Market Insight - October 2017
The third quarter ended in an intersection of newsworthy and potentially market moving developments; a no-longer surprising rejection of the Obamacare repeal bill, a frightening ramping up of tensions on the Korean peninsula, and the long-awaited unveiling of the tax cut/reform proposals, a cornerstone of the Trump administration’s objectives. Markets anticipated, and gained moderately on the promised corporate tax reductions, although legislators from states with higher state and local taxes pushed back almost immediately on the possible loss of these deductions, spelling potential trouble ahead. Still, the S&P 500 ended September with its eighth consecutive quarterly gain, and almost all segments of the stock and bond markets were positive.
Stocks drew inspiration from two factors, we think. First, an acceleration of economic growth, with the GDP revised upward to 3.1% for the second quarter, its fastest gain in two years. Second, surprisingly strong corporate profits, driven by real revenue growth and margin expansion, rather than cost cutting. Quarterly operating earnings per share will likely post nearly 18% growth year over year. By these metrics, the strong market gains have legitimate fundamental underpinnings. Expectations, though, have been raised as well.
Asset Class Returns
U.S large company stocks added 8% for the quarter; the Dow is now ahead over 15% year to date, the S&P 500 nearly 14%. After lagging for the first six months of 2017, mid cap and smaller company stocks joined the rally, gaining 9% through September 30th. Global markets were the best performers by far, reflecting a healthy dose of optimism abroad; the OECP global composite leading indicator, measuring forward looking data from 39 countries, has increased month over month for 17 straight months! With returns magnified by a falling dollar, developed markets returned over 20% to U.S. investors; emerging markets, over 28%.
The Fed and Interest Rates
At the September meeting, the Fed kept the funds rate at 1.00-1-25%, and made clear its intent to normalize its post-crisis balance sheet in small steps, beginning in October, by approx. $10 billion per month in the first quarter of implementation, $20 billion per month in the second quarter, and moving up incrementally to $50 billion per month in subsequent quarters. Adding to the mix; Fed Chairman Yellen’s term ends in February 2018, and President Trump has announced that he will make his nomination within a few weeks.
Named candidates include Ms. Yellen, as well as White House economic advisor Gary Cohen, former Fed governor Kevin Warsh, and Fed governor Jerome Powell.Markets seems at ease with these choices, although there are more names expected as interviews proceed. The 10-year U.S. Treasury benchmark bond was priced to yield 2.47% before the Fed raised rates in December 2016. After two rate hikes, with one more possible increase in December, the 10-year bond ended the quarter with a yield of 2.32%. Credit markets continued to price in moderate inflation and more modest growth expectations. Thus far 2017 has been more than satisfactory for bond investors, with YTD returns averaging 7% in the high yield sector, and 3.14% for the aggregate government bond index.
A Look Ahead
Teflon market…goldilocks market… call it what you will, investors have shrugged off what seems at times to be horrible market-rattling developments and forged ahead. Mostly, we believe, for good reasons. There are some early signs of asset overpricing, though. Price earnings ratios of the S&P 500 have risen to approx. 23.5 on trailing earnings and 17.7 on forward earnings, and at these levels markets can be more than a little prone to disappointment. We’re thinking of several quarters of underperformance rather than a short steep correction. In a recent post by Liz Ann Sonders, she noted the Ned Davis Crowd Sentiment Poll, an amalgam of several measure of investors’ confidence, is showing extreme optimism. In the past, readings at these levels are typically followed by periods of below average returns. We are lowering our expectations for the short term, seeking opportunity to rebalance our clients’ portfolios to more moderate levels, and reserving liquid assets for additions when markets weaken. However, our concerns are only for the short term.
We believe we are at the beginning of a phenomenal decade for investors. The pace of change is accelerating, as the global economic models and assumptions we have become accustomed to are turned on their heads, inside out, and in many cases just blown apart by what may be the greatest wave of innovation in our lifetimes. The automobile industry, transportation, healthcare, the retail industry, the food industry, the hotel and travel industry; the banking industry, all are likely to be unrecognizable to us within a very short time. These are dramatic and often unsettling changes, and there will be volatility and recessions along the way that will try the patience of investors, and unfortunately, leave many behind. The rewards for those with a plan and a long-term perspective, we are convinced, will be phenomenal.
The Bedminster Group is excited to announce our newest team member, Danielle Sto Domingo. Danielle is joining The Bedminster Group as Client Service associate, and will be part of our investment training program as well. Danielle is a recent Honors graduate of the University of South Carolina in Beaufort. She has worked as an administrative assistant with Absolute Island Management and Trident Technical College in Charleston, S.C., as well as an ABA Line Therapist with Autism Inc. in Bluffton. SC.
The Bedminster Group
Steven Weber, Gloria Maxfield, Frank Weber, Danielle Sto Domingo