US financial markets saw riskier assets, those including equities and lower quality corporate bonds, come under pressure at the start of last week as the utopian backdrop of low inflation, real interest rates, and economic volatility were all put into question following two key data points (CPI and PPI). These better readings, amplified by a new Federal Reserve chairman and board changes and the relative uptick to uncertainty that creates, raised concerns that monetary policy will become less accommodative. In fact, while the daily index moves were all mild in absolute terms, Wednesday (the worst of the 3) was actually the 13th worst day of 2017 with the S&P500 slipping of -0.53%. But in what has become a familiar pattern, the buy-any-dip mentality again held true when on Thursday the index sprung back with its 13th best day of the year (a rebound of +0.85%). All told, major US indexes concluded the week roughly where they entered it with the S&P off just -0.1%. And, with the Thanksgiving holiday now almost upon us, historical seasonality provides the expectation by many that smooth sailing and favorable returns should persist through year-end.
From an economic standpoint, recent data remains supportive of the view that global economic growth is stable to improving both through year-end and into 2018. This includes the prospects for both developed and developing economies. This theme of better economic activity is most likely the reason behind why we observe commodity prices (including oil, copper, industrial materials) moved noticeably higher in recent months as well. Also evident is that the global supply of money in recent years is massive; it seems to be manifesting itself in the form of major corporate deals; new plans for investment in plant, property, and equipment (cap-ex); and even flowing into high-ticket luxury items as evident through the record-shattering transaction price for a famed DaVinci painting last week. Clearly all the cash needs somewhere to land. With so much money sloshing around and economic readings looking increasingly favorable, the biggest near-term concerns seem to revert back to the evolving shape of the still-positive yield curve which has flattened significantly year-to-date and did so again last week. An inverted yield curve (where short-rates exceed longer-dated yields) has signaled economic recession would be coming; but on average the signal was some 5 quarters before the economy turned lower.
As investors and economists begin to look into 2018, the focus is on the potential for above-trend growth, a lower unemployment rate, and increasing inflation & wage pressures. Those themes while all short-term favorable from a consumption perspective, have the potential to be less supportive to corporate profit margins (if you are paying more for material inputs and labor, profits decline all-else equal). That is not to suggest these themes would not run for quite a while before the corporate earnings actually decline. So what permits this economic and market cycle to continue? Enter corporate tax reform. A lower, flatter corporate rate would seem to offer a quick boost to the level of corporate earnings which remain a key input to stock prices and valuation. That is why tax reform is such a big deal. But, after what seems like years and years of dysfunction from Washington and inability to work together, most remain pessimistic that anything meaningful or worthy of the word reform will be enacted. This remains the sentiment even as congress seems to be making faster than expected progress. But aside from that important theme, it will be interesting to watch activity around this holiday season. Historically, holiday retail sales directly benefited from strong financial markets as individuals feel wealthier and more generous. At the same time however, Amazon has created such disruption for traditional retailers that the number of companies benefiting from holiday shopping seems to be narrowing. In fact, an ETF was recently introduced aiming to capitalize on idea; owning Amazon and selling short more traditional retailers who have already seen their share prices severely punished this year. But has this winner-take-all view become too consensus (does the creation of such a product support that argument)? That may be the most interesting narrative over the coming few months in what seems like a year in which the wind is at the back of consumers and holiday spending.
Meantime, we want to take express our gratitude for each of our clients and the ongoing opportunity to work on their behalf. We pray you enjoy safe travels and a wonderful Thanksgiving this week.