General

There is a change coming in industry classifications: S&P Dow Jones Indices and MSCI are moving real estate out of the financial sector and into its own sector. The change could have a wide-reaching effect. Among those potentially affected by the reclassification are many funds, portfolio allocation models and sector-rotation strategies.

A bit of background will explain why this change is noteworthy. S&P Dow Jones Indices and MSCI oversee the Global Industry Classification Standard, which is more commonly referred to as the GICS (pronounced “gicks”). It currently comprises 10 sectors, 24 industry groups, 67 industries and 156 sub-industries (excluding the forthcoming creation of the new real estate sector as well as the creation of a copper sub-industry). The GICS determines what sector or industry a particular publicly traded company is considered a part of. It underlies various funds, portfolio allocation models and likely sector-rotation strategies. It also used in various screening tools and trading systems.

It’s not the only industry classification system out there. FTSE (the “ICB”), Morningstar and Thomson Reuters, for instance, have their own proprietary classification systems.

The announced change, which will tentatively take effect after the market’s close on August 31, 2016, will only affect funds, models and strategies based on GICS. For example, the Financial Select Sector SPDR (XLF) will likely lose Simon Property Group (SPG) and American Tower Corp. (AMT). These REITs are currently the ETF’s 12th- and 18th-largest holdings. All historical performance for any fund or asset allocation strategy based on current GICS classification of real estate will need an asterisk placed by it since future returns will be different. All asset allocation and sector rotation models based on GICS will also be altered, potentially affecting how portfolios are allocated.

(Source: AAII)

The retail industry is a sector of the economy that involves individuals and companies engaged in the selling of goods and services to consumers. The outlook for retail sales in a given year has a great deal to do with the financial resources of the average U.S. citizen. Consumer spending accounts for roughly two-thirds of our annual gross domestic product (GDP).¹ Currently, in the U.S., we are experiencing cheaper fuel prices, rebounding stock prices and job gains on pace for their strongest year since 1999.² This, in turn, may provide consumers with more disposable income to spend on one of the great American pastimes, shopping.

» Total U.S. retail sales grew to $4.53 trillion in 2013 up 4.2% from 2012³, outpacing GDP growth of only 2.2%⁴. In addition, retail accounted for 27.0% of nominal U.S. GDP, up from 26.8% in 2012. That share has been on the rise consistently since a drop-off in 2009, when consumer confidence was at a low after the recession.⁵ Consumer confidence closed October 2014 at its highest level (94.48) since October 2007 (95.24), as measured by the Conference Board’s Consumer Confidence Index.

» The Bureau of Economic Analysis reported that wages and salaries, which tend to drive consumer spending, increased 5.1% in September 2014 from the year-earlier level.⁶

» Declining gasoline prices, as the U.S. is currently experiencing, tend to boost real consumer income more than most other price declines. Therefore, more money is available to spend on other things.⁷

» Online holiday sales in November and December 2014 are anticipated to increase by 13% to an all-time-best $89 billion. It is estimated that 3.4 million consumers will buy online for the first time this holiday season.⁸

¹UnitedStatesConect.com

²Bloomberg

^3,5eMarketer

⁴IMF

^6,7Barron’s

⁸MarketWatch

(Source: First Trust)

China surpassed Japan as the world’s second-largest stock market for the first time in three years amid growing investor confidence that policy makers in Beijing will revive the economy with monetary stimulus.

China’s market capitalization climbed to $4.48 trillion yesterday after a 33 percent increase this year, according to data compiled by Bloomberg. Japan’s slipped to $4.46 trillion and has dropped 3.2 percent since the end of December. China was briefly the second-biggest market, behind the U.S., in March 2011 after an earthquake in Japan sent shares tumbling in Tokyo.

While the weakening yen played a role in Japan’s shrinking market value in dollar terms, the Shanghai Composite Index (SHCOMP) has climbed three times as much as Tokyo’s Topix this year. China cut interest rates for the first time since 2012 last week and economists predict authorities will take more steps to support an economy headed for its slowest annual expansion since 1990. The Shanghai gauge still has a price-to-earnings ratio 21 percent lower than its Japanese counterpart.

The growth in China’s market value, helped by the resumption of initial public offerings in January after a more than yearlong freeze, marks a turnaround for an equity market that was among the world’s worst performers from late 2010 through the middle of last year. It comes as authorities give foreign investors unprecedented access to mainland shares through the Shanghai-Hong Kong exchange link.

