September Pulls Through…
Despite major disruptions caused by the storms Hurricanes Harvey, Irma, and Maria, equity markets managed to post gains in September as the prospect of rebuilding efforts fueled growth estimates across various industry sectors.
The rise in equity markets was fueled by improving economic data and optimism surrounding the proposed tax plan for corporations. The third quarter saw the Dow Jones Industrial Average Index rise 4.9%, its eight consecutive quarterly advance. For September, the Dow Jones Industrial Average Index rose 2.1%, versus an average loss of -1.1% for the month over the past 100 years.
International stocks also did very well with the MSCI EAFE Index increasing 5.4% for the quarter. While U.S. stocks have led global markets for many years, there has been a noticeable shift towards international markets in both developed and emerging countries. Many foreign markets are a pulse or two behind in their economic recovery and, accordingly, valuations and room for future growth appear relatively attractive. This shift in market leadership may persist for several years in many cases. We are adjusting our client portfolios to participate more broadly in diversified international equity holdings.
Looking ahead, small cap company stocks may be the primary beneficiaries of the proposed corporate tax cuts since smaller companies tend to pay higher effective tax rates than larger cap companies. The tax proposals pushed the small cap Russell 2000 index higher by 5.7% for the quarter, helping them reduce the gap on large cap returns for this year. A stronger dollar also lifted small caps, which do not have the international exposure that large multinational companies have.
Fixed Income – Yields Move up
Treasury yields rose in September as the Fed indicated it would begin the task of reducing its holdings of government bonds. For the quarter, the Barclays U.S. AGG index rose only slightly, up 0.85% and up 3.14% year-to-date. Some of our unconstrained and total return bond funds, in the U.S. and abroad, are outpacing the AGG for 2017.
Additional influences on the bond market include tax proposals by the White House deemed to stoke inflationary pressures as well as better than expected growth data.
The Fed and Monetary Policy
The most recent median household income data revealed a 3.2% rise over the past year, net of inflation, according to the U.S. Census Bureau. This larger than expected increase helped stoke support for a Fed rate hike during December of this year. Overall, indicators of inflation are mixed, with rent and gasoline accounting for the primary rise in inflation while grocery costs and service-related fees fell.
Comments from the Federal Reserve in response to any possible interference caused by the hurricanes suggested that the storms were unlikely to prevent the Fed from its gradual rising rate trajectory or from reducing its $4.5 trillion balance sheet. Economists believe that the Federal Reserve will continue to find it difficult to normalize monetary policy, though, until an appropriate fiscal policy is in place.
Tax Reform/Reduction Proposal
Tax reform proposals spurred discussion and anticipation about their impact on the economy and the markets. The tax plan’s proposals include: reduce the number of tax brackets from seven to three, double the standard deduction amount, eliminate state and local tax deductions, tax “pass through businesses” at a 25% rate, plus eliminate the estate tax and the alternative minimum tax (AMT).
As a potential positive for U.S. equity markets, the tax proposals include a generous cut in the corporate tax rate
from 35% to 20%. The corporate tax proposals also include a penalty for companies taking advantage of foreign tax havens, where U.S. companies earning profits overseas will have to pay a minimum 10% tax on foreign income even if it isn’t brought home.
Since the tax plan is still only based on proposals, not an actual bill, market reaction may change as amendments are made throughout the process towards enactment.
Aftermath of the Hurricanes
Hurricanes Harvey, Irma, and Maria have impacted numerous sectors in three distinct geographical areas of the United States. Sectors affected include tourism, housing, energy, transportation, and jobs.
In the wake of Hurricane Irma, preliminary damage estimates across the state of Florida may exceed $45 billion based on various economists reviewing the storm’s impact. Federal Reserve member William Dudley said that the devastation caused by Hurricanes Harvey and Irma could boost U.S. economic growth in 2018 as rebuilding of infrastructure efforts get underway. The Fed also mentioned that the storms were unlikely to deter the Fed from its rising rate trajectory or from reducing its $4.5 trillion balance sheet.
Hurricane Maria exacerbated financial and infrastructure issues in Puerto Rico. A frail power grid and debilitated infrastructure has left the island nation in disarray.
The fallout of the hurricanes on the credit markets seems inevitable. As insurance companies begin the process of paying out claims to those insured, they may need to liquidate holdings of corporate and government debt to meet payouts. In addition, the situation in Puerto Rico calls into question how mainland munis may be affected.
Consumer & Business Confidence
While homebuilder confidence declined slightly in August, consumer and business confidence remained strong.
Consumer sentiment, as measured by the Conference Board and University of Michigan surveys, remained near year-to-date highs. In fact, the Conference Board survey currently sits at its second-highest level since 2001.
Looking at August’s retail sales report, the headline figure that includes volatile auto sales declined. The core reading that strips out autos rose by 0.2 percent—a solid if not spectacular figure.
Businesses also had positive news on the confidence and spending fronts. The Institute for Supply Management’s manufacturing and nonmanufacturing indexes both increased more than expected, indicating that business confidence remains strong. The manufacturing index for September was especially positive, reaching its highest level in 13 years.
Massive Credit Breach
The Equifax data breach has affected 143 million consumers and has led to numerous investigations and actions taken by various governmental entities including the FBI and the Federal Trade Commission. Compromised information included names, addresses, Social Security numbers, birthdates, and driver’s license numbers. We have suggested that clients request a “credit freeze” on their accounts with each of the three major credit reporting agencies.
While the investment climate is improved, we continue to try to protect our portfolios through diversification in stocks and bonds of different types, both in the U.S. and abroad. We continue to look for the best opportunities to balance risk and return for each client’s situation.
|*All index returns and other statistics are provided by blueroom.com, unless otherwise noted.|
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