November saw the second estimate of Q3 U.S. real gross domestic product released by the Bureau of Economic Analysis come in at 3.3%, slightly ahead of the advance estimate of 3.0%. Domestic growth was widespread with increases in private inventory investment, nonresidential fixed investment, personal consumption, state and local government spending and exports. Inflation-adjusted GDP grew at a 5.5% annualized rate and now measures the U.S. economy at $19.5 trillion.
The U.S. unemployment rate for October fell to 4.1%, down from the prior month’s reading of 4.2%.
Nonfarm payrolls increased by 261,000 for the month, slightly below expectations, while manufacturing payrolls increased by 24,000, ahead of expectations. Surprisingly, average hourly earnings were flat in October (versus expectations for a +0.2% rise), and are up +2.4% YoY. The labor force participation rate unexpectedly fell to 62.7%, down from the prior reading of 63.1%. The weekly initial jobless claims numbers continue to hover near the lows (see chart below), averaging 239,000 per week.
Broad inflation measures remained subdued as the PCE Deflator for October rose just +0.1% (+1.6% YoY).
The consumer price index also edged up just +0.1% on the month (+2.0% YoY) while prices at the wholesale level edged up a higher than expected +0.4% in October (+2.8% YoY). Ex food and energy, CPI is up +1.8% YoY while PPI has risen +2.4%.
The Conference Board’s Leading Economic Index edged up +1.2% in October suggesting U.S growth should remain strong well into 2018. The index is a broad measure of business cycles and both domestic and global readings point to synchronized global growth continuing across the global well into next year. We’ll look to any downturns in this number as a sign the economy might be slowing but for now all signs point to continued strength.
Domestic Equities
Domestic Equities were standout performers in November on renewed hopes of tax reform legislation by the GOP. Mid- and Small-Cap equities posted outsized gains as they likely have the most to gain from a reform package due to their higher relative tax rates.
Mid-Caps, as measured by the S&P 400 rose +3.67% on the month, followed closely by Small-Caps, as measured by the S&P 600, which rose +3.51% during the period. Large-Caps, as measured by the S&P 500 were not that far behind, rising a stellar +3.07% during the month.
Within the Large-Cap universe, Value stocks, as measured by the S&P 500 Citi Value Index, rose +3.39%, as their underlying constituents (largely bank financials) rose sharply. The KBW Bank Index of large money center banks rose +3.36% on the month, and an impressive +5.86% in the past week. Much of the rally in Banks (and Value stocks in general) came post-Thanksgiving in the last week of the month as tax reform discussions intensified. A rotation out of Growth oriented stocks (mainly Technology stocks) proved to be a source of funds; however, the S&P 500 Citi Growth Index still managed to post an impressive +2.82% during the period.
From a sector standpoint, more defensive-oriented laggards such as Telecoms, Consumer Staples, and Consumer Discretionary were the top performers on the month, gaining +6.03%, +5.67%, and +5.06%, respectively. The Telecom and Staples sectors are still some of the worst performers on a year to date basis, having returned -6.64% and +11.03%, respectively, while Consumer Discretionary continues to be led by Amazon (+56.93% YTD, 16.91% of sector).
Notably, Technology shares were laggards during the month, gaining a mere +1.15%, as Facebook, Apple, Google, and Microsoft underperformed the market, supporting the sector rotation theme that may be in play after Tech stocks have gained +38.82% YTD.
International Equity
International equities posted positive returns in November, with both Developed International and Emerging Markets equities in the black. Developed Markets, as measured by the MSCI EAFE Index, rose +1.08%, while Emerging Markets, as measured by the MSCI EM Index eked out a +0.21% return.
From a regional standpoint, the Eurozone, as measured by the MSCI EMU Index, rose +0.03% in USD terms, and -2.02% in EUR terms, as concerns over Brexit talks and German elections continue to dominate what has otherwise been a continued streak of strong economic fundamentals in the region.
From an individual country perspective, the U.K. (FTSE 100 Index) and Japan (Nikkei 225 Index) posted returns of -0.03% and +4.31% in USD terms, but returned -1.78% in GBP terms and +3.24% in JPY terms, respectively on the month. The U.K. continues to deal with uncertainties from Brexit, a recent interest rate hike, and deteriorating fundamentals. Additionally, a volatile GBP has added uncertainty to investing in U.K. equities as a U.S. based investor. As far as Japan is concerned, economic momentum remains strong across the board and the Bank of Japan continues to maintain Yield Curve Control (YCC) giving Japanese equities a stable monetary policy backdrop.
