a level that we would deem inflationary, wages in certain sectors are accelerating.

Takeaways for the Week

• Equity markets around the world responded positively to the new round of policies announced by the ECB this week
• Job growth of 217,000 was not enough to trigger sharp wage inflation in the month of May

¹Source: Barron’s

Disclosures