Stock markets around the globe continued their post-Brexit rallies in July as the Federal Reserve did not raise interest rates at its July meeting, although the central bank strongly hinted that an increase would be forthcoming this year. Markets traded sideways in August but, on September 9th, Boston Fed President Eric Rosengren, formerly a dove on interest-rate policy, gave a speech in which he said that current economic data made a “reasonable case” for rate increases, and that low rates were possibly overheating the U.S. economy. Rosengren’s strong statement and position change sent a chill through the market and the S&P fell 2.4% that day.
Near the end of the quarter oil prices rose sharply on a report that OPEC had agreed informally to a production cut, although the specifics still must be hammered out. Energy stocks rallied and that helped the S&P 500 recover to finish the quarter at 2168.27, just 1% below its all-time high.
Domestic Equity Markets
The S&P 500 gained 3.3% in the third quarter and is now ahead 6.1% for the year. The Dow Jones Industrial Average was up by 2.1% in the quarter and has gained 5.1% on the year. However, the star was the NASDAQ Composite, which had lagged during the first half. Technology stocks regained their footing and the NASDAQ increased by 9.7%. Like the S&P, the NASDAQ is up by 6.1% for the year.
Higher-yielding sectors of the market such as utilities, real estate investment trusts, and consumer-staples, hot earlier in the year, declined in the third quarter as market participants sensed higher interest rates coming. The selloff of those stocks has continued in the fourth quarter. The S&P Utilities sector fell 7.5% in the nine trading days through October 5th, cutting its year-to-date gain to 8.9%.
Developed international stocks fell more sharply than other markets in the wake of the Brexit vote and recovered more slowly. The MSCI EAFE index gained 5.8% in the quarter but is still down nearly 1% for the year.
Late in the quarter, a report circulated that the U.S. Department of Justice (DOJ) was seeking payment of a $14 billion fine from Deutsche Bank (DB) for its actions during the mortgage crisis. DB stock and bonds fell sharply as market participants feared DB might be insolvent. Then, on September 30th, DB stock surged 14% on a report in the French press that the bank was nearing a settlement with the DOJ for $5.4 billion. Nevertheless, DB stock is down more than 50% over the past year.
Emerging markets, already up 5% during the first half of the year, gained an additional 8% in the third quarter as the prices of oil and other commodities stabilized and began to rise. Emerging market economies have been struggling with a decline in world trade, but the Global Composite of Leading Indicators produced by the Organization for Economic Cooperation and Development (OECD) has been rising for six months, potentially foreshadowing an increase in trade volumes.
The yield on the 10-Year Treasury Note rose in the third quarter, its first quarterly increase this year; however, the 10-Year fell to a historic closing low of 1.366% in early July before rising to 1.6% by the end of the quarter. The current level is well below the 2.273% logged at the end of 2015 and many investors believe yields will remain exceptionally low with the central banks of Europe and Japan still using negative interest rates in an effort to stimulate growth.
The high-yield market staged a strong recovery this year after slumping for more than a year due to fear of major defaults in the energy sector. The SPDR Barclays High Yield Bond ETF, symbol JNK, has a total return of 13% year to date. The spread between high-yield and investment-grade bonds has fallen to 5.6% versus the long-term average of 5.9% per the J.P. Morgan Domestic High-Yield Index.
U.S. Gross Domestic Product has been improving gradually this year as second quarter GDP was revised higher from 1.1% to 1.4%. Many analysts expect third quarter growth to come in between 2.5% and 3%. OPEC’s decision to cut oil production, if carried out, should be positive for the stability of both the global economy and financial system.
U.S. economic indicators were ticking up for several months until some softness in August. The Institute for Supply Management (ISM) Purchasing Managers Index (PMI) slipped below the growth threshold of 50% with a reading of 49.4%, but the PMI for September rebounded to 51.5%. Consumer confidence and consumer sentiment indicators remain resilient, and the National Association of Home Builders (NAHB) gauge of builder confidence is near a post-recession high.
Technically, the U.S. equity market is in reasonably good shape as the S&P 500 moved decisively above the 2100 level in the third quarter, but dangers and uncertainties lurk. The outcome of the Presidential election and the actions of the Federal Reserve could unsettle markets. In addition, the weakness of Deutsche Bank and other European banks is a concern.
The U.S. national debt is nearing $20 trillion. An increase in interest rates would strain the U.S. budget, possibly causing a slowdown in growth or even a recession. As always, we will closely monitor all developments affecting your investments and keep you advised.