Growth Accelerates In The Third Quarter, Again

ECONOMIC DATA

Economic reports received in November, which mostly reflect economic activity in October and early November, generally exceeded expectations, as reports on manufacturing, consumer activity, and the housing market were all notably better than expected. While not as timely as the data for October and November, the revised estimate of 2016 third quarter gross domestic product growth (GDP), released on November 25, surprised to the upside, accelerating to 3.2% annualized growth from 1.4% in the second quarter, above economists’ consensus expectations of 3.0% and solidly above the initial reading of 2.9%. Despite the pickup in GDP, growth remains at a tepid 1.6% year over year.

Aside from the better than expected (and upwardly revised) 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 is now accelerating after a nearly two year slump related to falling oil prices. Many of the regional Federal Reserve (Fed) surveys on manufacturing also exceeded expectations in November, including the Dallas Fed’s index, which is heavily dependent on oil and energy. Readings released on consumer spending in October also came in better than expected, notably the 17.9 million sales pace for light vehicles and the 0.8% increase in core retail sales.

However, despite the better than expected tone of the data released in November, not all the data exceeded expectations. Noteworthy disappointments included payroll employment, inventories, home sales, and construction spending. Remarkably — despite the rancor surrounding the presidential election — consumer sentiment exceeded expectations in November and improved from October.

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Camden Capital Wealth ManagementWith the modest bounce in economic reports continuing in November, 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 0.1% month over month, but decelerated slightly year over year from 1.5% in September to +1.1% in October. 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.

Although the reports released in October largely matched expectations, inflation as measured by the Consumer Price Index (CPI) continued to accelerate, from a 1.5% year-over-year gain in September to 1.6% in October. Wages also continued to accelerate, as the year-over-year increase in average hourly earnings (a timely gauge of wage pressures) accelerated from +2.7% year over year to +2.8% in October, the highest reading in seven years.

CENTRAL BANKS

The Federal Reserve (Fed) met early in November and while they didn’t raise rates, the discussion at the meeting (as found in the meeting minutes released in mid-November) suggested that the Fed remained on track to raise rates in December. At the start of November 2016, the odds of a Fed rate hike at the December 2016 FOMC meeting stood at around 75%, but by the end of the month, markets were placing the odds of a December hike at 100%. Overseas, the Bank of England was the only major central bank to meet, as policymakers there continued to weigh the consequences of the U.K.’s vote in June 2016 to leave the European Union.

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.

GLOBAL EQUITIES: TRUMP VICTORY AND STOCK MARKET RALLY BROUGHT TWO SURPRISES IN NOVEMBER

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U.S

Stocks rebounded from a down October to the S&P 500 posting a 3.7% return in November, the best monthly performance since March of 2016. Improving economic conditions played a role in the strength, but the biggest driver was potential pro-growth policies under a Trump presidency with Republican control of Congress, including tax reform, infrastructure spending, and less regulation. Stocks proved resilient to several risks, including U.S. and European political uncertainty, rising interest rates, and a strong U.S. dollar. November’s gains brought the S&P 500 year-to-date return to 9.8%. Election impacts were evident in the moves of politically sensitive groups. On the plus side, financials (+13.9%) surged on rising interest rates and a steeper yield curve, good for lenders, and prospects for less regulation; and industrials (+8.8%) rallied on prospects for more infrastructure spending. Conversely, emerging markets (EM) fell on risk of protectionist U.S. trade policy, exacerbated by currency weakness; rising interest rates hurt dividend-focused investments; and healthcare, after a brief post-election rally, underperformed due in part to uncertainty around the future of the Affordable Care Act.

The month was not all about the election, as stock and bond investors continued to watch the Fed closely ahead of the central bank’s next policy meeting in December where a hike is widely expected. The earnings recession officially came to an end as third quarter 2016 earnings gains were cemented. And oil got a lot of headlines, taking markets on a dizzying ride as mixed signals out of OPEC throughout the month culminated in an agreement to cut production on November 30, fueling a 9% rally in crude oil prices.

