News & Press: Updates

Harry A. Koch Co. Quarterly Economic Update

Thursday, August 21, 2014  
Posted by: Kelly Koepsell
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The Second Quarter 2014 Economic Update from the Harry A. Koch Company 

from:Susan Hilton, LUTCF
Financial Advisor
Direct: 402-861-7086
Fax: 402-861-7286

After a first quarter marked by dismal GDP and a tepid stock market, the second
quarter of 2014 brought welcome change. The S&P 500 posted a Q2 gain of 4.69%.
Hiring picked up, and so did inflation. The housing market left its winter slump
behind. Gold rallied and so did oil, with unrest in Ukraine and Iraq providing some
upward pressure on prices. The Federal Reserve incrementally reduced its bond
purchases on schedule. Was the first quarter simply a bump in the road for the
economy? History may record it as nothing more.1

Two notable trends emerged in the quarter. The job market improved, and yearly
consumer inflation aligned with the Fed’s target. In tandem, these developments
made Wall Street wonder if the Fed might raise interest rates a little sooner than

By the end of Q2, the unemployment rate was down to 6.1% following job gains of
304,000 in April, 224,000 in May and 288,000 in June. In fact, by June the
economy had created at least 200,000 jobs in five straight months, something that
hadn’t happened since the late 1990s. The U-6 rate (the unemployed + the
underemployed) reached a 69-month low of 12.1% in June.2
While the jobless rate went south, consumer prices moved north. The federal
government’s Consumer Price Index rose 0.3% in April and 0.4% in May, taking
yearly inflation to 2.1%. Retail sales were up too – they rose 0.5% during April and
another 0.3% in May, even as consumer spending was flat in April and up but 0.2%
for May. The University of Michigan’s consumer sentiment index wobbled – it was
at 84.1 in April, 81.9 in May and 82.5 in June. On the other hand, the Conference
Board’s consumer confidence index reached a 6-year peak in June at a reading of
The manufacturing and service sectors continued expanding, according to the
purchasing manager indices kept by the Institute for Supply Management. By
June, ISM’s service sector PMI indicated growth for a 53rd straight month with a
56.0 reading. The ISM factory PMI stood at a healthy 55.3 in June.5
Annualized wholesale inflation ticked down to 2.0% in May from 2.1% in April, in
part thanks to an unanticipated 0.2% dip in May’s Producer Price Index. Factory
orders and hard goods orders also dipped in May: orders for durables fell 1.0%
after a 0.6% rise in April, and factory orders followed up their 0.8% April rise with
an 0.5% May decline.3,6

The Fed kept tapering QE3. By June, the central bank had moved to reduce its
monthly asset purchases to $35 billion. As Q1 GDP was a subpar -2.9%, it revised
its full-year economic growth expectations down to 2.1-2.3%. All these moves were
expected, but what was unexpected was St. Louis Fed president James Bullard
going out on a limb and telling Fox Business in June that he expected an interest
rate hike by the end of Q1 2015. If current hiring and inflation trends continue,
could it even occur sooner?3,7,8

Armed conflict (and the threat thereof) gave investors pause in the quarter. The
Islamic State’s takeover of some of Iraq raised worries about oil exports from that
country being disrupted; some interpreted Russian troops hovering on the border
of Ukraine as a prelude to invasion and possible interruption of natural gas
delivery to the eurozone. While these fears exerted pressure on natural gas and oil
prices in the quarter, there were no systemic shocks. Most of Iraq’s current oil
output occurs south of the present combat zone, and Russian natural gas deliveries
to the euro area through pipelines in Ukraine were not slowed (though Gazprom,
the giant Russian energy supplier, cut 100% of its natgas supply to Ukraine in mid-
The eurozone factory sector was expanding, but its lack of inflation was worrisome
for the European Central Bank. During the quarter, the Markit manufacturing PMI
for the eurozone averaged 52.4. Any reading above 50 means sector growth, but
the Q1 average was 53.4. Just as factory activity slowed a bit for the whole
eurozone in the quarter, Markit manufacturing PMIs for Germany, Austria, and
the Netherlands also signaled the pace of expansion slackening. In France, the
factory sector contracted in the quarter. The eurozone unemployment rate was
11.6% as of May. The ECB actually cut its deposit rate to -0.10% in the quarter, in
light of the fact that annualized eurozone inflation was merely 0.5% by June.11,12
Now as for China, its manufacturing PMIs went back into positive territory in the
quarter – the PRC’s official PMI was 50.8 in May and 51.0 in June, while Markit’s
PMI improved from 49.4 to 50.7 in those months. Analysts polled by Reuters,
however, forecast China’s annualized GDP at 7.3% for Q2 and for 2014; that would
be a 24-year low.13

