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STA Weekly Report – US Stocks Under Pressure Amid Tensions with North Korea

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INSIDE THIS EDITION:
Featured: Hurricane Harvey Help
Harvey Update
Hurricane Irma
North Korea “Begging for War”
Trump Threatens Halting Trade
Fed Accepting Its Assessments Have Been Wrong
Market Internals
What could last week’s jobs report mean for the Fed and Markets?
401k Plan Manager



In this week’s report, our featured article is entitled “Hurricane Harvey Help”.  While Harvey was still showering Houston with unending rain, several journalists from InvestmentNews, CNN Money, and Wealthmanagement.com reached out to us to see how we were looking out for our clients during this time of need and worry. Our Director of Financial Planning, Scott Bishop organized the article with important financial information to assist in decision making in this difficult time.

Hurricane Harvey Help

Friends of STA Wealth, Truett Allen (took picture) and others helping those in need during Hurricane Harvey.

After a disaster like Hurricane Harvey, many struggle with keeping track of finances and things that need to be done.  This is very understandable considering all the decisions that need to be made.  Many of you may be VERY anxious right now and it may seem overwhelming.  To help you get from worry to action, I suggest that you start by writing down all you need to do and then just begin attacking this list one item at a time (writing a list and making progress in the list can be lethargic).  One thing we did at STA Wealth to help our clients and employees was to compile a list of emergency contacts so that they could reach the emergency assistance if needed.

Read Full Hurricane Harvey Help Article Here

If you have any additional questions you can email me directly, Scott@stawealth.com.

-Scott Bishop
Executive VP, Financial Planning

It was a profitable week and month for most of the major stock indexes. Leading the charge last week were Healthcare and Technology issues, while Utilities fell. This week our report highlights several important factors affecting markets including, hurricanes, North Korea, Trade, Federal Reserve and market internals.

Harvey Update

Many in our city and region are now dealing with the aftermath of Hurricane Harvey. Not all, but many, have been able to return to their homes to assess the damage, begin clean-up efforts, and communications with insurance companies and FEMA.

Houston and the region are beginning making progress. Mayor Turner told CBS News that people scheduled to attend a conference, see a concert or attend a sports event shouldn’t alter their plans. The airport was open, the water system was functioning and the electrical grid was sound, he said.

The population at the George R. Brown Convention Center, once a shelter for almost 10,000, fell below 2,000. More than 50,000 flooding evacuees had moved into FEMA-sponsored hotel rooms.

Several suburban school districts scheduled classes for Tuesday, although Houston was waiting until Sept. 11 to greet its 200,000-plus students.

The evacuation order around the Arkema chemical plant in Crosby was lifted. The plant was flooded and lost power last week, causing some chemical canisters to burn. Most have burned out and the area is safe, the company said Monday.

There have been lives claimed, and many tears over the devastation of the storm. However, the outpouring of help from those in the region is amazing. From those trailering boats and rescuing victims to volunteers lining up to bring badly needed supplies and aid has been very encouraging.

Hurricane Irma

It is difficult to believe that the U.S. has another hurricane to contend with so soon after Hurricane Harvey, but Hurricane Irma strengthened into a highly dangerous Category 5 storm today. The storm is barreling toward the Caribbean and the southern United States, threatening deadly winds, storm surges and flooding as Texas and Louisiana are still reeling from devastating Hurricane Harvey.

Irma has now marked a serious milestone, becoming the strongest hurricane in the Atlantic basin outside of the Caribbean Sea & Gulf of Mexico in NHC records.

Hurricane Irma is already causing insurance stocks to plunge. Shares of Homeowners Choice, Universal Insurance Holdings and Heritage Insurance Holdings were down by double digits. Reinsurers XL Group and Everest contributed some of the largest losses to the S&P 500’s decline, down 4.3 and 3.7 percent respectively.

While Irma is still a few days off the United States coast, many are bracing for storm surges, flooding and deadly winds.

North Korea “Begging for War”

South Korea warned that North Korea appears to be preparing to test another intercontinental ballistic missile, and the U.S. told the United Nations that the regime is “begging for war” after Pyongyang on Sunday set off its most powerful nuclear bomb yet.

In a televised statement, North Korea described the underground explosion, which triggered a large earthquake, as a “perfect success in the test of a hydrogen bomb for an ICBM.” Pyongyang said “the creditability of the operation of the nuclear warhead is fully guaranteed.”

The test came just hours after leader Kim Jong Un showed off what he described as a hydrogen bomb capable of being mounted on an intercontinental ballistic missile.  Geopolitical risks are difficult to predict and outcomes are unknown, but they are very real. The markets do not seem that concerned…yet.

Trump Threatens Halting Trade

President Donald Trump’s stern warning that the U.S. may halt trade with countries doing business with North Korea was seen as a direct shot at China, the regime’s biggest trading partner. But China is America’s largest single trading partner as well, highlighting how difficult it would be for the Trump administration to follow through on its threat.

China’s goods and services trade with the U.S., meanwhile, totaled nearly $650 billion in 2016. China produced more than one-fifth of the total goods the U.S. imports, from cellphones and computers to furniture and footwear. After Canada and Mexico, China is the U.S.’s third-largest goods export market, which totaled nearly $170 billion in 2016. Top American exports to China include airplanes and helicopters.

Because the trade volume is so heavy, severely restricting trade with China would be nearly impossible to implement without wreaking havoc on the U.S. economy. Therefore, we believe the threat is not that credible.

Fed Accepting its Assessments Have Been Wrong

The Federal Reserve appears ready to accept that its inflation assessments have been wrong, indicating an important shift in how it will approach rate hikes ahead.

