With monetary stimulus winding down here in the U.S., all eyes are on Washington, D.C., looking to see if Congress can enact some form of fiscal stimulus in hopes of driving U.S. GDP above 3.0% going into 2018.
Tax reform is at the center of the debate currently, with Republicans vowing to pass some measures in the coming months. It remains to be seen how effective their plans will be; however, following the healthcare repeal debacle, it’s no wonder the markets are casting doubts whether anything substantial will get done.
There were 156,000 jobs were created in August, shy of the 180,000 estimate and down from the prior month’s 189,000. The unemployment rate ticked up to 4.4% while the underemployment rate held steady at 8.6%. Average hourly earnings edged up +0.1% in August, below expectations, and are now up +2.5% YoY.
The Markit US Manufacturing PMI held steady MoM at 52.8, despite somewhat lackluster readings on factory orders and durable goods. Factory Orders declined -3.3% in July while Durable Goods for July dropped -6.8%, although they did bounce back with a preliminary August reading of +1.7%. Industrial Production unexpectedly fell -0.9% in August while Capacity Utilization came in at a weaker than expected 76.1%.
The Federal Reserve continues to struggle with the absence of inflation in the U.S. economy. The PCE Deflator rose just +0.2% in August (+1.4% YoY) while the Core PCE edged up just +0.1% (+1.3% YoY). Consumer inflation did increase more than expected in August (+0.4% MoM v. expectations for +0.3%), although CPI is up just +1.9% YoY. Producer Prices rose +0.2% in August and are up +2.4% YoY.
Despite mixed economic data throughout the month, consumer confidence remained strong. Going forward, the data is bound to be quite noisy given the devastating impact of hurricanes Harvey, Irma and Maria. As rebuilding efforts get underway in Texas, Florida and the Caribbean, we’re likely to see some pickup in economic activity throughout the early part of 2018. And should Congress implement meaningful tax reform, it’s possible we could see +3.0% growth throughout next year.
Domestic Equities were positive performers in September, led by the S&P 600 Small-Cap Index, which returned +7.71% during the period. Mid-and Large-Caps followed suit, returning +3.92% and +2.06% during the month. Value stocks, as measured by the S&P 500/Citi Value Index, returned +3.28% on the month, outpacing their growth brethren by more than +2%, thanks to the resurgence of the “Trump Trade” that propelled markets post-election. With the performance delta between Growth and Value stocks currently at more than +10% (in favor of Growth), it may be time that Value stocks regain popularity among investors.
Continued U.S. economic growth and newly found positive investor sentiment should help as investors rotate out of the year’s best performing sectors (Tech and Healthcare) into those that have lagged.
Notable “Trump Trades” that performed well in September included value oriented sectors and industries such as Industrials and Banks, as well as smaller-cap, domestic oriented companies that stand to benefit from renewed talks of tax reform. Banks, as measured by the KBW Bank Index, rose +6.90% in September, while Large-Cap Industrials rose +4.0%. Energy stocks also rose nearly +10.0% during the period helped higher by a surge in WTI crude oil prices.
While a great rotation out of Growth tilted sectors (i.e. Tech) may still be a ways off, it is likely that we begin to see investors pare back the year’s winners (i.e. FAANMG names such as Facebook, Apple, Amazon, Netflix, Microsoft and Google), and rotate into cheaper areas of the market.
With the Federal Reserve set to raise interest rates in December, bond proxies were again under pressure, with Utilities, Real Estate, and Consumer Staples shedding -2.74%, -1.39%, and -0.86%, respectively. These sectors are likely to remain under pressure into 2018, as the Fed is projecting another three interest rate increases, which should lessen the appeal of high dividend
International equities were largely positive performers in September, with the MSCI EAFE Index of developed market companies returning +2.50%. Emerging Markets, as measured by the MSCI EM Index, came under slight pressure from a strong U.S. Dollar, as the index gave back -0.39% during the period.
Regionally, the Eurozone posted strong gains in Euro terms, with the MSCI EMU Index returning +4.46%; however, recent Euro weakness weighed on gains. The Euro’s -0.81% drop against the Dollar means Eurozone equities gained +3.78% in USD terms. Looking ahead into the end of the year, the Euro could come under increasing pressure from political risk (i.e. Germany, Spain/Catalonia) and a “sell the news” type event from the European Central Bank (ECB) as they get set to begin reducing monetary stimulus in the near future. This, coupled with the Federal Reserve allowing some of its balance sheet to run off could put downward pressure on the Euro in the near term.
From an individual country standpoint, Japan was a standout performer, with the Nikkei 225 Index returning +4.19% in local currency terms thanks to a weaker Yen (more than -2% during the period). U.S. Dollar investors that were hedged against the currency weakness could have captured both return streams, instead of having their returns eroded from being a USD investor.