Beyond the election theme, more economically sensitive sectors continued their run of outperformance in November, consistent with improving economic conditions, as cyclicals outperformed defensives for the fth straight month. The impact of rising interest rates was clear, with financials, a beneficiary of higher rates, topping the sector rankings while the most interest rate sensitive sectors such as real estate, utilities, and consumer staples all suffered losses. Energy was another big winner, gaining 8.4% for the month thanks in large part to the rally on the OPEC agreement at the end of the month.

Value outperformed growth in November due primarily to the strong performance from financials and energy, the two biggest value sectors, and technology sector underperformance. Value has also historically fared well when economic growth and earnings growth are accelerating, as occurred the past two months based on data received in October and November. In terms of market cap, small caps were a standout performer to the upside due to prospects for tax reform, as tax cuts bene t more domestically focused companies with higher tax rates than their larger, more global counterparts. Smaller companies are also generally less impacted by trade policy.

INTERNATIONAL

International equity markets lagged that of U.S. markets during November, as the MSCI EAFE Index for developed international markets lost 2.0% for the month and the MSCI Emerging Markets (EM) Index slid 4.6%. It has still been a good 2016 for EM equity investors, with the MSCI EM Index having returned 11.3% year to date, slightly ahead of the S&P 500, and well ahead of the 1.9% year-to-date loss for developed international equities.

The biggest story in international equity markets, as in the U.S., was the U.S. election. Fears of a possible trade war weighed on EM as President- elect Trump has stated his desire to redo trade agreements to promote better deals for the U.S. Accordingly, it was no surprise that Mexico, with its 12.7% loss, was one of the worst EM country performers in November. EM also faces increased headwinds from a potentially faster pace of Fed rate hikes and rising interest rates, which are pushing the dollar higher. These headwinds more than offset the benefits of better economic data in China, an improving EM earnings outlook, and commodity price stability. Buoyed by oil, Russia was among the top performing EM countries for the month, while Turkey and Egypt fell most.

Foreign developed market returns were also hurt by the strong U.S. dollar, as well as uncertainty ahead of the December 4, 2016, constitutional referendum in Italy that may lead to a regime change and increased pressure on the Eurozone structure. Selling pressure was more pronounced in Europe—Germany, Italy, and Spain in particular—while Asia-Paci c markets generally held up better, including Singapore and Australia. The United Kingdom also produced a modest gain for the month as its economy has largely shrugged off its pending separation from the European Union.

FIXED INCOME: RATES RISE ACROSS THE CURVE

Camden Capital Wealth ManagementThe yield curve steepened in November, with interest rates rising dramatically across the yield curve. The 2-year Treasury rose by 0.25% and the yield on the 10-year Treasury rising by 0.53%. The increase in rates came as markets digested the surprise presidential victory of Donald Trump. His calls for fiscal stimulus, in addition to concerns of rising Treasury supply to fund that stimulus, drove a strong pickup in inflation and growth expectations. Short-term interest rates were pushed higher by market confidence that the Fed will raise the federal funds rate during its December meeting. Trump’s pro-growth policies, if they come to fruition, would likely lead the Fed to be more aggressive than they otherwise would have with the pace of rate hikes. This put additional upward pressure on shorter-term Treasury yields.

The rise in yields across the maturity spectrum was a headwind for high-quality fixed income. The broad Barclays Aggregate Bond Index returned -2.4% during the month, its worst monthly total return ever (data going back to 1976). The aforementioned rise in inflation expectations was a slight tailwind for TIPS, which returned -1.9% on the month, outperforming Treasuries, which returned -2.7%. Municipals were weighed down on supply concerns and weakening demand, leading to a -2.7% return during November.

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 bene t for bank loans, returning 0.2% during November. Emerging market debt fell 4.6% during the month amid concerns of the impact of trump’s protectionist trade policies on emerging markets (EM). The dollar drove 3.2% higher during the month, hurting unhedged foreign bonds, which returned -5.7% amid globally rising rates. The long duration of preferreds was a headwind, leading it to a -4.2% return on the month.