In a speech Tuesday, Fed Governor Lael Brainard said the long-standing assessment at the central bank that persistently low inflation is the result of transitory factors that eventually will pass does not add up considering current circumstances.

As a result, she said, policymakers should reconsider the current path they expect for future rate hikes.

“I am concerned that the recent low readings for inflation may be driven by depressed underlying inflation, which would imply a more persistent shortfall in inflation from our objective,” Brainard told the Economic Club in New York. “In that case, it would be prudent to raise the federal funds rate more gradually.”

Brainard’s comments are important because she is considered a close ideological ally of Fed Chair Janet Yellen.  While Yellen herself has indicated that the end of the rate-hiking cycle could be near, she and her fellow Federal Open Market Committee members have stood by the belief that inflation ultimately will gravitate toward their 2 percent target.

Tuesday’s speech challenges that notion.

Specifically, Brainard pointed to the current low unemployment rate — 4.4 percent — and compared it to the last time the economy was around “full employment” from 2004 to 2007. During that run, inflation averaged about 2.2 percent. Currently, the three-year average is 1.5 percent.

Market Internals

What has made the rally over the last month so interesting and perhaps dangerous, is the lack of support by market internals. Over the last five weeks, more stocks declined than advanced on both the New York Stock Exchange (NYSE) and the NASDAQ. Further, during the last four weeks, more stocks set 52-week lows than highs. For a market flirting with new record highs, these internals are disquieting.

The S&P 500 has been trading around the 50-day moving average (2,450) for the last couple of weeks now. As discussed in last week’s report, the index briefly broke below the 100-day moving average (2,421) for the first time since the election.

Overall, we continue to suggest caution for stock investors. Generally, this is a time for most to be somewhat risk-adverse and not hold too many assets in stocks. Although prices can go higher, risk levels suggest a more cautious path may be prudent.

What could last week’s jobs report mean for the Fed and Markets?

Heading into the August payrolls report, economists projected that the economy added approximately 180,000 jobs while the unemployment rate was likely to remain at 4.3%. Additionally, average hourly wages were expected to increase 2.6%. History would have told you that these estimates were likely to be missed as August payroll data is notorious for coming in below expectations. In fact, the last time the August payrolls report beat expectations was in 2010 – that’s six straight years of missing consensus estimates. After Friday’s report, it is now seven straight years of disappointment. The official print showed U.S. August Payrolls rising only 156,000 which resulted in a 0.1% uptick in the unemployment rate to 4.4%.

*Click to Enlarge

The key takeaway is that the labor market remains on generally solid footing. In fact, through July, only two states (Wyoming and Kansas) have seen no job growth. For those wondering, Texas had the third highest job growth at 2.17%. This is certainly a positive trend.

*Click to Enlarge

We also note strength from the manufacturing sector as manufacturing payroll data showed an increase of 36,000, which is the strongest monthly change since 2014.

Click to Enlarge

That’s the good news.

The bad news is that we also had negative revisions from the prior two months which pushed nonfarm payrolls lower by 41,000. More importantly however was the disappointment we saw on the wage front, an area that investors need to pay close attention to.

Average hourly earnings growth eroded from 0.3% in the prior month to merely 0.1% this month. Although still positive, we think it is this weakness in wage growth that could imperil the Federal Reserve’s plans to lift rates further. It appears that investors seem to agree with us as the likelihood of a rate hike following the jobs report declined following the payroll report on Friday.

The Fed has a dual mandate to maximize employment and stabilize prices. With an unemployment rate of 4.4%, the Fed appears to have met its first mandate. But wage growth remains weak, and we think this will make the Fed’s inflation target of 2% difficult to reach.

*Click to Enlarge Source: STA Wealth Management, Bloomberg

So, what does this mean for markets?

As we have already stated, the report may push the Fed to take a more dovish stance. We certainly believe it will and now don’t expect a rate hike until 2018. This echoes what we see in the current implied probabilities for a rate hike in the table below. A September hike looks to be completely off the table with merely a 0.6% probability, November looks in doubt with a probability of 1.4%, and even December looks suspect with a 32.8% chance. In fact, we really don’t see the implied probabilities jump higher until June of 2018.

*Click to Enlarge

Source: STA Wealth Management, Bloomberg

If this interest rate forecast holds true, then we could see pressure on both interest rates and the US dollar. We already got a glimpse of this as you will see in the chart below. The vertical dotted blue line marks the release of the August payroll report. In the red oval you will note the dollar’s fall immediately following the release.

*Click to Enlarge

Of course, there could be offsetting circumstances, including a changing timeline for Eurozone quantitative tapering. In fact, we got one of these offsets as ECB comments related to tapering were released on Friday.

All else equal though, we believe this environment could lead to additional risk taking as longer-lasting policy accommodation might be a welcome development for investors in stocks. Additionally, a lower for longer interest rate environment could also provide a boost to fixed income securities whose prices could move higher with continued low interest rates.

While we view it as unlikely, the Fed may choose to interpret economic data in a way that justifies raising rates again this year in a bid to further normalize interest rates. This simply means that anything can happen and risks remain. As a result, investors should remain nimble and focus on ensuring that they have a well-designed risk management discipline as it could be key to safely navigating through any surprises markets may throw at them.

Weekly Snapshot of Global Asset Class Performance

*Click to Enlarge

 

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer
Mike Smith, President
Andrei Costas, Senior Investment Analyst (Equity Strategies)
Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

 


Disclaimer: Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA Wealth Management, LLC. Please remember to contact STA Wealth Management, LLC, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. STA Wealth Management, LLC is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice. A copy of the STA Wealth Management, LLC’s current written disclosure statement discussing our advisory services and fees continues to remain available upon request.

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