China surpassed Japan as the world’s second-largest economy in 2010. Its gross domestic product was valued at $9.2 trillion last year, about 89 percent more than Japan’s, data compiled by Bloomberg show. China’s market capitalization data includes companies with a primary listing on mainland exchanges.

(Source: Bloomberg)

Fed made the following historic announcement today:

• QE program would end at month end
• Fed will keep reinvesting principal payments from its holdings to maintain its balance sheet at approx. $4.4 trillion
• The QE program had met the Federal Reserve’s goal of reducing unemployment
• Acknowledged that the labor market slack is “gradually diminishing”
• Assured its support of low interest rates for a considerable period of time, unless the economic data improves faster than its forecast
• Pointed to short-term downside risk to inflation
• Future rate hikes will depend on the pace of improvement in the job market

(Source: WSJ, Fed)

Quite the week it has been. For much of the year, we have been recommending that periods of market placidity should be used as precious opportunities to assess and re- position. Those benign times are when changes are best made, but of course, human nature being what it is, those times are also when it feels less urgent to make such changes.

Now we have been greeted with volatility, and then some. One to two percent moves daily in stocks; currencies globally declining with the dollar strengthening; and sovereign yields dropping with negative cascade effects on emerging-market and high-yield instruments. Some of these sharp moves may have been triggered by warnings from the IMF that Europe was on the edge of another dip into recession and that global growth is weakening. Some may be a product of continued digestion of the end of quantitative easing by the Fed. And some may be a nervous environment in the face of multiple global concerns such as Ebola spreading and ISIS advancing.

Next week, market attention will turn to the slew of third quarter earnings, which will likely offer some decent upside surprises akin to what we saw in July. Even so, once markets plunge into volatility, it takes a while to subside. We have had a few bouts this year already, early in the year and again in August, and the past week felt even more substantial. While the S&P 500 has only declined about 5% from highs, other areas of the market are much, much weaker, especially small-cap stocks (as measured by the Russell 2000 Index) which are already in correction and are off in excess of 10% from their highs. While this is not an optimal time to trade and react (unless you are a trader…), it may be a time to dip into sectors or asset classes that seemed too pricey only a few months back. The operative word is dip, given that what now looks less expensive may of course be less expensive still if the current downtrend continues.

Still, this sell-off and global market unease has not been triggered by any clear or radical deterioration, or by a sudden unexpected shift in anything other than sentiment. That matters, as absent genuine crisis, markets will sooner or later follow underlying fundamentals, especially stocks. Those fundamentals may not be stellar (and have not been at any point in the past few years), but they are hardly terrible. Markets can detach from that for a while, but not completely.

With no evident catalyst, this past week proved to be a quite messy one for equities. Though the week ended calmly, there was heavy selling for much of the week, though not selling characterized by anything resembling panic or intense volatility.

As usual, there were various theories and explanations, ranging from rumors of harsh Russia reprisals against western sanctions to further anticipation of interest rate rises in the U.S. to questions about China’s growth trajectory and the Beijing government response. The week was also capped by the surprise announcement that one of the most influential bond managers in the world – Bill Gross of PIMCO – had decided to leave his longtime firm.  While not a market-moving event in itself, it certainly caught the attention of the investing community.

Earlier in the year, there was frequent chatter that equities were going up too much too quickly. Now, however, with nearly three-quarters of the year passed, we are facing a very decent but hardly excessive year of returns in the high-single digits. Of course, markets might well stage a strong fourth quarter rally. If anything, the fact that indices have barely budged in the past months makes such a rally more credible, not less. Much will depend on fourth quarter earnings and general sentiment.

Similarly, the early year chatter about the coming volatility in bonds has not come to pass. Yields on the U.S. 10-year have been trading in a very narrow band between 2.50% and 3.00% for much of the year. Traders can certainly make money on the basis point moves, but yields remain low and not especially volatile.

There have been several periods of equity surges and sell-off. The first week of August was notably negative, followed by weeks of gains. Much of September was quite strong, followed by this week of sell-offs. It is hard to discern an evident pattern here. Overall, the earnings, revenue and economic picture domestically continue to improve, while the global picture is somewhat more ambiguous.

In short, the trend of gradually rising stocks and static interest rates with a slight bias to the upside remains in place. We all know that multiple factors could alter that trend, but it will take more than a discombobulating week.