Monthly Market Commentary – July 2013

The markets went through a lot of turmoil in June, as stronger economic reports were offset by fears of the Fed tapering its bond-buying programs. Home prices, employment reports, and auto sales were all better than expected, unlike trade and GDP data. Together with falling business investment and government employment, that leaves the consumer and housing as the two main engines of economic growth.

Federal Reserve news: Fed statements and a news conference suggested that the economy was stronger than it previously thought, and, as a direct result, bond purchases could be cut back as early as this year and eliminated as early as the middle of 2014, if the economy tracks Fed forecasts and the unemployment rate is around 7%. This, combined with a solid employment report, caused a significant increase in mortgage rates the Friday after Independence Day. For example, 30-year fixed rates climbed into 4.75% territory, with some lenders at 4.875% (according to Mortgage News Daily).

GDP: The third and final revision of first-quarter GDP growth revealed a lower-than-expected 1.8%. The Fed’s outlook for the economy has been remarkably bullish, with forecasted GDP growth for 2013 of 2.3%–2.5%—a little too high, in light of the weak first quarter.

Employment: The June employment report showed growth of 195,000 jobs, similar to the previous three months when all revisions are considered. This number was better than the 12-month average and the consensus estimate of about 160,000 jobs. Year-over-year three-month average data has remained virtually stagnant in the 1.9%–2.1% range for almost a year (2.0% for June). However, the mix of jobs added wasn’t great. The leading categories were leisure/entertainment and retail; manufacturing and government were down. In other words, jobs considered to be higher-quality and better-paying were down, while lower-paying jobs showed most of the growth. Also, health care and education, normally strong sectors, showed about half of their normal growth. The unemployment rate remained unchanged at 7.6%.

Housing: Reported CoreLogic data for May showed that prices increased 12.2% compared with May a year ago, the biggest percentage increase since 2006. This also marks the 15th consecutive monthly increase in prices. These price increases (along with falling gasoline prices) may be behind the jumps in consumer confidence and consumer spending that exceeds income gains. Even higher mortgage rates are not likely to quell recent price movement by much. In fact, attempts to beat the mortgage-rate increases may be driving some of the real estate activity.

Consumer spending: The personal consumption report showed that spending was locked in its same tight range, with income growth improving but trailing way behind spending growth. Regrettably, income growth is likely to keep a lid on consumption growth, which in turn will keep GDP in check.

Trade: The U.S. trade deficit jumped from $40.1 billion in April to $45.0 billion in May. Exports shrunk by about 0.3%, as expected, but imports grew by 1.9%, indicating that the U.S. economy is stronger and improving compared with most of its trading partners. Global Purchasing Managers Index (PMI) data for the manufacturing sector was strongest for the U.S., with Europe second and China the weakest. This is probably not great news for those expecting China and other emerging markets to drive the world economy.

Quarter-end insights: Overall, it still looks like the economy is on the road to continued (if moderate) 2% growth, inflation is likely to remain below 2%, and long-term interest and mortgage rates are destined to go higher. When, not if, is the correct question to ask relative to interest rates. A tougher Fed and a tightening U.S. federal fiscal policy may keep a lid on short-term economic activity, but long-term fundamentals look strong.