This commentary was excerpted from the Weekly Roundup sent to subscribers of Action Alerts PLUS, a charitable trust co-managed by Jim Cramer and the AAP staff. Click here to learn about this actively traded stock portfolio.
Markets pushed higher this week despite several potentially market shaking events early on, including hurricane Harvey and the launching of another missile by North Korea on Monday night. While the North Korean projectile traveled over Japan before thankfully, landing in the Pacific Ocean, Japan's prime minister, Shinzo Abe, called it an "unprecedented, serious and significant threat," a sentiment markets reflected in early trading on Tuesday. Later in the week, markets bounced back as we received several key macroeconomic reports including the second reading on GDP for 2Q17 on Wednesday and the always important monthly jobs report on Friday (more below). Lastly, as a reminder, the U.S. markets will be closed for Labor Day, on Monday next week.
Treasury yields trended lower as investors sought safety in the bond market due to hurricane Harvey and geopolitical unrest regarding North Korea, however, we did see some relief on Friday on the back of a better than expected ISM manufacturing report. Gold also pushed higher on the flight to safety, reaching the its highest levels of the year. The euro declined relative to the dollar despite reaching a 2.5 year high on Tuesday. Lastly, oil ended the week flat to slightly lower as hurricane Harvey caused a shutdown of many refineries in the Gulf Coast, causing a decrease in the demand for crude (more below).
Second-quarter earnings are officially in the books and have been largely positive versus expectations.
Turning to the economic front, much of Monday's market action revolved around assessing the damage caused by Hurricane Harvey. Among the hardest hit by the weekend's events was the already beaten down energy sector, as the hurricane prevented Permian producers (think Cimarex (XEC) and Apache (APA) ) from exporting crude out of the Permian to the Corpus Christi-Houston region, the location of about one-third of U.S. oil refineries and over 15% of domestic oil production. The refineries' limited capacity also decreased the demand for crude, sending the commodity lower earlier in the week. Also affected were the airlines (including Southwest (LUV) ) as flooding caused Houston airport operations to close for several days until conditions improved.
Moving to Tuesday, while trading continued to be affected by the hurricane, the turmoil was compounded by Monday night's North Korean missile launch, which sent markets lower in after-hours trading on Monday, a move that carried over into Tuesday morning trading (which the market later viewed as a non-event). In response to the launch, President Trump released a statement in which he said that "all options are on the table for North Korea." However, as has become the new normal, markets ultimately shrugged off the news as the week went on and resumed their push higher.
On Wednesday, the Bureau of Economic Analysis reported (in its second reading) that real GDP (GDP adjusted for inflation) increased at an annual rate of 3.0% in 2Q17, revised up from 2.6% previously reported and above expectations for an upwards revision to 2.7%. This comes off the heels of 1.2% in 1Q17. Recall that GDP is our best gauge for economic growth. The revision was based on a more complete set of data and was aided by better than previously estimated readings in personal consumption expenditure (the largest component of GDP), nonresidential fixed investment. However, these positive results were partially offset by a downward revision in state and local government spending. With this, GDP for the first half of the year is estimated to have grown at a rate of 2.1%, up from 1.9% based on the advanced 2Q17 reading reported last month.
As we've mentioned previously, the Commerce Department releases quarterly GDP numbers three times as new data comes in, allowing for a more accurate reading each time. The next reading will be released on September 28th.
Moving to Thursday, the Commerce Department reported that month-over-month personal income rose 0.4% (or $65.6 billion) in July, edging out expectations of a 0.3% increase. Personal consumption expenditures (PCE) -- i.e., personal spending (over two-thirds of U.S. economic activity) -- increased 0.3% (or $44.7 billion) month-over-month, falling just short of estimates for a 0.4% rise. Additionally, the monthly increase for personal spending in June was revised up from 0.1% to 0.2%.
The rise in personal income resulted primarily from an increase in wages, salaries and personal income receipts on assets. The rise in personal consumption can be attributed to an $18.7 billion increase in spending for goods (primarily on furnishings and durable household equipment) and an $11.8 billion increase in spending on services (primarily on food services and accommodations).
