Markets Log Moral Victory for august, But is More Meaningful Storm Coming – Week Ended 9/1/17

Despite what felt like one of the first bouts of increasing volatility amid sharply rising geopolitical risk and ongoing turmoil coming from inside Washington, US stock indexes managed to close out the month of August positive on both the S&P500 and Dow. One might consider it a major moral victory when reflecting all that went on during the month of August (Charlottesville, N. Korea, and most recently Hurricane Harvey to name a few). But a look below the surface suggests the broader stock market struggled more during the month than the most publicized indexes otherwise reveal. For example, Apple added +104.5 points to the level of the Dow during August, more than accounting for the 57 point gain achieved by the blue-chip index. Perhaps more easily observed, mid- and small-sized company stock barometers were decidedly lower on the month. Is this weak performance and relatively better experience by larger-sized companies indicative of the financial markets assigning low probability of meaningful tax reform occurring? The trend is persisting throughout much of 2017 and is seems logical to expect smaller companies are the biggest beneficiaries of regulatory and corporate tax reform bearing relatively larger burdens than large counterparts who have the means to employ tax strategists and legal experts to exploit loopholes inherent in the existing regime.

From an economic perspective, the big news last week with 2Q corporate earnings now concluded was the disappointing employment report for August. The data showed a noticeable decline in the number of new jobs added, an uptick in the unemployment rate, and a miss and downshift in the pace of wage growth. While the data is typically volatile during August each year and Hurricane Harvey likely began to influence the numbers (as it will for the coming months), it was a weak report. In that regard, the financial markets are increasing their odds that the Fed will be unable to justify any further hikes to interest rates in 2017 and perhaps through a good portion of 2018. This lower-for-longer interest rate view decreases the near-term odds that policymakers will short-circuit the current economic cycle via overtightening of financial conditions. Aside from the weak US employment data, other economic data points were mostly stronger for the week, continuing to support the view that the current economic expansion is global and on solid footing.

With the slow-trading and often more volatile month of August in the books without any noticeable effect, eyes turn toward September which is often cited as the weakest month of the year from a historical perspective. This September seems vulnerable to a very negative flow of news as well. As highlighted in these musings last week, there are just 12 short days following the Labor Day congressional recess for agreement to take place on the debt ceiling and budget. At the margin however, the unfortunate chaos being experienced by Texas residents probably serves as a positive unifying force toward agreement; no politician wants to be accused of shutting the government down when a highly public catastrophe requiring federal assistance just occurred. In that same regard, escalating stress around North Korea also unifies parties in the view that defense and financial stability are important. Still, in the words of Strategas Research Partners, we are likely to observe messy political spinach in the near-term before we can enjoy the candy of desirable corporate tax reform and foreign earnings repatriation. Obviously if we can digest the spinach, and move successfully to the candy, the markets could quickly enjoy a nice bump up. From a technical perspective, the market has enjoyed better than average gains in each of the months so far YTD; does that bode well or ill for the balance of the year? Said differently, can the pattern of better than normal gains continue, or have those gains pulled-forward full-year progress? It will certainly be an interesting conclusion to what is so far an attractive year.

Posted in Blog Post.