Despite several significant events during the quarter — including multiple natural disasters and rising political tensions — equity markets continued their upward trajectory over the past three months. All three major U.S. stock indexes ended higher, with the S&P 500® up 4.48%, the Dow Jones up 5.58% and NASDAQ up 6.06%. Both the S&P 500 and NASDAQ closed the quarter at all-time highs, while the Dow Jones ended only a handful of points below its highest-ever level. The U.S. stock market continues to be remarkably resilient in these later stages of the economic cycle and consumer confidence remains relatively strong, seemingly undeterred by the policy stagnation, personnel upheaval and general chaos that have come to define the first eight months of the Trump administration. In fact, the S&P 500 has hit 52 new all-time closing highs since the election, accounting for 24% of all trading days during that time.
September marked a change in course for equity markets. At the start of the month, the best performing securities to date had been more defensive-oriented stocks in the Technology and Health Care sectors, while riskier small cap stocks lagged behind safer large caps and long-term interest rates fell. Investor risk appetite returned in September, boosting the year’s worst performers — including Banks, Energy and small cap stocks — while interest rates rose. This has been called a “reflation” trade because it reflects how the market responds to a growing economy and faster inflation. Whether or not it can continue depends on how the economy performs moving forward.
Indexes for both investment grade and high yield bonds ended the quarter in positive territory, with the Bloomberg Barclays U.S. Aggregate Index up 0.85% and the Bloomberg Barclays U.S. High Yield — Corporate Index gaining 1.98%. In commodities markets, WTI crude rallied to finish the quarter up approximately 10.50%, buoyed by better-than-expected demand and a tightening of global oil supplies. Gold fell during the month of September but also finished higher for the three-month period, gaining over 7%.
Three major hurricanes made landfall in the United States during the months of August and September, killing dozens of people and causing hundreds of billions of dollars in damage and lost productivity. While the havoc wreaked by these storms was massive and will require significant reconstruction efforts, history suggests that the economic impact of such natural disasters is shorter term in nature and that any dip in the economy will likely only be temporary. In fact, New York Fed President William Dudley said in an interview with CNBC that “the long-run effect of these disasters . . . is it actually lifts economic activity because you have to rebuild all the things that have been damaged by the storms.”
In early September, President Trump surprised members of both political parties by agreeing to a debt ceiling deal with Democrats Nancy Pelosi and Chuck Schumer. The deal raised the debt ceiling for three months, delaying the possibility of a government shutdown to at least mid-December. The President’s agreement to this deal was in direct conflict with the desires of Republican leadership, who first pushed for an 18-month extension to the debt ceiling before officially proposing a six-month deal. While Democrats applauded President Trump’s decision, Republicans were left frustrated by what they felt was an inability — or unwillingness — by the President to negotiate a stronger agreement that was more in line with Republican priorities.
After multiple failed attempts to repeal and replace the Affordable Care Act (“Obamacare”), Republican’s health care reform efforts officially died in the Senate. While abandoning health care reform was a significant disappointment for Republicans, it became clear that sufficient support for the legislation didn’t exist in any of its current forms. Now at the top of Republican’s legislative list is tax reform. An outline of the President’s tax proposal was released in late September and contained potential changes to both corporate and individual taxes. Key highlights of the proposal include: a reduction in the corporate tax rate from 35% to 20%; a reduction of the pass through tax rate (business income “passed through” their owners and taxed as individual income) from 39.6% to 25%; an increase in the standard deduction from $12,600 to $24,000; an elimination of the state and local tax deduction; and an elimination of the estate tax. It is highly unlikely that the proposal passes Congress in its current form, as Republicans have many hurdles to overcome before tax reform can become reality. However, investors cheered the fact that the process was started and equity markets responded by climbing higher.
At its September meeting, the Federal Reserve left the Federal Funds rate unchanged, keeping the target at 1.00% to 1.25%. As expected, the Fed confirmed that it would begin reducing its $4.5 trillion balance sheet in October 2017. Specifically, the Fed will stop reinvesting in maturing mortgage-backed securities and Treasuries totaling approximately $10 billion per month to start ($4 billion in mortgage securities and $6 billion in Treasuries). It will gradually increase these amounts until the monthly total reaches $50 billion. This is anticipated to be a slow process, as the Fed wants this unwinding to be as measured and telegraphed as possible so as not to unduly upset equity markets. As mentioned in our second quarter review, no country has ever undertaken this type of monetary stimulus reduction, so it’s uncertain exactly how markets will react. Even though markets have likely priced in a very gradual unwinding, we would expect at least some degree of volatility for risk assets in the upcoming months.
Many financial pundits have described the current market as a “Goldilocks” environment, with increasing corporate earnings and recovering global growth as reasons for continued optimism. We tend to think, however, that the “Goldilocks” descriptor is more of a justification for current asset prices than an accurate representation of actual market fundamentals. As such, we’ve made proactive de-risking moves in some of our Funds in an effort to lock in gains and better position the Funds for what we believe could soon be a lower-return market environment defined by higher levels of risk and unpredictability. In times of uncertainty, it is important for investors to be appropriately diversified and remain committed to their long-term investment strategy. As always, we do not recommend trying to time the market.
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