Growth Accelerates In The Third Quarter


Economic reports received in October, which mostly reflect economic activity in September, generally showed some bounce back after disappointing data last month. While not as timely, the first estimate of 2016 third quarter gross domestic product growth (GDP), released on October 28, surprised to the upside, accelerating to 2.9% annualized growth from 1.4% in the second quarter, above economists’ consensus expectations of 2.6% and well ahead of Federal Reserve (Fed) NowCast Models of 2.1% (Atlanta Fed) and 2.2% (the New York Fed). Despite the pickup in GDP, growth remains at a tepid 1.5% year over year.

Consumer spending, the largest component of GDP, had a subpar third quarter, partly as payback for a surge in growth in the second quarter, but two components that haven’t been strong contributors to GDP growth over the last several years still helped push GDP ahead of expectations. Net exports made its largest contribution to GDP growth in over 10 quarters, and inventory build made a positive contribution to GDP growth for the first time since the first quarter of 2015. While the inventory component tends to be mean reverting, the reading this quarter was more likely a response to more than a year of negative contributions to growth and may not weigh on the fourth quarter

Aside from the better than expected reading on third quarter GDP, the month’s economic releases were highlighted by improving readings in the manufacturing sector (Institute for Supply Management’s [ISM] Purchasing Managers’ Index [PMI] for manufacturing), which continues to stabilize after a nearly 18-month long slump related to falling oil prices. In another sign that stabilizing oil prices are starting to help steady manufacturing, October saw better than expected readings for industrial production and factory orders. Readings released on consumer spending in October also came in better than expected, notably the 17.7 million sales pace for light vehicles and the 0.3% increase in personal spending.

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Camden Capital Wealth ManagementNot all the data exceeded expectations in October however, with notable disappointments in housing starts, employment, average hourly earnings, and importantly, consumer sentiment, which was weighed down by the rancor surrounding the presidential election.

With the modest bounce in economic reports in October, leading economic indicators continued to signal low odds of a recession. The Conference Board’s Leading Economic Index (LEI), an aggregate of economic indicators that tends to lead the overall economy, rose 0.2% month over month and accelerated slightly year over year from 1.1% in August 2016 to 1.5% in September. Historically, when the change in the LEI has been at this level or higher, the economy has been in a recession a year later less than 10% of the time.

On the inflation front, although the reports released in October largely matched expectations, inflation as measured by the Consumer Price Index (CPI) continued to accelerate, from a 1.1% year-over-year gain in August to 1.5% in September.


After a very busy September, October was relatively quiet as meetings by the Bank of Japan (BOJ) and the European Central Bank (ECB) came and went without any changes in policy. The Fed didn’t meet in October, but did release its Beige Book ahead of the November 1–2, 2016 Federal Open Market Committee (FOMC) meeting and the minutes of its September 20–21 meeting. Fed Chair Janet Yellen and Vice Chair Stanley Fischer also each delivered a speech in October. At the start of October 2016, the odds of a Fed rate hike at the December 2016 FOMC meeting stood at just 60%, but by the end of the month, markets were placing the odds of a December hike at over 70%.

Both the BOE and the ECB showed restraint at their September policy meetings, neither central bank reducing rates. With little of the feared economic damage from the Brexit vote manifesting in European economies to date and a broad sense of diminishing returns from further monetary easing, central bank officials were reluctant to step in without further evidence that it was warranted. The BOE did gesture at the possibility of lowering rates in November.


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The S&P 500 lost 1.8% during October, marking its worst month since January of 2016. The upcoming election garnered most of the market’s attention and shoulders much of the blame for the losses, although anxiety surrounding the Fed’s next move, renewed oil weakness, and U.S. dollar strength also weighed on investor sentiment. October ended the six-month stretch that has historically been the worst for the stock market; on average since 1950,* the S&P 500 has been up just 1.4% from May through October, compared with gains of 7.1% from November through April. Stocks bucked this trend this year with a 2.9% advance during this six-month period, bringing the S&P 500 year-to-date return to 5.9%.

The election had an increasing impact on markets in October as the most politically sensitive groups, including financials, healthcare, energy, and trade-sensitive emerging markets (EM) moved with the polls. Although measures of consumer sentiment have reflected investor election anxiety, market participants may have taken some comfort from the historically strong seasonal performance for stocks during the fourth quarter of election years, limiting October weakness.

