Washington Weighs on Wall Street

The Week in Review

  • Gains Are Welcome, Complacency Is Not
  • Tax Plan Hopes Lift Markets
  • Global Economic Strength
  • Looking Ahead

After a week that saw stocks and stock markets continuing to set new highs, news from Washington threatened to derail the euphoria. Stocks fell Friday morning on the news that former National Security Adviser Michael Flynn pleaded guilty to making false statements to the FBI concerning Russia and reports that he had been directed by President Trump to speak with the Russians.

The unsettling news from Washington countered the encouraging economic data and positive momentum seen earlier in the week—as we write this, U.S. stock markets are bouncing off of their lows but remain below their highs for the day.

In the bond markets, certain tax-exempt municipal bonds came under pressure as supply overwhelmed demand. This came about as some issuers raced to sell new bonds to hedge against the possibility that changes to the tax code would force them to pay higher yields next year. We believe this is a short-term phenomenon and that bond-market dynamics will bring prices back in line as this supply is absorbed.

For the year through Thursday, the Dow Jones Industrial Average has returned 25.7%, while the broader S&P 500 index has gained 20.5%. The MSCI EAFE index, a measure of developed international stock markets, is up 23.1%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 2.71% from 2.61% at 2016’s end. On a total return basis, the U.S. bond market has gained 3.1% for the year.

Gains Are Welcome, Complacency Is Not

To say it’s been a remarkable year so far would be an understatement. The S&P 500 index has now registered 13 consecutive months of positive total returns. If December ends with even a point or two of profit, the S&P 500 will have its first calendar year without a month in the red since its late-1950s inception.

The gains are especially noteworthy when you consider that volatility has been almost absent. The 12 months since Election Day have seen the lowest average intraday changes in the S&P 500 in over half a century.   

Now is not the time to become complacent. We remain surprised by the absence of a normal market correction. And the longer we go without one, the more panic a pullback is likely to cause. Headline writers continue to focus on point gains or losses, not percentage gains or losses, because they’re more eye-catching. A 2,000-point decline for the Dow would likely be met with a thunderous herd of panicky headlines, despite the fact that it would only represent an 8.2% drop based on last night’s close.

Our investment view remains unchanged: So long as economic data reflects growth, such pullbacks will likely be buying opportunities for investors like us.

Tax Plan Hopes Lift Markets

The markets’ recent upswing has some underpinnings in the belief that a tax reform plan, which is really just a mosaic of tax cuts rather than a fundamental change to the tax code, is a fait accompli and will yield greater economic growth. If the tax bill is not passed, investors and traders may rush to hit the sell button. However, even if the tax bill does pass, it may be met with selling—a case of buy the rumor, sell the news.

Whether the Senate tax plan passes or not, we think headlines will turn to focus on a possible government shutdown in the coming weeks—with a lot of rhetorical sparring and disaster-projecting headlines to boot. A shutdown likely does more damage to the party in power than the opposition, and political self-interest is a good motivator to at least float another temporary patch.

Global Economic Strength

Headlines are great fodder for conversations at the bar—but we set our bar much higher. We focus on actual data. We see fundamentals that support more economic gains in the months ahead.

The initial estimate of 3.0% third-quarter economic growth appears to have been too low; a revision this week showed the economy expanded at a 3.3% annualized pace—the best rate in three years and the second straight quarter above 3%. We’ll get the final read later this month, but it’s clear that the U.S. economy continued to grow at a decent clip despite the hurricanes that were expected to crimp output.  

On top of that, consumers are employed, confident and spending. Unemployment, whether you prefer the headline number or the broader U-6 figure, is below pre-credit-crisis levels. Consumer confidence numbers hit a 17-year high in November and buyers spent 16.9% more on Black Friday this year ($5.0 billion in total sales) and 17.0% more online on Cyber Monday ($6.6 billion) than they did a year ago. New home sales have also been strengthening. 

It’s not just the U.S. that’s growing nicely. A recent report from the European Central Bank found that the global economy continues to travel on a sustained growth track, and the International Monetary Fund forecasts fewer than 10 countries worldwide will be in recession next year. That’d be the lowest number since 1980 and stands in stark contrast to the more than 90 countries tracked by the IMF that were suffering recessions in 2009.

Looking Ahead

December opens with reads on factory orders, the service sector (90% of our workforce), consumer credit and sentiment, as well as the midweek release of ADP’s private sector job report, a precursor to next Friday’s unemployment rate for November. And further down the calendar, the Federal Reserve’s final meeting in 2017 on December 12 and 13 should end with yet one more small increase in short-term interest rates—a boon for savers who’ve only recently seen yields begin to rise on their interest-bearing bank accounts.

Taken as a whole, this week’s data-rich reports have yielded what we expected to see: A strong economy, consumer and markets—we anticipate next week’s reports will reinforce that picture. We’re confident in our ability to advance or defend as we march forward in the last month of 2017 and the new year ahead.

Please note: This update was prepared on Friday, December 1, 2017, prior to the market’s close.

This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations or personal investment advice, or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.

Our statements and opinions are subject to change without notice and should be considered only as part of a diversified portfolio. You may request a free copy of the firm’s Form ADV Part 2, which describes, among other items, risk factors, strategies, affiliations, services offered and fees charged.

Past performance is not an indication of future returns. The tax information contained herein is general in nature, is provided for informational purposes only, and should not be construed as legal or tax advice. We do not provide legal or tax advice. Always consult an attorney or tax professional regarding your specific legal or tax situation.

Companies mentioned in this article are not necessarily held in client portfolios and our references to them should not be seen as a recommendation to buy, sell or hold any of them.

© 2017 Braver Capital Management, an Adviser Investments company.