Sector performance during the month was led by Energy stocks, with the sector gaining +6.49%. Notable negative performing sectors included bond proxies such as Utilities, Telecoms, and Consumer Staples, which lost -2.19%, -1.40%, and -0.84%, respectively, as yields inched higher across the developed world.
From a year to date standpoint, Emerging Markets remain the standout, up +28.08% during the period, followed closely by Developed Markets, which have gained +20.47%. These returns compare with a +14.24% gain for the S&P 500 Index year to date. Looking ahead, there remains ample runway for international equities to continue outperforming. Emerging Markets remain attractively valued and growth is accelerating in the Eurozone. The recent strength in the U.S. Dollar is a slight concern in the near term, as a stronger Dollar could negatively impact international returns.
It was a relatively eventful month for Fixed Income related news.
President Trump reached across the aisle to cement a debt ceiling deal with the Democrats, postponing the issue for a few months. The debate will likely reignite near year-end, possibly running into early 2018.
Fed Reserve Vice Chair Stan Fischer tendered his resignation, with a target effective date of mid-October. This opened another seat on the FOMC that needs to be filled. The Federal Reserve began to unwind the massive balance sheet that grew significantly following the Great Financial Crisis, topping out in excess of $4.5 Trillion.
They will begin by allowing $10 Billion in monthly coupon/maturity receipts to run off (no longer be reinvested).
The process of shrinking the balance sheet will be gradual and take many years.
Yields moved higher, with the 10 year Treasury increasing to 2.33%, after starting the month in the 2.12% area.
The odds for a December rate hike also adjusted markedly higher in September. Fed Chairwoman Yellen said in a speech that it would be imprudent to keep monetary policy on hold until inflation rises to 2%. After beginning with a 34.5% probability, the likelihood of a December raise closed out September at 70%, roughly doubling.
The move up in yields resulted in weak bond return numbers for the month. The High Yield Corporate and Municipal Indices, along with the EM Sovereign/Credit were able to produce positive returns due to their yield being significant enough to compensate for the impact of the rate increase. The remainder of the high grade indices experienced moderately negative returns for the month, although year to date performance is still good.
Spreads tightened across the board, as risk-on in fixed income remains strong. Investment grade, high yield, and global corporate spreads are all near multi-year lows, as investors stretch for yield. One interesting sign of global bond investors’ strong stomach was Ukraine’s ability to not only access the debt market ~2 years after forcing a 20% “haircut” onto bondholders, but to have the $3 Billion issuance oversubscribed by approximately $7 Billion!
Alternatives were a mixed bag in September with notable price action in multiple assets. The Dollar snapped a seven month losing streak in September, with the greenback rising +0.4%. Dollar strength came on the back of renewed expectations for the Federal Reserve to raise interest rates in December (now 70%), as well as weakness in the Euro due to political concerns from recent German elections.
The Euro has fallen from a high of $1.204 to $1.174 after the AfD party won 13% of the German vote to become the first far-right party to win seats in the Bundestag since WWII, achieving the 5% hurdle required to gain seats. This likely serves as a reminder that populist views are still alive in the developed world, especially evidenced by Catalonia’s vote over the weekend to break away from Spain.
Whether or not this movement continues to gain momentum remains to be seen; however, the possibility will likely continue to give investors pause, and keep a lid on the Euro around $1.20.
The Dollar’s strength contributed to weaker Gold prices during the period. Gold prices fell $41/oz, or more than -3.1%, to close at $1,280/oz on the NYMEX. Despite September’s weakness, Gold has served investors well thus far in 2017, up +11.1%. The safe haven alternative continues to be a favorable hedge against potential geopolitical conflict with North Korea, even though a strong Dollar may weigh on prices in the near term.
West Texas Intermediate (WTI) crude oil rose sharply by +9.4%, or $4 per barrel to close September near $52/bbl.
Hurricane Harvey’s aftermath continues to be felt at the pump, with gasoline prices up more than +10% in the past two months, as large swaths of production and refinery capacity in Texas remains subdued. WTI prices have remained largely range bound between $45 and $55 over the past 18 months, with $50 serving as a psychological line in the sand as well as the point where U.S. producers begin to sell oil futures forward. We continue to see prices range bound for the foreseeable future, as drilling activity continues to ramp up within U.S. shale plays.
Hedge Fund performance was largely positive in September, with Macro strategies the lone negative performing strategy, down -0.99% on the month. Interestingly, Macro strategies are also the only negative performer on the year too, down -0.05%, in a year where nearly all major global equity indices have posted double digit returns.