The pickup in economic growth in the third quarter of 2016, as measured by GDP, failed to provide much of a lift for stocks in October due to election and Fed rate hike fears. Better growth helped drive the rise in interest rates amid increasing inflation expectations. Improved surveys of manufacturing activity also provided evidence of a pickup in economic activity, while helping to buoy market participants’ earnings outlooks. Accordingly, third quarter earnings season got off to a good start, with particularly strong results from the financials and technology sectors.

The more economically sensitive sectors continued their run of outperformance in October, consistent with improving economic conditions. Financials topped the sector rankings and technology outperformed the S&P 500, while the less economically sensitive telecom and healthcare sectors were the biggest laggards.

Financials got a lift from well-received earnings reports and rising interest rates (which helps improve loan profitability), while election-related policy concerns dragged healthcare lower amid the controversy over high drug prices. Utilities managed a small gain and outperformed the S&P 500 despite the more than 20 basis point (0.20%) increase in the 10-year yield during the month, benefiting from its historical below average sensitivity to stock market moves. Energy underperformed as oil prices pulled back amid doubts regarding the Organization of the Petroleum Exporting Countries’ (OPEC) ability to agree to a production freeze and strength in the U.S. dollar.

The strong performance for financials led to value’s outperformance over growth, based on the Russell indexes, despite outperformance by the largest growth sector, technology. Value has also historically fared well when economic growth and earnings growth are accelerating, as is occurring based on data received in October. Performance by market cap was as expected during a down month for stocks: large caps, which tend to be the least market sensitive, held up best, followed by midcaps and then small caps.


International equity market performance was mixed during October. The MSCI EAFE Index for developed international markets slightly trailed the S&P 500 with a 2.0% decline, while the EM benchmark, the MSCI Emerging Markets Index, outpaced the S&P 500 in producing a modest 0.2% gain. Year to date, through October 31, 2016, the MSCI EAFE Index has returned 0.1%, behind the S&P 500’s 5.9% return, while the EM index has produced a very strong 16.6% return.

Foreign developed markets were helped by relative outperformance in Japan, which benefited from weakness in its yen currency, due to continued bold monetary policy initiatives from the Bank of Japan, and the related potential boost to the country’s exporters. Markets in Italy and Spain also held up relatively well. However, weakness in the rest of the continent amid sluggish economic growth and the drag from currency translation as the euro and British pound currencies weakened outweighed those positives. The U.K. and Switzerland markets were particularly weak, despite the rebound in financials stocks during the month.

Emerging markets continued to benefit from expectations that the Fed would take a go-slow approach to interest rate hikes. A firming economic and earnings growth outlook also provided support. Brazil was the top performing equity market during the month as the country started to rebound from political turmoil, whereas Mexico delivered strong gains despite weakness in the peso currency related to the risk of increased protectionism under a possible Trump presidency. South Korea was among the biggest drags on the index, while the energy-driven Russian market managed a slight gain despite oil price weakness during the month. China underperformed the EM benchmark amid lingering concerns about its bad debt problem despite evidence that the overall economy has stabilized.


Camden Capital Wealth ManagementThe yield curve steepened over October, with the yield on the 2-year Treasury rising by 0.09% and the yield on the 10-year Treasury rising by 0.24%. The rise in yield on the 30-year Treasury was more pronounced, increasing by 0.26% during the month, powered by a meaningful pickup in inflation expectations. Positive economic data fueled a rise in growth expectations as well, culminating late in the month with an above-consensus annualized GDP growth reading of 2.9% for the third quarter. Short-term interest rates were pushed higher by increasing expectations that the Fed will raise the fed funds rate during its December meeting.

The rise in yields across the maturity spectrum was a headwind for high-quality fixed income. The broad Barclays Aggregate Bond Index returned -0.8% during the month, its worst monthly total return since June 2015. The aforementioned rise in inflation expectations was a tailwind for Treasury InflationProtected Securities (TIPS), which returned -0.4% on the month, solid outperformance relative to Treasuries, which returned -1.1%.(Based on Barclays U.S Treasury Index.)

The rise in short-term interest rates continued to help drive up Libor (London interbank offered rate), a short-term global benchmark interest rate, which was a benefit for bank loans. Bank loans, which returned 0.7% during October, benefited from higher short-term interest rates because of their adjustable interest rate feature. Despite a 1.9% decline in the price of oil, high-yield valuations continued to richen, as high-yield returned 0.1% during the month. Emerging market debt (EMD) fell 2.0% during the month, succumbing to profit taking, weak oil, and heightened prospects for a Fed rate hike in December. The U.S. dollar jumped 3.1% during the month, hurting unhedged foreign bonds, which returned -4.9 % amid globally rising rates.


