A Review of the Markets - Q4 2017
Threats of a nuclear conflict between the U.S. and North Korea, increased tensions between right and left here at home, a stalled Trump Administration agenda, and a spate of major hurricanes would in a typical environment likely lend to a pullback in risk assets and a flight to quality. However, the rally in the U.S. equity market continued in the third quarter, at a pace consistent with what investors experienced in the first half of the year. Returns were positive across the capitalization range for U.S. equity investors, but while large cap stocks had outperformed for much of the first half of the year — and into third quarter — small cap stocks delivered a whopping +6.2% return for the month of September. The catalyst for this strong move in U.S. small cap names was the announcement of a meaningful corporate tax cut proposal, to 20%, which would benefit U.S. small businesses, as they tend to be more domestically oriented and thus pay a higher effective tax rate. The proposed tax cut, which still faces the path to legislative passage, also buoyed value names in September, but the outperformance of growth stocks in 2017 has been marked, apart from the last month.
On a sector basis, energy stocks rebounded nicely in the quarter, as crude oil prices moved higher and appear to be trading in a sustainable range. Financial names benefited in the quarter from the Fed’s move towards tightening coupled with the tax cut proposal, and technology stocks found their footing once again after some valuation scares in the second quarter. Overall, the laggards in the market in the quarter are those stocks which would benefit little from the above mentioned catalysts – namely consumer staples, health care, and utilities stocks.
International stocks have performed well throughout 2017, and the third quarter was no exception. Europe, which continues to reflect a modest, apparently sustainable level of growth supported by accommodative monetary policy, has posted the strongest equity returns of any region of the developed world in 2017. While the threat of terror attacks and the weight of the Syrian refugee crisis have continued to fuel anti-immigration rhetoric, the improving employment picture and a strengthened position in Brexit negotiations have created a calmer political environment. In the U.K., the reality of a post-Brexit economy looms, but stocks have moved higher as relative valuations of multinational firms still prove attractive, despite the uncertainty. The Japanese economy, too, has provided enough of a foundation to support inflows, and the government’s move to buy equities as part of its overall monetary program has continued to push asset prices higher. Emerging markets equities continued their winning ways, up over +27% for the year so far. Driving the index higher in the third quarter were gains in the BRIC countries, led by China, as the economy shows some signs of life over the past several months.
Within fixed income, returns were once again only modestly positive in the quarter. While demand has continued for U.S. Treasuries against a backdrop of even lower sovereign yields in developed Europe and Japan, the combination of higher interest rates, the slow roll off of the Fed’s balance sheet, and a potential influx of new debt to fund a tax cut for individuals could finally push yields higher into next year. Credit continues to outperform government bonds, and high yield bonds have outperformed investment grade issues as the appetite for risk has continued unabated. Municipal bonds have performed well this year, outperforming taxable issues, but may face some pressure as details of an individual tax cut are further articulated.
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