Importantly, the PCE price index rose 0.1% in July, following a flat June reading and 0.1% decline in May.
Core PCE (which takes out food and energy to reduce month-to-month volatility) also rose 0.1% in June (following a 0.1% increase in both June and May), in line with expectations. More importantly, on a year-over-year basis, the core PCE price index is up 1.4% (down from a 1.5% year-over-year rise in June and May). This measure is closely followed given that it represents the Fed's preferred measure of inflation, which is one portion of the Fed's dual mandate when determining the outlook for rates (the other being maximizing employment).
Recall that the Fed ideally targets a 2% rate of inflation -- the core PCE has generally run below this target in recent years, and despite some strength in prior months, including the 3.0% 2Q17 reading mentioned above, investors must balance additional rate hike expectations this year against the declines in core PCE in recent months.
Also on Thursday, the National Association of Realtors (NAR) reported that pending home sales index in July fell 0.8% to 109.1, well short of expectations for a 0.6% increase and marking the fourth drop in the past five months. Recall that the pending home sales number represents contracts signed for existing homes for sale that will close in the next one to two months. In addition to the decline, the NAR downwardly revised June's reading to 110.0, from 110.2 previously reported. On a year-over-year basis, pending home sales are down 1.3%, the third decline on annual basis in the past four months.
As has been the case in past months, the reading was again impacted by a lack of supply, which is now 9.0% lower on annual basis and has decreased for 26 consecutive months. As we've pointed out previously, the lack of supply continues to be an issue in the overall housing market and is causing upward pressure on the price of homes, with the national median existing-home price expected to rise roughly 5% this year, after a 5.1% rise in 2016.
According to NAR chief economist, Lawrence Yun, "the housing market remains stuck in a holding pattern with little signs of breaking through. The pace of new listings is not catching up with what's being sold at an astonishingly fast pace." He went on to state that, "the combination of weaker contract signings and the expected pause in activity in the Houston region because of Hurricane Harvey will likely slow overall sales growth in coming months."
By region, on a month-over-month basis, pending home sales fell slightly in the Northeast (-0.3%), Midwest (-0.7%) and South (-1.7%), while rising marginally in the West (0.6%). Annually, sales have increased in the Northeast (2.4%), while falling in the South (-0.2%), Midwest (-2.8%) and West (-4.0%).
As for jobs, on Thursday, the Department of Labor reported that initial jobless claims for the week ending August 30 were 236,000, an increase of 1,000 claims from the prior week's revised level (revised up from 234,000 to 235,000) and 1,000 claims below expectations of 237,000 initial claims. Importantly, the four-week moving average for claims (used as a gauge to offset volatility in the weekly numbers) was 236,750, a decrease of 1,250 from last week's revised average (revised up from 237,750 to 238,000). The low rate of layoffs reflects a strengthening labor market as claims have remained below 300,000 -- the threshold typically used to categorize a healthy jobs market - for an incredible 130 consecutive weeks, the longest streak since 1970.
Finally, on Friday, the Labor Department reported that the economy added 156,000 jobs in August, missing expectations of 180,000. Employment numbers were also revised down for June to 210,000 (from 231,000 previously reported), and for July to 189,000 (from 209,000 previously reported). Job gains now average 185,000 a month for the last three months. Unfortunately, the poorer-than-expected release appears to back our belief that the Fed will not raise rates again before the end of the year.
The unemployment rate bumped up slightly to 4.4%, just missing expectations for a flat monthly reading at 4.3%. Following a decline earlier in the year, unemployment has bounced between 4.3% and 4.4% since April.
In line with the steady unemployment rate, labor-force participation was unchanged in August at 62.9%. The low participation rate continues to suggest that many able-bodied Americans are remaining on the sidelines despite what appears to be growing optimism within the economy.
