The Week in Review
- Strong Job Market and Consumer Strengths
- Trump Nominates New Fed Chair
- Questioning Rate-Hike ‘Consensus’
- Are Treasurys Signaling a Bear Market?
- Looking Ahead
This has been a very busy and eventful week. Not only did we receive hundreds of earnings reports and virtually every market-moving economic report on the list, we also got the Republican tax reform plan as well as President Trump’s nominee to run the Federal Reserve when Chair Janet Yellen’s term expires this coming February.
Oh. We also got more record market highs at home and abroad.
We continue to think that expansion, not contraction, is the road we’re on. We understand the feeling that we have been on this road for so long that a bear market must be around the bend. But the fundamental facts don’t back that up—plus, bull markets don’t die of old age. Investors looked to Friday’s market open poised for gains on the back of Apple’s best quarterly growth in two years and the prospect of lower corporate tax rates buoying profits. As we’ve said from the outset of this tax reform debate, the crux of the matter is as much in the details as it is in the unintended consequences.
Our view is clear: No investment decision should be made on the assumption that every, or perhaps any, aspect of the proposed tax plan will be enacted. More central to our investment decision-making is the strength of the consumer, improved business spending, historically low interest rates and still-growing corporate profits.
For the year through Thursday, the Dow Jones Industrial Average has returned 21.3%, while the broader S&P 500 has gained 17.1%. The MSCI EAFE index, a measure of developed international stock markets, is up 22.5%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has inched down to 2.60% from 2.61% at 2016’s end. On a total return basis, the U.S. bond market has gained 3.3% for the year.
Strong Job Market and Consumer Strengths
Data this week reflected a consumer who is enjoying the upside of full employment within an expanding economy. As reported this morning, October’s unemployment rate fell to 4.1%, the lowest since December 2000, as employers added 261,000 new jobs last month. The initial hurricane-impacted estimate of 33,000 jobs lost in September was revised up to a gain of 18,000.
We are seeing a virtuous cycle featuring a more fully employed consumer base that tends to spend more, further pushing corporate profits higher, which in turn allows companies to hire more employees and raise wages.
Trump Nominates New Fed Chair
President Trump nominated Jerome Powell to succeed Janet Yellen as head of the Federal Reserve when her term as chair expires in February. Powell has been a member of the Fed’s board of governors since 2012 and has supported the Fed’s patient approach to raising interest rates. He is reportedly a low-profile consensus-builder. So we’d expect a Powell-led Fed to look similar to the one under Yellen: Data-dependent, transparent and deliberate, even if unlike most Fed chiefs before him, Powell is not an economist but a Wall Street guy. It’s unclear for now if Yellen will stay on as a Fed governor rather than leader once Powell takes over; her term as a governor ends in 2024.
Questioning Rate-Hike ‘Consensus’
Whatever Yellen decides to do with her future, it is clear Powell and company will have their work cut out for them. The Fed met this week and did not raise the fed funds rate, but hinted that a December hike was likely. (Market-watchers currently view a December hike as a near certainty.) But we’ll take the contrarian route and argue that the Fed cannot hike rates based on current inflation. Sure, those itching for an increase would contend that inflation is accelerating, and it is, but not quickly.
Core prices of goods in the Fed’s preferred inflation gauge—which excludes food and energy costs—rose in September at the second-slowest pace since November 2015. Only August’s growth rate was worse. Add to that the muted wage growth in today’s jobs report—rising wages are typically a precursor to higher inflation—and a holding pattern might make more sense than a hike. If the Fed’s job is to battle inflation, it seems to us that they can stand down for now. We shall see.
Are Treasurys Signaling a Market Correction?
We’re also keeping our eyes on the yield curve, or the difference in yields between Treasury bonds of varying maturities. You may have heard about a yield curve “flattening.” That’s what we’re seeing now. At the start of the year, the difference, or “spread,” between the 2-year Treasury and the 10-year Treasury was 1.23%. As of Thursday night, the yield on the shorter-term bond had risen while the 10-year’s had slipped, narrowing the spread to just 0.74%.
Why does this matter? In the past, short-term interest rates rising above longer-term rates suggested that the Fed had overreached and presaged economic contraction. We’re nowhere near that, but a flattening yield curve could signal a slowing in the economy just as the Fed is preparing to continue raising rates.
Next week you’ll be able to hear a pin drop as we’ll get only three reports of any merit—job openings, consumer sentiment and consumer credit. Volatility could glom on to that vacuum and momentum could swing enough to create a false sense of sustained direction.
If you'd like to learn more about our tactical or fundamental strategies, please contact Steve Johnson at 844-587-7393 or email@example.com.
Please note: This update was prepared on Friday, November 3, 2017, prior to the market’s close.
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