Capital Market Commentary – May 2016

By: Stephen Clinton, President, Capital Market Securities, Inc.

Market Update – Slow Liftoff
Following its first rate increase in almost a decade in December, the Fed has decided to proceed cautiously on future rate increases. At the Fed’s meeting in March, the Fed held rates unchanged. The minutes of the March meeting indicated that there were various opinions as to how quickly interest rates should be increased. It appears that two increases is the most likely scenario this year.

In other economic developments:

  • U.S. GDP expanded at a 1.4 percent seasonally adjusted annual rate in the fourth quarter of 2015. This continues the economic recovery that began seven years ago.
  • The latest inflation rate for the United States is 1.0 percent for the 12 months ending February 2016. This is well below the Fed’s target of 2 percent and gives the Fed latitude to slowly increase interest rates.
  • Job creation has been at the forefront of the economic recovery. The Labor Department reported that more Americans were hired to start a new job in February than in any month since before the recession began in 2007. The unemployment rate edged up to 5 percent in March, but that was largely due to more Americans joining the labor force.
  • Manufacturing activity remains soft. Weak global growth, low oil prices, and financial volatility were cited as reasons for a decline in orders for durable goods. A bright spot, however, was the U.S. auto industry that recorded its best month of sales in over ten years in March.
  • Another indicator of the impact foreign economic growth has had on the U.S. economy was revealed in the decline in U.S. exports. In February, the export activity was 4.2 percent below the level of the prior year. The strong dollar also has impacted exports in that the stronger dollar makes U.S. products more expensive.
  • The non-manufacturing sector of the U.S. economy continues to show strength. According to the Institute for Supply Management, non-manufacturing activity rose to 54.5 in March. (A reading above 50 signals expansion.)
  • U.S. consumers barely increased their spending in February and spent less in January than the government had estimated earlier. Consumer spending edged up 0.1 percent in February. The government also revised downward its estimate of spending growth in January from a solid 0.5 percent gain to a much weaker 0.1 percent, which matched December’s lackluster figure. With consumer spending, which fuels about 70 percent of the economy, off to a weak start in 2016, economic growth in the first quarter is anticipated to be weak. Impacting consumer spending is the slow growth in incomes which moved up just 0.2 percent in February.
  • Home prices continued rising at a steady clip in January, another sign that 2016 will offer more of the same in the housing market: tight inventory leading to rising prices and sales volatility. The S&P/Case-Shiller Home Price Index, covering the entire nation, rose 5.4 percent in the 12 months ending in January.
  • Oil prices have moved up recently. Oil prices remain down more than 20 percent from last year. Most analysts still see the market as over-supplied but some expect that falling U.S. output and rising demand will alleviate some of the glut later this year.

We do expect the economy to strengthen later this year. We anticipate GNP reaching 2 percent for the year as a whole. Job growth remains positive and the dollar’s strength has weakened somewhat perhaps aiding export growth. We think home building and home sales will be a positive to the economy and expect the limited supply to cause home prices to continue their upward trend. We agree with the forecast of two rate increases this year, as we expect the Fed to move cautiously.

Interesting Tid Bits

  • The GSEs continue to be a source of funding for US government spending. In all, Fannie and Freddie received $187.5 billion from the Treasury but have paid $245.8 billion back in the form of dividends.
  • Baby boomers are re-writing the old adage that as you get older you seek to get out of debt. The Federal Reserve reported that the average 65 year old borrower today was reported to have 47 percent more mortgage debt than in 2003. They also have 29 percent more auto debt. Both figures were adjusted for inflation.
  • It is projected that this year Americans will use prepaid cards (including gift cards) to a total of $651 billion, an increase of 57 percent from six years ago.
  • During the first six weeks of 2016, the KBW Bank Index dropped nearly 23 percent to a three-year low. Over the same period, the Dow Jones Industrial Average fell slightly more than 10 percent over the same period.

Short-term interest rates remain low, with the 3-month T-Bill ending March at 0.21 percent. The 10-year T-Note ended March at 1.78 percent. The yield curve has flattened with the 10-year T-Note falling 49 basis points since December 31, while the three-month T-Bill increased 5 basis points.

The general stock market struggled out of the gate in 2016. As noted above, the market recorded a significant correction in the first six weeks of the year. The market has recovered with the Dow Jones Industrial Index ending March 31 up 1.49 percent for the quarter. This marks a new high for the Dow. The KBW Bank Index ended the March quarter down 12.11 percent. The poor performance of the banking sector is attributable to a variety of concerns, including problem loans surfacing related to the oil industry, continued margin compression issues as interest rates are not rising as quickly as anticipated, and limited growth prospects due to the slow growth of the U.S. economy.

Merger and Acquisition Activity
For the first quarter of 2016, there were 64 bank and thrift announced merger transactions. This compares to 66 deals in the first quarter of 2015. The median price to tangible book for transactions involving bank sellers was 129 percent which is down slightly from 2015’s median value.

Young & Associates, Inc. has been a resource for banks for over 37 years. Through our affiliate, Capital Market Securities, Inc., we have assisted clients in a variety of capital market transactions. For more information on our capital market services, please contact Stephen Clinton at 1.800.376.8662 or click here to send an email.