Digging deeper, job gains were led by the manufacturing industry, which added 36,000 new jobs last month, followed by an additional 28,000 jobs added in the construction industry. We also saw gains in professional and technical services, which added 22,000 jobs in August and in health care, adding 20,000 jobs last month.
Average hourly wages are up roughly 2.5% on a yearly basis, relatively unchanged from July's year-over-year rise, while the average workweek ticked up 0.1 hours from the same time last year to 34.4 hours. Month-over-month, the average workweek declined 0.1 hours from 34.5 hours in July.
For those skeptical of the headline measure of unemployment (for reasons such as the decline in the labor-force participation rate), a different, broad measure of unemployment and underemployment known as the U-6 -- which accounts for those working part time due to the inability to find full-time work -- was 8.6% in August, unchanged from June and July. The U-6 had averaged around 8.3% in the years before the recession.
Overall, while the report was negative, it was largely shrugged off by the market in Friday trading.
Wrapping up the week, we also heard from the Institute of Supply Management (ISM) on Friday when it reported that manufacturing index jumped 2.5% in August to 58.8%, exceeding expectations of 56.3%. Recall that anything above 50 represents expansion while anything below 50 indicates a contraction. The rise comes on the heels of July's 56.3% reading, and marks the fastest rate of growth for American manufacturers in roughly six years. August marked the 99th consecutive month of expansion in the overall economy and the 12th in the manufacturing sector.
Digging deeper, of the 18 manufacturing industries tracked by ISM, 14 showed growth in August led by Textile Mills; Petroleum & Coal Products; and Machinery. Apparel, Leather & Allied Products; Primary Metals; and Furniture & Related Products were the only three to indicate a contraction.
The new-orders index fell 0.1% month over month to 60.3% (indicating a slightly slower rate of growth) while production increased 0.4% to 61.0%, accelerating in August after a slowdown in July. The employment index also jumped, rising 4.7% to 59.9%, while prices remained flat at 62%.
On the commodity front, oil was heavily affected early in the week because of Hurricane Harvey slamming into the Gulf Coast region of Texas, causing a complete shutdown of operations in the region. As reminder, located in this region is the energy exporting port of Corpus Christi as well as nearly one-third of U.S. refining capacity and over 15% of U.S. oil production capabilities. As a result, upstream exploration and production (E&P) companies in the Permian (such as Cimarex and Apache) were limited in their ability to transport crude (via midstream transport companies such as Magellan Midstream Partners MMP) to the region for refining and export. In addition, reduction in refinery capacity weakened the demand for crude due to the decreased capacity to refine oil. This lack of crude demand pressured both commodity prices and the stocks of upstream (E&P) and midstream (transport) companies as a result. On the other hand, with a reduction in possible crude refinement into gasoline, gas prices spiked due to an increase in demand. On a brighter note (for investors but not so much for those looking to fill up their car this weekend), we did get a brief rally later in the week as gas futures surged even higher Thursday on reports that Motiva Enterprises' Port Arthur refinery, the largest refinery in Texas, could be closed for as long as two weeks, indicating more supply shortages to come. While the news initially pulled crude up with it, much of the gains were given back heading into the weekend as the refinery closure may indicate a longer than expected decline in crude demand for refinement.
Moving on to the broader market, second-quarter earnings are nearly complete and have been relatively positive vs. expectations, with 72% of companies reporting a positive EPS surprise. Total second-quarter earnings growth increased roughly 11.2% year over year vs. expectations for an overall 10.74% increase throughout the season; of the 431 non-financials that reported, earnings growth is up 11.8%. Revenues are up 4.9% vs. expectations throughout the season for a 5.08% increase; 72% of companies beat EPS expectations, 18.5% missed the mark and 9.5% were in line with consensus. On a year-over-year comparison basis, 75.45% beat the prior year's EPS results, 22.33% came up short and 2.21% were virtually in line. Healthcare and information tech have had the strongest performance vs. estimates, whereas consumer staples, telecom and energy have posted the worst results in the S&P 500 for the second quarter.