Third quarter highlights

The U.S. stock market once again embarked on a gradual upward climb in the third quarter, despite widespread skepticism by the investing public. Though economic reports continued to improve from earlier in the year, they were initially overshadowed by concerns that Brexit might require a bailout of Italian banks. As a result, sovereign bond yields in Europe, America and Japan dropped to new lows in early July but soon began to recover.

Aiding the yield bounce were positive political developments in Japan, where the ruling coalition did very well in elections, as well as in the UK, where the leadership succession went very smoothly with Theresa May installed as the country’s new Prime Minister. Meanwhile, news from S&P 500 companies was “better than feared”.  Though earnings were still down on a year-to-year basis, they were better than analysts had predicted. New highs in advancing over declining stocks in most major indices were corroborated by strong internal market statistics, indicating that small and mid-cap stocks were also participating in the rally.

“If you can’t convince them, confuse them.”  — Harry S. Truman

Fed ambiguity and political uncertainty

At least part of the increase in yields was due to private and public pension funds having difficulty in meeting their return requirements because of prolonged low-interest rate policies that hurt investors. Fed officials tried to prepare financial markets by sounding more hawkish at the annual Jackson Hole economic summit in late August, but wound up causing a selloff similar to the “taper tantrum” of mid-2013. After a series of softer economic releases, the Fed wound up leaving rates unchanged at the September meeting. This has led many to wonder what government officials are really trying to communicate to the public. At this point, it appears that a rate hike this year (most likely in December) will occur, but of course, the outcome will be data dependent.

The upcoming Presidential election is also causing investment angst, with surveys indicating that the campaign rhetoric is having a negative effect on consumer and capex spending plans. Besides impacting individual sectors such as Healthcare and Financials, the uncertainty extends to multinational companies and major trading partners, such as Mexico and China. Fortunately, we are now entering the last full month before the November election.


Trends in other countries have been mixed. European bank issues, now focused on Deutsche Bank, will likely weigh on Eurozone bourses. Fortunately, Deutsche Bank is not another “Lehman moment”.  With the European Central Bank (ECB) serving as a backstop, Deutsche’s short-term liquidity is not an issue although its lack of profitability is causing longer term capital adequacy problems. Meanwhile, China, whose economy had been slowing for the last two years, is having a growth pickup that should help multinational companies and global economies.

Hawaii’s economy continues to grow, with the unemployment rate lower than the national average and still dropping. Tourism remains strong, with the number of visitors hitting an all-time high for the month of August, while spending per tourist rose 5% from last year. Tourism has now been climbing for 19 straight months. Terrorist attacks abroad, particularly in Europe, may be helping to fuel the numbers. The absence of any major storms hitting the islands so far during this hurricane season may also be contributing.

Looking ahead

U.S. economic growth should pick up in the third quarter between 2.5-3.0%, a marked improvement from the first half of the year. We see a continued slow upward grind in equities, with occasional pullbacks, characteristic of the markets earlier this year. We are somewhat more cautious on bonds if prices move higher, as the risk-reward ratio is unfavorable if we re-test the lows in yields reached this summer.

  • Better trade statistics and an end to the five-quarter inventory drawdown should bolster growth while weaker consumer spending, especially with regard to auto sales, may temper gains.
  • A stable U. S. dollar, a recovering China and oil prices should lead to an earnings upturn soon. For the first time since last year, corporate sales, which preceded the profits drop, are forecast to increase in the third quarter.
  • Though equity valuations are not inexpensive, the continued moderate growth in the U. S. economy should limit selloffs and contribute to a “buy the dip” strategy for many money managers holding large amounts of cash.