US equities, as viewed through the lens of the S&P500, added another +86 bps last week bringing month-to-date performance to +2.3%. If US equities are roughly flat or better through the balance of the month, October will conclude as the second strongest month this year. That is a noteworthy accomplishment when considering that US equities are now up more than +15% YTD and there are unsurprisingly a number of other very strong monthly advances already on the books, not to mention that September and October have often proved troublesome. In fact, last week was the 30th anniversary of the stock market crash in 1987 referred to as Black Monday, wherein the stock market plummeted more than 30% in just two trading days.
Historical seasonal context aside, from an economic perspective, the market action (rise) last week makes sense when built on the theme of synchronized global acceleration. The market did briefly take note of some elevated geopolitical tensions mid-week; but globally conditions remain indicative of improvement. In the US, we are witnessing corporate surveys that continue to reflect upbeat business and consumer confidence; at the same time unemployment claims returned back to pre-hurricane levels more quickly than expected and manufacturing appears robust. Outside the US, indicators reveal the second largest economy in the world, China, is again growing very rapidly; that provides a tailwind to global demand. Sales are also running at an attractive pace in Europe, and leaders in Japan responsible for the pro-growth economic reforms of recent years were affirmed through a snap-election that essentially keeps the green light lit on Abenomics priorities. Of added bonus, US investors also received the headline US tax reform actually occurring might be better amid congress making swift and encouraging progress on budget-related items and a tax framework are advancing. Of course tax reform remains highly uncertain and final efforts are likely to remain highly partisan (making almost any supporter defections potentially catastrophic to passage), but early indications suggest the probability for meaningful reform is much higher than investors broadly believe.
As encouraging as this extended period of favorable market appreciation and low volatility is, it is hard not to ponder how investors and markets might be getting at least somewhat complacent. Severe down-days are virtually non-existent over the last 20 months and the market has now gone more than 340 trading days without a correction of 5% or more. Of course we are not rooting against continued advance, but we suspect the perception of calm amid ongoing worry might actually result in outsized negative reaction if/when any unforeseen shocks present themselves to the system. Investors are becoming conditioned to markets that seemingly only go up and pullbacks that are promptly viewed as benign entry points. Economic data continues to support the view that the economy is on sound expansionary footing with risk of near-term recession highly remote, but monetary policy here in the US as well as in Europe looks increasingly likely to continue tightening and prone to departing from the very cautious pursuit of normalization that characterizes this cycle. Here in the US, the yield curve is now the flattest it has been since 2009; without an uptick in inflation expectations and/or economic growth, it looks set to flatten further. This is significant in that many believe the yield curve (if inverted) has been the most reliable forward indicator of market turbulence and warning of recession. We remain watchful of how the yield curve will evolve from here; we expect the current cycle still has more fuel in the tank amid short-term money costs still reside firmly below that of expected inflation (a condition indicative of still easy money). But a change in the composition of the Fed or liquidity abroad, has the potential to restrict monetary policy beyond what the economy can support, ushering in the end of this economic and market cycle.