Domestic Output Report Sours Sentiment
The U.S. equity markets finished the holiday-shortened week lower following a revision to 1Q GDP that showed a contraction in output, as well as an unexpected decline in regional manufacturing activity. A solid rise in crude oil prices limited the damage in the energy sector, which was the only sector that notched a gain in today’s action.
Treasuries were higher, with yields falling, amid the negative mood, along with gold, while the U.S. dollar was flat. Earnings reports from the retail sector continued to show mixed results, while news of two possible major corporate deals reaped some positive attention.
The Dow Jones Industrial Average declined 115 points (0.6%) to 18,011
The S&P 500 Index fell 13 points (0.6%) to 2,107
The Nasdaq Composite lost 28 points (0.6%) to 5,070
In heavy volume, 1.1 billion shares were traded on the NYSE and 1.9 billion shares changed hands on the Nasdaq
WTI crude jumped $2.62 higher to $60.30 per barrel, wholesale gasoline rose $0.09 to $2.06 per gallon
The Bloomberg gold spot price increased $1.98 to $1,190.38 per ounce
Markets were lower for the week, as the DJIA dropped 1.2%, the S&P 500 Index decreased 0.9% and the Nasdaq Composite Index was 0.4% lower
Downward revision to 1Q GDP smaller than expected
The second look (of three) at 1Q Gross Domestic Product, the broadest measure of economic output, showed a quarter-over-quarter annualized rate of contraction of 0.7%, revised lower from the 0.2% expansion reported in the first report. This compared to the Bloomberg forecast of a downwardly adjusted 0.9% contraction. 4Q GDP expanded by an unrevised 2.2%. Personal consumption came in at a 1.8% gain for 1Q, from the 1.9% increase previously reported, and compared to the slight upward revision to a 2.0% rise that was expected. Personal consumption grew by an unrevised 4.4% in 4Q.
Along with the softer-than-initially reported personal consumption, the downward 1Q GDP revision came as imports were adjusted higher and private inventory investment was revised lower, partially offset by an upward modification to residential fixed investment. 1Q output was hamstrung by the stronger U.S. dollar, the West Coast port shutdown, harsh winter weather and reductions of capital expenditures out of the energy sector as crude oil prices dropped.
On inflation, the GDP Price Index was unrevised at a 0.1% dip, matching forecasts, while the core PCE Index, which excludes food and energy, was revised slightly lower to a 0.8% rise, compared to forecasts of an unadjusted 0.9% gain.
The final University of Michigan Consumer Sentiment Index was revised higher to 90.7 from the preliminary level of 88.6 for May, versus an expected 89.5 figure, but was down from the 95.9 level posted in April. Components pertaining to current economic conditions and the economic outlook were both revised higher, but both were lower versus April. The 1-year inflation projection was revised to 2.8% from 2.9%, and compared to 2.6% in April, and the 5-10 year inflation outlook was unrevised at 2.8%, up from 2.6% in the month prior.
The Chicago Purchasing Managers Index showed growth in Midwest activity fell back into contraction (below 50), dropping to 46.2 in May, from 52.3 in April, and versus expectations of an improvement to 53.0.
Treasuries finished higher, as yields retreated, the yield on the 2-year note declined 2 basis points to 0.61%, while the yields on the 10-year note and the 30-year bond are decreased 1 bp to 2.12% and 2.88%, respectively.
Europe lower on data and festering Greek uncertainty, Asia mixed
The European equity markets finished lower, with traders digesting a plethora of data in the region, along with the downward revision to U.S. 1Q GDP. Also, Greek debt deal uncertainty lingered to hamstring sentiment with the nation continuing to offer optimism that a deal to unlock further bailout aid and likely avoid a default could be reached this weekend, contradicting recent commentary from European officials suggesting a deal is not imminent. The euro traded higher versus the U.S. dollar, while bond yields in the major eurozone markets dipped. In economic news, German retail sales rose more than expected for April, while French consumer spending for the month rose by a smaller amount than expected. Moreover, a plethora of 1Q GDP reports were released, with Greece and Switzerland both posting quarter-over-quarter contractions of 0.2%, while Italy’s output grew 0.3%, inline with expectations.
The U.K. FTSE 100 Index was down 0.8%, Germany’s DAX Index declined 2.3%, France’s CAC-40 Index dropped 2.5%, Italy’s FTSE MIB Index traded 1.1% lower, Spain’s IBEX 35 Index moved 1.5% to the downside, Switzerland’s Swiss Market Index descended 1.7%, and Greece’s ASE Athens Index fell 1.4%.
Stocks in Asia finished mixed to close out the month, with Japanese stocks modestly extending their winning streak to 11-straight sessions, and to a fresh 15-year high, but strength in the yen and an unexpected drop in April household spending limited gains. As well, the island nation’s core consumer price inflation was slightly hotter than expected for April. Meanwhile, Chinese and Hong Kong markets dipped, extending yesterday’s sharp drop, with the former tumbling 6.5%, amid exacerbated liquidity concerns as more brokerage firms tightened margin lending requirements. Finally, stocks in Australia and India’s advanced, supported by optimism that their respective central banks could cut interest rates following their monetary policy meetings next week. After the closing bell, India reported a stronger-than-expected 7.5% y/y pace of expansion.
The Week in Review: Stocks stumble in shortened week
The domestic equity markets posted a weekly loss after sentiment remained sluggish following the three-day Memorial Day holiday weekend. The U.S. dollar resumed its rally as some upbeat reads on domestic new home sales, Consumer Confidence and core durable goods orders teamed up with recent Fed commentary to foster a flare-up in rate hike uncertainty. Greek debt deal uncertainty stymied conviction, along with a sharp midweek sell-off in mainland Chinese stock markets amid intensified liquidity concerns as brokerage firms tightened margin trading requirements. Retail sector earnings reports remained mixed, while M&A news dominated the equity headlines, with Charter Communications Inc’s $55 billion agreement to acquire Time Warner Cable Inc. and Avago Technologies Ltd’s deal to acquire Broadcom Corp. for $37 billion.
As noted, investors may be waiting for a catalyst, while international developments are moving toward center stage. A rebound from the weak start for the U.S. economy this year has yet to surface, but it remains our base case. The consensus, and ours, expectation is that the Fed will remain on hold through the summer and not begin raising rates until at least September. But it’s the subsequent path of rates that matters more than the start point.
The Week ahead: Heavy week of data looms
With Fed rate uncertainty resurfacing, next week’s heavy U.S. economic calendar will likely drive the market action with Monday’s May ISM Manufacturing Index, Wednesday’s ISM non-Manufacturing Index and Fed Beige Book, while culminating with Friday’s non-farm payroll report for last month.
Our long-term view continues to be that the Fed’s approach to tightening monetary policy will be slow and that the potential upside in yields will be limited due to structurally slower economic growth and lower inflation than in the past. Its goal is to “normalize” policy rather than slow down an overheating economy. However, in the near term, investors should expect more volatility as expectations about central bank policies evolve.
Other domestic reports slated for next week include: personal income and spending, Markit’s business activity reports, construction spending, factory orders, monthly auto sales, ADP’s Employment Change report, the trade balance, 1Q nonfarm productivity and unit labor costs, and consumer credit.