What was the top Q2 performer among major world stock indices? That honor
goes to the Sensex. India’s benchmark went +13.52% for the quarter. If you include
the minor indices, Argentina’s MERVAL takes first place at +23.75%. Very few
indices lost ground in Q2, as the following 3-month performance numbers bear
out: Global Dow, +4.06%; Asia Dow, +6.64%; Europe Dow, +0.04%; STOXX 600,
+2.26%; Shanghai Composite, +0.74%; Hang Seng, +4.69%; Nikkei 225, 2.25%;
KSE 100, +9.18%; KOSPI, +0.84%; CAC 40, +0.71%; DAX, +2.90%; ISEQ, -5.91%;
FTSE MIB, -1.88%; RTS, +11.42%; FTSE 100, +2.21%; Bovespa, +5.46%; IPC All-
Share, +5.62; TSX Composite, +5.66%. The MSCI World Index rose 4.15% for Q2,
while the MSCI Emerging Markets Index posted a 5.64% Q2 gain.1,14

The comeback of gold continued as futures rose 3.0% on the COMEX in the
quarter. COMEX silver climbed 6.6% in three months, and platinum 4.4%;
palladium set the pace among precious metals by rising 8.5% in Q2 (putting it up
17.4% for the year). As for the dollar, it wasn’t quite as fortunate: the U.S. Dollar
Index went -0.40% in the quarter.15,16
NYMEX crude rose 3.7% for Q2, spiking in June but then falling at quarter’s end as
fears of supply disruptions in Iraq eased. Natural gas futures went +2.1% in Q2
while heating oil futures went +1.4% and unleaded gasoline futures +5.4%. In ag
futures, corn had a bad quarter with prices dropping 15%. Year-to-date, Arabica
coffee and lean hog futures were both up 55% at the end of Q2; a drought in Brazil
had affected coffee prices, and a virus had thinned America’s hog herd. The
Thomson Reuters/CRB Commodity Index ended Q2 up 10% YTD.17,18,19

Fortunately, the housing market heated up again with the arrival of warmer
weather. Existing home sales rose 1.5% in April, and then another 4.9% in May –
and in addition, the National Association of Realtors found pending home sales
rising 0.3% and 6.1% in those successive months. The Census Bureau reported a
3.7% rise in new home buying in April, then an 18.6% jump for May.3,20
True, existing homes weren’t quite moving like they had a year ago: NAR had the
pace of resales down 5.0% year-over-year. Both housing starts (1.071M to 1.001M)
and building permits (1.06M to 991K) logged April-to-May declines. On the bright
side, home prices – as measured across 20 metro areas by the S&P/Case-Shiller
monthly index – had increased 1.1% in April and 10.8% in 12 months, and the pace
of new home sales reached a 6-year peak in May.3,21
Another factor aided the real estate market: cheaper mortgages. Looking at
Freddie Mac’s March 27 and June 26 Primary Mortgage Market Surveys, you see
some pronounced declines for average interest rates on home loans. By the June
26 survey, the average rate on the 30-year fixed had dropped 0.26% to 4.14%. The
average rate on the refinancer’s tool of choice, the 15-year FRM, had fallen 0.20%
to 3.22%. The average interest rate on the 5/1-year ARM sank from 3.10% to
2.98%. Interest rates for 1-year ARMs averaged 2.44% in the March 27 survey and
2.40% in the June 26 survey.22
Q2 was the sixth winning quarter in a row for the S&P 500. (Only once in the past
50 years has it had seven straight winning quarters.) The Russell 2000 notched its
eighth straight winning quarter (a new record) with a gain of 1.70%. As for the
CBOE VIX, it ended Q2 down at 11.57, going -16.64% in Q2. At the close on June
30, the S&P was at 1,960.23, the DJIA at 16,826.60, the NASDAQ at 4,408.18 and
the RUT at 1,192.96. Look at how the S&P is outperforming the Dow this year.1,23

The major geopolitical crises of 2014 (the tensions between Ukraine and Russia,
the Islamic State’s takeover of parts of Iraq and Syria) have had no profound effect
on Wall Street. While volatility hasn’t been absent from the market, we haven’t
seen much of it of late. Investors seem more preoccupied with what the Fed might
do over the next 6-12 months. The possibility of sudden crises aside, the feeling
persists that a return to equilibrium in central bank policy might rein in the bull
more than anything else. As QE3 presumably has a few more months to go and as
an interest rate hike seems at least a couple of quarters away, Q3 might amount to
relatively smooth sailing on Wall Street – and decent earnings and solid economic
indicators might provide a little more of a tailwind for stocks.

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