“Time in the market
is more important
than timing the market.”
— Unknown
Third Quarter Recap
The summer of 2017 proved to be a good one for financial markets, especially for equities. In spite of cautionary adages such as “sell in May and go away” and “September is the worst month”, pullbacks proved to be short and shallow. Global stocks also rose, while ten-year Treasury yields ended largely unchanged for the quarter, after dropping to almost 2.00% in early September.
The relative lack of market volatility largely reflected steady economic growth in the U. S. and gradually improving conditions around the world. The Eurozone continued its long-awaited recovery after a favorable outcome in the French elections, and China lent strength to the rest of Asia.
The stability of the markets was somewhat surprising, given such unnerving events as North Korean missile launchings and the domestic rancor from the Charlottesville tragedy, together with the lack of progress in new health care legislation. However, each incident seems to have a shorter shelf life than the previous one, a sign of a market that is more focused on the economy than anything else.
Interesting developments at the Fed
The second half of the quarter included some notable changes on the investment landscape. One change was oil prices finally hitting a temporary bottom. Consumption has been picking up, with the International Energy Agency (IEA) moderately raising demand forecasts and OPEC members adhering to surprisingly high production quotas.
Also, tax reform legislation moved into the spotlight, and global economic reports in the U. S., China and the Eurozone have been largely upbeat. This resulted in a rotation into Value stocks and more economically sensitive stocks in the Financials, Energy and Materials sectors. Small and midcap (SMID) stocks also rose, leading to a broadening of the rally, a positive development. Almost lost in the headlines was the announcement that the $970 billion Norway Sovereign Wealth Fund, the world’s largest, was moving from 60% to 70% equities.
Meanwhile, Fed watchers now have three things to handicap:
- Pace of interest rate increases
- Shrinking of the Fed’s $4.5 trillion balance sheet (also known as QT or quantitative tightening)
- Composition of next year’s Board of Governors
At this point, it appears that a third rate increase will occur in December. The monthly QT runoff will initially be $10 billion, with the monthly total increasing by $10 billion each quarter over the next year. This amount represents less than 7% of the total and appears manageable, at least for now.
The big question is who will be nominated to be on the Board, especially the Chairman. Current head Janet Yellen, Governor Jerome Powell, former Governor Kevin Warsh and Stanford professor John Taylor are on the short list of candidates. The announcement, due soon, could cause some short-term volatility in the markets, though both Yellen and Powell would likely continue to pursue a gradual pace of monetary tightening next year.
Looking Ahead
Though tax reform is not a certainty and would likely be a 2018 event, we feel that a watered down package will eventually pass Congress. If the bill contains a lowering of the corporate tax rate to the mid-20s, some repatriation for foreign profits and substantial depreciation of capital spending, the effect could increase real GDP growth by 0.3-0.5% to about a 2.3-2.5% pace. Although a long way from the 3% or 3.5% that some in the Administration have suggested, it would still be a noticeable improvement while keeping the Fed from tightening too quickly.
We believe that the secular (multi-year) bull market in U. S. stocks highlighted in our October 2013 Market Commentary will continue. The key is the economic expansion, whose moderate pace is intact and absent of almost all of the excesses that normally accompany recessions and subsequent bear markets. Valuations are not cheap, but neither are they in bubble territory.
We also are constructive on global equities, both in developed and emerging markets. We remain cautious on fixed income with yields still at low levels.