November saw a run of steadily improving economic data, setting the stage for a likely December interest rate hike by the Federal Reserve. The overall employment picture remained strong, as did the housing market, while industry and the consumer both showed marked signs of improvement.
While the market has fully priced in a quarter-point rate hike in December, it remains to be seen what the impact of the surging US dollar and the sharp rise in interest rates will have on corporate earnings. The Unemployment Rate for October ticked slightly lower to 4.9% as Nonfarm Payrolls increased by +161,000.
The Underemployment Rate dropped to 9.5% and the Labor Force Participation Rate held steady at 62.8%. Of note, Average Hourly Earnings rose +0.4% MoM in October and are now up +2.8% from a year ago. Rising wage pressures are a key ingredient to broader price inflation and Fed policy makers will be eyeing these numbers closely.
Despite pockets of strength in various markets around the country, the broader housing picture looks stable with the number of newly built housing units still trailing long-term averages. As well, rising rents are making home buying look more attractive for many would-be renters.
Housing Starts surged +25.5% MoM in October while Building Permits were up +0.3%. Existing Home Sales rose +2.0% on the month while New Home Sales declined -1.9%. The S&P CoreLogic CS US Home Price Index edged up +0.83% during September and is up +5.46% YoY. The second reading of third-quarter GDP was up slightly from the prior reading and ahead of expectations.
According to the report, the US economy grew at a +3.2% annualized rate as the US consumer continues to do the bulk of the heavy lifting in the economy. It will bear watching as the Trump administration puts forth its proposals around tax reform and fiscal stimulus whether or not there’s enough to stimulate the so-called animal spirits which can spur investment and broader economic growth. Lower taxes, increased government spending and a less bureaucratic business environment could help push US GDP north of 4% in 2017.
Domestic Equity
Donald Trump’s presidential victory was a boon to domestic equity markets, as Large-, Mid-, and Small-Caps rose +3.70%, +8.00%, and +12.53%, respectively. Small-Caps regained leadership among the other market cap indices, as the Index has gained +22.39% YTD. Markets rewarded small cap companies this month with the likelihood that Donald Trump’s policies will benefit small-cap companies especially.
A strong dollar, coupled with protective trade policies, would likely benefit smaller companies with less exposure to international sales. Large-Cap equities continue to lag their smaller counterparts, only returning +9.79% so far in 2016, while Mid-Caps are up +18.15%. Value Stocks, as measured by the S&P 500 Citi Value Index, rose +6.30% in November, outpacing Growth stocks by over 500 bps! This monthly outperformance was also the largest difference in return between Value and Growth stocks this year.
Furthermore, Value has outperformed Growth eight out of the last twelve months, leaving Growth stocks to lag Value by over 900 bps YTD. Domestic Equity valuations expanded in November, as the S&P 500 trailing P/E multiple rose from 19.9x to 20.6x. Last month’s rally bolstered market cap and style based indices to appear expensive relative to long term averages.
Moving forward, stretched valuations could continue through the support of expansionary fiscal policies. However, higher interest rates and a stronger U.S. dollar could also be a headwind for corporate earnings, thus putting pressure on equity market valuations. As for sector performance, Financials rose +13.94% in November, leading all other sectors for the second month in a row. The possibility for reforms of the Dodd-Frank Act by President-Elect Trump may bode well for banks and financial institutions, but much remains to be seen.
Furthermore strong economic data suggests an increase in the Fed Funds Rate at the next FOMC meeting is likely. Industrials and Energy were neck and neck for second place among sectors this month, rising +8.85% and +8.40%, respectively. Industrials, which consist of the machinery, construction, defense, and other manufacturing industries, were buoyed on support from Donald Trump, who looks to increase infrastructure spending and reduce effective corporate tax rates.
Energy’s +24.95% return this year leads all other domestic equity sectors. Consumer Staples and Utilities fell -4.29% and -5.40%, this month, respectively, while Information Technology fell slightly by -0.30%. Donald Trump’s victory, paired with rising interest rate expectations, caused a shift away from defensive, higher-yielding sectors like Consumer Staples and Utilities this month. Although Health Care recovered +1.95% in November, the sector remains alone as the only sector still negative for the year.
International Equity
International equities underwhelmed in November, with only two major market indices posting positive returns (China and Japan). Developed market equities, as measured by the MSCI EAFE Index, fell -1.94% on the month, helped lower by the UK, where the FTSE 100 Index shed -2.00%, but buoyed by Japan’s Nikkei 225, which rose +5.07%.
Regionally speaking, the Eurozone, as measured by the MSCI EMU Index fared slightly better, losing -0.23% on the period, thanks to better than expected economic data. The Citi Eurozone Economic Surprise Index rose from 40.8 at the end of October to 56.90 in November, signaling economic data that continues to beat estimates for the Eurozone.
China’s Shanghai Composite Index rose +4.83% on the month, in sharp contrast to broad based emerging markets, which were hit hard by a strong U.S. Dollar and sold off after U.S. Presidentelect Trump’s victory. The broad based MSCI EM Index lost -4.60% during the month after rising sharply through the first three quarters of the year. China’s Purchasing Managers Index has slowly been improving, from 51.2 to 51.7, likely helped by a weaker Yuan.
The Peoples Bank of China (PBOC) has continued to allow the Yuan to weaken versus the Dollar, hitting a recent low of 6.92 CNY/USD and the end of November, the lowest level in more than 8 years. At the individual sector level, ACWI ex. U.S. sectors were mostly negative, except for Energy (+0.71%) and Financials (+1.21%).