Third Quarter 2017 Market & Economic Summary
Despite three major hurricanes that caused extensive damage to the islands of the Caribbean and the U.S. mainland, as well as considerable international tension, the U.S. stock market continued its advance. The current bull market gain of over 270% is exceeded only by the decade-long market of the 1990s with its 417% advance. While hurricane damage can have a negative effect on the economy in the short term, the demand for goods and services for recovery and reconstruction efforts often leads to an increase in economic activity in the intermediate to long-term. Nevertheless, the entire island of Puerto Rico, already in financial distress, was left without power by Hurricane Maria.
After years of underperformance, international equity markets have registered significant gains in 2017. The world is experiencing synchronized growth with manufacturing expanding in all major economies for the first time since the 2008-2009 recession.
Domestic Equity Markets
The U.S. market continued its strong performance in the third quarter as the S&P 500 added 3.96%, the Dow Jones Industrial Average 4.94%, and the Nasdaq Composite 5.79%. Those three indices have gained 12.53%, 13.37%, and 20.67% respectively through September 30th. Investors are anticipating possible passage of the first major tax reform legislation in 30 years, but the Trump administration has released few details. Further, as the attempt to pass healthcare legislation showed, interest groups that benefit from the current tax system will lobby hard to keep it in place.
The energy and telecom sectors, which declined in the first half of the year, rebounded strongly in the third quarter with each gaining 6.8%. Oil prices rose after sinking earlier in the year, and fears eased that cut-rate wireless plans from smaller competitors would erode the customer bases of the two largest telecom providers, AT&T and Verizon.
International stocks continued their strong gains in the third quarter with the MSCI EAFE index of developed international stocks up 4.81% and the MSCI Emerging Market index up 7.02%. Those indices have advanced 17.21% and 25.45% for the year respectively. International equities have been aided considerably by the falling U.S. dollar.
The performance of foreign stocks came despite a very tense international climate, including the testing of ballistic missiles and a hydrogen bomb by North Korea, contentious negotiations between Britain and the European Union over Brexit, and a secession movement by the Catalonian region in Spain, to name a few.
Even with this year’s excellent gains, the three-year annualized return for the MSCI EAFE index is just 2.3% while the emerging market index has done slightly better at 2.5%. By contrast, the annual return for the S&P 500 over that period is 8.5%.
The U.S. 10-Year Note fell from a starting yield of 2.3% in the third quarter to a yearly low of 2.04% on September 7th as inflation remained low and international tensions ran high. Then, yields increased through the rest of September as the Federal Reserve reaffirmed that it would deliver another rate increase by year-end and concern grew that the Trump administration tax plan would add significantly to the U.S. budget deficit. The 10-Year Note ended the quarter at 2.33%.
The corporate bond market was relatively calm in the quarter. Investment-grade bonds increased modestly as interest rates ended September close to their levels on June 30th. High-yield was the best performing sector as the default rate fell to a low 1.1%.
The third and final reading by the Commerce Department on U.S. Gross Domestic Product (GDP) for the second quarter showed an increase of 3.1%, the fastest pace of growth since the first quarter of 2015. The labor market remains healthy, producing about 175,000 jobs per month this year while unemployment is low at 4.4%. As noted above, hurricane damage could temporarily result in slower growth, but the effect is likely to be transitory.
In addition, the August reading for the Purchasing Managers Index (PMI) by the Institute for Supply Management (ISM) was the highest since 2011 and one of the strongest levels in the past twenty years. This forecasts continued expansion in manufacturing. Also, the Conference Board’s Leading Economic Index (LEI) pushed higher for the 12th straight month in August, suggesting that a recession is not on the near-term horizon.
While economic indicators in the U.S. and around the world point to economic expansion, the caveat is the action of central bankers. The Federal Reserve has already begun raising interest rates and has clearly stated that increases will continue, albeit at a measured pace. The European Central Bank has signaled that the era of cheap money will be ending, although they have not said when new policies will be put in place.
Therefore, while the signs are encouraging, economic growth could slow or stall as monetary policy around the world becomes more restrictive. As always, we will closely monitor all developments affecting your investments and keep you advised.