The markets continued to trek higher following the Brexit bounce in late June. All of the major indices posted solid gains during the month, with the S&P posting a 3.52% positive gain. US Q2 GDP was released at month-end and posted a meager +1.20%. We were very surprised since we actually expected a strong GDP report powered by consumer spending which makes up roughly 70% of the economy. While consumption was strong, investment fell -1.20% and government expenditures fell for the first time since Q4 2014. The biggest surprise was the GDP deflator which went from +.50% to +2.20% (a delta of +1.70%) which caused GDP to fall to 1.20% instead of being 2.90%. The GDP deflator is what the Fed believes inflation is during a quarter so they can show true gains in the economy. If the Fed used 2.20% in Q1, we would have had a negative GDP for the first time in a long time. It’s quite possible the Fed is playing games. Lets face it, if GDP printed +2.90%, they would have felt pressure to raise rates which I would argue is a very bad thing right now. By increasing the deflator to 2.20% (which is probably accurate although last quarter should have been higher also) and GDP being at +1.20% for Q2, they are in a position to continue their dovish rhetoric. In case you weren’t counting, the Fed has changed their tone 5 times since December when they raised rates. They’ve gone from hawkish (December starting point) to dovish to hawkish to dovish to hawkish and now back to dovish!
Also released around the same time as GDP, durable goods declined -4.60% MoM and -6.40% YoY. Durable goods are goods not used for immediate consumption (appliances, cars, boats, etc.). Capital goods did increase to +.20% MoM but registered a -3.70% YoY decline, extending its epic run of negative growth to 17 of the last 18 months. Capital goods are goods used in producing other goods. Needless to say, these are not strong numbers and indicate growth slowing. Luxury goods consumption has also been falling dramatically since since beginning of the year. It’s important since estimates on the impact of the wealthy on consumer spending put the share of consumer outlays by the top quintile at greater than 40%.
There has been a few folks who’ve stated central banks are not allowing stock markets to correct, which in turn creates bigger problems. Check out this chart which shows direct and indirect interventions through mid-July by global bankers.
GMO released its 7 year asset class real return forecasts and it doesn’t bode well. As you can see, there aren’t many asset classes that they’re forecasting to have a positive real return. For US pension funds and pensioners, they are crossing their fingers that GMO is wrong. According to a recent study, pension funds are estimating their returns going forward will be high single digits.
Internationally, there’s been a lot of attention on Italian banks since a large % of the loans on their balance sheets are non-performing (more details about Italian banks in this blog post). The troubled Italian bank Monte dei Paschi di Siena (“MPS”) arranged a last-minute sale of its bad loans just as the ECB stress test results were released. However, while MPS’s shares were up, other Italian/Eurozone banks, such as UniCredit, tumbled. MPS’s deal puts a public price on a very large pool of bad loans that will be hard for others to ignore. Officially, the price is 33% of face value or €9.2 billion for a portfolio of €27.7 billion of bad loans. In reality the way the deal was structured, the price was closer to 27% which means more losses and write-downs to come. Check out the chart below which shows banks non-performing loans as a % to total loans.
And lastly, please enjoy this Star Wars intro parody, The Fed Awakens.
As always, please contact us if you have any questions.
CEO & Founder, Proper Wealth Management