Camden Capital Wealth ManagementCompared with the 1.8% decline in the S&P 500, long/short equity managers provided strong downside protection during a volatile month and outperformed the broader equity market by approximately 1.0%. While long exposure struggled, as only the underowned financial sector was positive on the month, managers were able to offset losses with meaningful performance from their short positioning. This was particularly valuable for those strategies shorting small cap names, as the Russell 2000 declined by over 4.0%. Managers in the equity market neutral category were also able to protect capital, as the HFRX Equity Market Neutral Index declined 0.1%, which was slightly higher than their beta adjusted risk profile.

Distressed debt strategies continued their streak of positive returns since this past March, as the HFRX Distressed Debt Index added 1.7%, bringing year-to-date gains to 15.5%. For certain managers, overall portfolio performance was further supported by employing credit index hedges to protect against a backup in rates. Convertible arbitrage managers have also continued to deliver consistent gains since a January drawdown, as the HFRX Convertible Arbitrage delivered a 0.44% gain for the month and has now returned 5.6% for 2016.

As measured by the HFRX Macro: Systematic Diversified Index, managed futures declined 3.74%, the worst month of performance since mid-2015, as the industry’s long exposure to Treasury bond contracts and sovereign rates weighed heavily on returns. For those managers employing short-term trend following models, portfolio declines were marginally supported by participating in the sharp upward price trends in agriculture markets such as coffee, soybeans, and cotton.


Camden Capital Wealth ManagementReal asset returns were weak in October as a strong U.S. dollar hurt prices. The Trade Weighted U.S. Dollar Index was up 3.1% while the Bloomberg Commodity Index slumped by -0.5%. The 10-year Treasury yield rose significantly from 1.60% at the end of September to 1.84% on the last day of October.

MLPs & Global Listed Infrastructure

As oil prices fluctuated throughout the month, master limited partnerships (MLP) were affected dramatically. The Alerian MLP Index ultimately ended down with a return of -4.5%. This came amid an earnings season that was generally favorable for midstream companies. Distributions for the space remain largely intact, with 69 midstream companies having reported upcoming distributions. Of these, 29 announced quarter over quarter increases, 37 announced unchanged distributions, and three announced cuts (two of these three came from two separate entities associated with the same corporate entity). The average quarter-over-quarter change was an increase of 0.49%, with the average yield for the universe now standing above 7.5%.

Global listed infrastructure, as measured by the S&P Global Infrastructure Index, returned -2.6% in October, marking the fourth negative month for the index this year.


Real estate investment trusts (REIT) were hit hard by the impact of rising rates and returned -5.7% for the month. After a stellar first half of the year, the MSCI US REIT Index has had three straight negative months of returns. As a “bond proxy” asset class, returns could continue to be impacted if interest rates continue rising.


WTI crude oil prices fell by 1.9% in October as markets reconsidered the possibility of an OPEC production cut deal. As news leaked out through the month of various OPEC and non-OPEC countries potentially not going along with cutting production, prices fell significantly specifically in the second half of October. A formal vote on production cuts will take place at the end of November. Agricultural commodities were one bright spot in the real assets space as the Bloomberg Commodity Agriculture Subindex increased by 3.1%. Managed money (speculators) raised its net long positioning in the top agricultural commodities to the highest level in three months near the end of October. Industrial metals were largely unchanged save for aluminum, which was up by greater than 4%. Precious metals were also affected by rising interest rates. Gold and silver were volatile with gold ultimately ending up returning -3.2% and silver -8.2%.

Commodity-linked investments may be more volatile and less liquid than the underlying instruments or measures, and their value may be affected by the performance of the overall commodities baskets as well as weather, geopolitical events, and regulatory developments.

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This publication is intended for informational purposes only and contains the opinions of Camden Capital and should not be taken as a recommendation to invest in any asset class or foreign securities market. The information contained in this report is current only as of the earlier of the publishing date and the date on which it is delivered by Camden Capital. All information in this report has been gathered from LPL Financial and sources we believe to be reliable, but we do not guarantee the accuracy or completeness of such information. The economic performance figures displayed herein may have been adversely or favorably impacted by events and economic conditions that will not prevail in the future. Past performance is not indicative of future results. All investments involve risk including the loss of principal.