As is always the case, the number of developments relevant to financial markets over the last two weeks was numerous. That said, the pace of change feels more robust than usual; perhaps this feeling is a normal awakening following what are often sleepy and low-volume summer seasons, but there is much to review. Headlines range from ongoing geopolitical issues (North Korea continuing to boil); US political drama (controversial tweeting) and another renewed stab at healthcare reform by republicans; to fresh news from the US Federal Reserve and the resulting microanalysis performed by market participants on projected interest rate path and withdraw of unprecedented monetary stimulus following the financial crisis 8 years ago. With all that occurring, US equities managed to drift upward and establish several new all-time highs in recent weeks. The end result for the major indexes last week was mixed however following some mild weakness to conclude the week; for the five days ending September 22, the tech-heavy Nasdaq slipped -0.1%, while the S&P and Dow managed to climb +0.1% and +0.4%, respectively. Noteworthy and in a departure for what has been the trend throughout much of the year, small-size and more economically sensitive segments of the market jumped higher, meaning a good portion of the market is actually enjoying better performance that the most cited indexes would otherwise indicate. Could it be that investor optimism is beginning to re-warm to the idea that tax reform might actually be possible from our policymakers in Washington? These exact areas are thought after all to be the biggest beneficiaries of a lower corporate tax rate compared to large companies which employ armies of legal and tax personnel and effectively navigate what is one of the most tax complex systems in the world to their benefit. This churning seemed evident in recent days. Following the debt limit deal by the President with Democrats, it would seem maybe something actually can get done in Washington?
From an economic perspective, we are seeing a more mixed bag compared to a month or two back. That makes commenting on any one fresh data point seem of little value. Normally this disconnected data might suggest the economy is beginning to reach an inflection point; yet we are cognizant that the heightened noisiness of data both in the last several weeks and for many to come is probably a result of distortion created by recent severe weather events endured by much of the southeastern US states. Such weather events historically have not surprisingly introduced significant noise into regular data series rendering them anything but signal. Internationally, the data remains more consistent with an improving backdrop, and the theme of a more synchronized and positive direction of growth globally coupled with benign inflation remains firmly intact. It is this data and historical context that continues to give investors room to remain optimistic that things even still have room to improve further. Typical signposts one might be mindful of for early warning signs of economic (and market) downturn are not yet presenting themselves. Specifically, wages still have significant room to accelerate relative to when they historically became problematic; annual GDP growth not yet achieving 3% after adjusting for inflation; capacity remains unconstrained as suggested by current productivity and labor force participation rates; and pent-up demand persists for housing.
As we move our way into the final week of the 3Q, perhaps what is most surprising (and puzzling to skeptics) continues to be the resiliency of the US stock market. Often, financial markets struggle during the middle to late summer section of the year. While we are not yet entirely out of the woods, this September is firmly positive as we write today. For most skeptics however, one of the most convincing and easy arguments provided for why we should expect a more meaningful pause or pullback rests solely on the amount of time it has been since we last experienced such a down-move. We often cite this as reason for caution too; while this bull market and recent 20 month rally are not unprecedented, periods as long are in fact rare. We remain open to the possibility that any number of catalysts could upset the recent trend. Obviously escalating friction between the world and North Korea seems capable of such in the very short-run; but the biggest intermediate- to long-term uncertainty in our minds really exists with the next chapter to be written by US Federal Reserve as they embark on a well-telegraphed journey to begun shrinking the size of their ballooned balance sheet. Once begun, it will not be easy to pull back from should data soften, reducing the Fed ability to be data-dependent. More importantly, how will financial markets respond to measures that should, all-else equal, result in a gradually rising cost of money? For the moment, synchronized and improving global growth can remain the offset, but consumer and business sentiment also remain important to that dynamic. 2017 continues to be encouraging, and a perfect example of how one cannot afford to wait for calming headlines to be a market participant; the market often marches to its own beat and will climb the wall of worries.