Emerging Markets continue to post positive returns and remain the world’s best performing major market index, up +32.88% year to date. Within the broad MSCI Emerging Markets Index, performance attribution can be boiled down to exposure to China and the Technology sector. While the widely followed Shanghai Composite Index has returned +9.08% YTD in CNY terms, and +14.61% in USD terms, the broader MSCI China index has gained +51.41% in USD terms. Almost more importantly, exposure to Technology stocks such as Samsung, Tencent, Taiwan Semiconductor, and Alibaba (to name a few) have provided outsized returns and positive attribution, having returned +56.36%, +109.15%, +37.49%, and +99.86% YTD in USD terms.
Emerging Markets continue to be led by robust earnings growth and remain attractively valued on a relative and absolute basis versus other major global equity markets. Furthermore, for those believers in mean reversion (like us!) the S&P 500’s annualized return of +15.73% per year over the trailing 5-year period dwarfs the MSCI EM Index annualized return of +4.96% per year over the same period, adding to the allure of Emerging Market equities in 2018 and beyond.
Fixed Income
Yields rose coming into month end, as the congressional tax plan seemed to be picking up momentum. Originally, the President had hoped to have it signed by Thanksgiving. Of course, that was overly ambitious and failed to happen. A secondary concern that may be influencing yields is the revival of the debt ceiling debate. The President bought himself some time when he made the agreement to extend it a few months, but its year-end reappearance is not ideal.
The curve continued on its flattening trajectory, with 2-year yields rising 20 bps, while 10-year yields rose only 4 bps, and 30-year yields fell 5 bps. While the curve is fairly flat, we are not yet nearing an inversion, which many would read as a sign of an impending recession. It will be important to continue monitoring the shape of the yield curve as the Federal Reserve expects to raise rates three more times in 2018, while at the same time they hope to continue increasing the amount of Treasury and Agency bonds that are eliminated from their portfolio holdings.
Incoming Fed Chairman Jerome Powell was welcomed by a Congressional interrogation. He came off as intelligent and self-assured, failing to become flustered, even when aggressively, and perhaps disrespectfully addressed by those present. He did note, “I think the case for raising interest rates at our next meeting is coming together.”
Not surprisingly, the market currently puts the chance of a December rate increase at 98.3%.
Municipals had a rough month due to concerns over potential tax cuts reducing the demand for tax-free bonds.
Additionally, there is potential for a deluge of deals coming into the market prior to year-end as issuers try to take advantage of current rules which will disappear in 2018 if tax reform is successful. Fears are likely overblown, as reduced demand should be offset by reduced supply as the tax bill decreases the number of entities qualified to issue tax-exempt bonds.
High Grade and High Yield spreads widened slightly in the month, but remain near historically low levels. Very little additional yield is being offered to compensate for the inherent credit risk, at a point quite late in the cycle.
We currently favor higher quality holdings for this reason.
Alternative Investments
Alternative Investments posted mixed results in November. The U.S. Dollar, as measured by the DXY Index, lost -1.6% on the month, even as prospects for tax reform and a December rate hike by the Federal Reserve remain in vogue.
Tax reform talks gained steam in the final days of November, but didn’t manifest itself in a stronger Dollar.
Additionally, the Senate confirmation hearing for newly appointed Fed Chair Powell was positive and the probability of a rate hike at the Fed’s December 12-13 meeting stands at 98.3% according to data compiled by Bloomberg. The weaker Dollar didn’t provide much of a boost for Gold, as spot gold prices rose a few dollars to $1,275/ounce, a gain of +0.3% on the month. Gold prices have remained relatively stable over the past few months, and remain a viable hedge against global geopolitical risks and equity market volatility that may emerge in the future. The weaker Dollar did propel the Euro, which gained +2.22% on the month to close at $1.19 USD/EUR, near the highest level in 3-years.
Strong gains from U.S. equities (the S&P 500 gained +3.07% during the month) and gains from the more “unloved” sectors of the year, helped Real Estate catch a bid. REITs, as measured by the FTSE NAREIT All REIT Index gained +2.4% during the month, with the index hitting a new 52-week high; however, REITs remain an underperforming asset class versus the broader market, returning +11.41% YTD.
West Texas Intermediate (WTI) crude oil gained $3/barrel, or +5.6%, during the month, to close above $57/barrel on the NYMEX. Crude’s gains were stronger intra-month, having neared the psychological $60 / barrel mark for the first time since June 2015 as prospects for an new OPEC production deal were anticipated and confirmed on November 30.
Under the new deal, production curbs will be extended through December 2018; however, a number of OPEC countries remain exempt and continue to bring on additional supply, while the U.S. continues to pump oil at near record volumes. Despite the strong gains in crude, the broad based Bloomberg Commodities Index shed -0.6% on the month and remains down -2.1% for the year.
Hedge Funds continued to struggle in November, with only 3 of 10 strategies posting positive returns. All 10 strategies have posted year to date gains; however, even the top strategies on average trail the S&P 500 by more than 10 percentage points, highlighting the difficulties hedge funds have had in the current bull market.
This article was written by Nottingham Advisors, a participant in the ETF Strategist Channel.