ALTERNATIVES: MACRO STRATEGIES STRUGGLE POST-ELECTION

Camden Capital Wealth ManagementFollowing the November 8, election results, equity markets underwent a sharp sector rotation, with capital ows favoring economically sensitive names, at the expense of more defensive sectors such as utilities and consumer staples. This market development impacted hedged equity performance in several manners. While domestic risk assets delivered a broad based rebound, strategies favoring small cap value, as well as financial and industrial exposure delivered the strongest returns. However, given the rally’s breadth, these gains were partially offset with losses from short positions that also appreciated in price during the month. Overall, the HFRX Equity Hedge Index gained 1.5% with a beta of 0.4, as compared to the 3.7% gain of the S&P 500. Distressed debt strategies also bene ted from the post-election optimism, as the HFRX Distressed Debt Index gained 1.8%, bringing year-to-date returns to 17.5%. Barring any steep declines in December, the index has the potential to deliver the best annual performance since 2003.

Discretionary macro strategies ended up on the negative side of November’s market rotation, as the HFRX Macro Index declined 0.7%. Long foreign equity positioning, specifically in Latin America, as well as any non-long U.S. dollar exposure detracted from portfolio performance. Within currency allocations, losses stemming from long yen versus the U.S. dollar were particularly sharp as the yen declined over 8% against the dollar, paring the yen’s year-to-date strength.

Managed Futures also experienced weak returns following the election, as the HFRX Systematic Diversified Index declined 0.3%. The backup in Treasury rates weighed meaningfully on portfolio returns, as the rate on the U.S. 10-Year note increased to 2.37% from 1.84%, resulting in losses from long futures positioning.

RISK-ON RALLY LEAVES MIXED RESULTS FOR REAL ASSETS

Camden Capital Wealth ManagementReal asset prices were mixed in November as the U.S. election and OPEC dominated headlines. The U.S. dollar rallied with the trade–weighted index up 3.2% as 10-year Treasury rates rose from 1.84% at the end of October to 2.37% at the end of November.

MLPs & Global Listed Infrastructure

News ow in November was all about OPEC as the cartel held a meeting on the last day of the month to agree upon upcoming production cuts. Master limited partnerships (MLPs) rallied with the bullish outcome to end the month up 2.3%, as measured by the Alerian MLP Index. The U.S. election results also undoubtedly had a positive impact on MLPs as the incoming administration promises to be much more energy-friendly and lax on regulations compared to the government’s current stance. This bodes well for growth prospects for pipelines. The potential for tax reform could impact the asset class, but chances are relatively slim. The asset class remains attractively valued as the index is yielding greater than 7.5%.

Global listed infrastructure, as measured by the S&P Global Infrastructure Index, returned -4.1% leaving year-to-date returns just above 9%.

REITs

Real estate investment trusts (REITs) were impacted by rising rates leading to a -1.7% return for the MSCI US REIT Index. Hotel REITs outperformed the index as investors expect this segment of the market to bene t from a higher growth environment. As long as rates continue to rise, the asset class will be facing a significant headwind.

Commodities

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%.

WTI crude oil prices rose 5.5% for the month, turning positive on the final day of November. The main story in oil was the agreement by OPEC to cut oil production by 1.2 million barrels per day. Non-OPEC nations, including Russia, agreed to a preliminary cut of 600,000 barrels per day. Prices were volatile throughout the month as the market assessed the likelihood of an agreement. Grains in particular gave up ground leading to a return of -2.9% for the Bloomberg Agriculture Subindex. Gold and silver were heavily impacted by the stronger dollar and higher interest rates, with gold down 8.0% and silver down 7.8% on the month respectively. Industrial metals responded to the perceived potential for fiscal stimulus as copper prices rose 18.9% reaching their highest level since mid-2015.

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IMPORTANT DISCLOSURE INFORMATION

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.