Market Outlook: December 2017

ECONOMIC SUMMARY

Improving economic growth. Economic growth in the U.S. was revised higher to a rate of 3.3%, its fastest pace since 2014. Consumer spending was revised downward from 2.4% to 2.3% due to the effects of the recent hurricanes. Equipment spending by companies increased significantly from 8.6% to 10.4% as companies continued to increase capital expenditures. Improving net exports and a rise in business inventories added to the growth as well. The outcome of the tax bill working its way through Congress could add to fiscal stimulus in 2018 if passed.

Improved job growth. The U.S. economy added 261,000 jobs last month, higher than expected and accompanied by an upward revision to the previous month’s number. The unemployment rate decreased to 4.1% and the participation rate fell slightly to 62.7%. Wage growth continues to be sluggish, increasing only to 2.3% year-over-year. If the labor market continues to tighten (lower unemployment rate), we would expect wage pressures to increase. The labor market has improved from the negative effects of hurricanes Harvey and Irma. The economy seems to be close to full employment.

Inflation still soft. The headline consumer price index (CPI) fell to 2% year over year even with the lower unemployment level. We still need to see more wage growth before rising inflation becomes a major concern. The Fed’s preferred measure of inflation, the Personal Consumption Expenditures (PCE) index, which covers a wide range of household spending items, remained stable at 1.4%. The Fed’s target for inflation is 2%.

Corporate profit growth shows continued strength. With almost all companies having reported 3Q earnings, 74% of companies have beat earnings expectations. Revenue growth in the third quarter have shown particular strength, with revenue growing faster than expected in almost three times as many companies (outside of financials) as in the recent past. The 9.4% average profit growth in companies has been robust.

The Federal Reserve and interest rates. The Federal Open Market Committee (FOMC) did not change the federal funds rate from its 1% to 1.25% range at its October meeting, as expected. The Fed confirmed that its plans to reduce its balance sheet holdings of Treasuries and mortgage-backed securities, begun in October, is on track. They will begin by reducing their holdings by $10 billion in the first month and gradually increase this rate each quarter for the next five quarters. It will be interesting to see what effect this has on longer-term interest rates. The President nominated Jerome Powell for the position of Chair of the Federal Reserve. If he is confirmed, he will take over in March of 2018. The Fed is on track to raise rates in December.

EQUITY MARKET SUMMARY

November 2017 saw the S&P 500 index reach another new high. The S&P added 3.07% in the month of November for a year-to-date (YTD) total return of 20.5%. Similarly, the Dow Jones Industrial Average (DJIA) advanced 4.24% and the NASDAQ Composite 2.35%. Small cap stocks (Russell 2000) were up 2.9%. Stock prices rose on expectations that the House and Senate will come together to pass some form of tax reform. Developed foreign markets as measured by the MSCI EAFE index increased by 1.08% for the month (+23% YTD), while emerging markets stocks were nearly flat +0.2% (but +33% YTD).

Stock market volatility ticked up during November with the CBOE Volatility Index (VIX) ending the month up 10.8%, but still down almost 20% year to date, on what could be the beginning of a sector rotation.

Expectations for corporate tax reform should help drive the U.S. equity markets going forward. Investors debate whether the current year’s rally has already baked in reform or whether it has been driven by other factors such as global growth and earnings. Investors are focused on the potential cut to the corporate tax rate, which would be a boon to companies with effective high tax rates and overseas operations. Accelerating the ability to depreciate capex would also benefit companies dependent on capex for operations.

LARGE CAPS OUTPERFORM SMALLER CAPS YTD:

GROWTH OUTPERFORMING VALUE YTD :

The bond yield curve continued to “flatten” in November. This difference between the 10-year and 2-year Treasury yields has continued to decrease to 59 basis points. This move reflects the Fed raising short-term rates and the expectations of another rate hike before year-end, raising the 2-year yield. The 10-year yield has remained relatively stable. This continued decrease in the differential in yield between long-term and short-term yields could be a signal of lower growth in the near to medium term.

The proposed U.S. Presidential administration’s plans for tax cuts has contributed to the slight selloff of U.S. Treasury securities (and pushing the benchmark 10-year yield to 2.36% as of the 5^th of December) as analysts debate how any cuts would affect economic growth and the federal deficit’s need for more Treasury debt issuance. The President has asked the Congress for the tax cut bill to be delivered by Christmas for his signature into law.

Fixed income investment performance was positive for the month except for high yield. The Barclays Aggregate index increased by 0.41% for November and the Barclays High Yield returned (0.56%) for the month. Corporate bonds increased by 1.48%.

Year-to-Date Index Returns (as of 12/1):