After 8 consecutive positive weeks for the S&P, the index suffered its first weekly loss since early September. Make no mistake however, the -0.2% giveback for the S&P500 and Nasdaq on the week was anything but panicky (Dow off -0.5%) and probably does little to change the broad perception that markets have not experienced any meaningful pause in 2017 and are long overdue for a setback. But could volatility and some heightened pressure be developing? Credit markets, specifically high yield spreads, seemed to awaken a bit last week in what has otherwise been a sleepy year of flat-line activity. Often, widening high yield spreads lead observable hiccups in equity markets. At the same time, the yield curve continues to flatten; it is not yet inverted (worrisome signal), but is worth watching closely as it has never provided a false positive signal preceding economic recession by an average of 5 quarters.
With that said, data continues to support the theme that the US economy and the vast majority around the world are soundly growing and not yet experiencing much inflation. It seems that creating inflation is extraordinarily difficult in a world where large technology companies are disrupting so many industries (ie Amazon and retail, pharmacy, grocery, etc). This explanation is particularly sound when noting that the 4-week average of US unemployment claims declined to a 44 year low last week (persistently low unemployment should be the starting point for inflation via upward wage pressure). At the same time, areas like Japan and Europe which have only managed to see short spurts of better economic activity for much of the post-financial crisis period are continuing to enjoy a strong activity in 2017. Nominal retail sales in the Eurozone are up 5% over last year and China is reporting metrics indicative of robust activity. These readings support the theme that more favorable economic activity is not just a US story, but rather synchronized across the globe. Still, it is noteworthy that corporate profits in the US for 3Q are +7% higher than their year-ago levels and 4Q estimates project high-single to low double-digit year over year gains; that is particularly relevant when considering there has never been an economic recession when corporate earnings are buoyant.
While underlying fundamentals continue to support the idea that more time remains this economic cycle despite its longer-than-average age, a key theme with sentiment heightened (hard to see consumer sentiment move much higher increasing the prospects for short-run disappointment) is the urgency for the US economy to break out of its sub-par trajectory. Yes, 3Q GDP (nominal) was quite respectable and a needed start; better earnings and nominal GDP gains are the hard data that many were looking for to support confidence-related readings evident around the end of last year. But valuations are still above historical average creating the sense that the market is quite vulnerable to shocks. When that is true, there are a number of mistakes that can be made by policymakers that quickly erode confidence. For example, a Fed that moves too quickly even in the absence of inflation or bubbles can choke off the access to capital and spook markets (yield curve inverts). Alternatively, failure to pass corporate tax reform could also hurt small business confidence and impair the ability to further grow corporate earnings. Make no mistake, in talking with most it would seem that few expect Congress and actually agree on reform. If they can defy the pessimism on that front, it would seem a number of sectors are due for a quick upward adjustment. Amid what should be rising wage pressure, corporate tax reform may likely be the missing key ingredient to boosting real and nominal growth from this point in an already long cycle.