ECONOMIC SUMMARY

Economic growth exceeds 3.5% in the third quarter. This pace of economic growth was a slowdown from the 4.2% pace in the 2nd quarter of 2018. The growth was slightly above consensus estimates and was boosted by strong growth in inventories. Consumer confidence decreased slightly in the third quarter but remains near 18-year highs. Manufacturing remained robust as production increased.

Continued strong job growth in October. The U.S. economy added 250,000 jobs in October, slightly higher than expected. Wage growth for production workers increased 3.2% year-over-year after an upward revision last month, the strongest wage growth since April 2009.  The labor force participation rate edged up to 62.9% from 62.7%, a strong gain at this late stage of an economic expansion. The unemployment rate also held steady at 3.7% (the lowest level in five decades). Since 2015, wages have been rising faster than benefits as the number of available workers become smaller.

Corporate profits show continued strength. The 3rd quarter 2018 corporate operating earnings numbers are almost complete (78% of market cap having reported), and corporate profits show a 29.3% year over year growth rate. Sectors showing strong profit growth include energy, technology, financials and healthcare. Almost 49% of companies are beating revenue estimates and 78% of companies have beat on earnings. Expanding margins are a big driver of earnings growth this quarter and are set to expand to 12%, their highest level on record.

Inflation shows gradual increase. While the headline consumer price index (CPI) increased slightly to 2% year over year, the core measure (less food and energy) was up by 0.2%. Increases were mainly from businesses passing along rising costs to consumers in the form of higher prices. Wage growth is showing signs of increasing which is causing investors some concern that rates may increase faster than expected, although this month’s report indicates stable inflation.

The Federal Reserve raised its target for the Fed funds rate to a range of 2-2.25%. The Fed committee increased the forecast for economic growth and inflation and cut the unemployment rate forecast for this year and next. Most economists expect one more rate hike this year (December) and at least two more hikes in 2019, although there seems to be some discussion about whether the Fed will back off its projected increases next year.

EQUITY MARKET SUMMARY

October sell-off sees all major equity indices down for the month. The S&P 500 Index closed at 2,711.74, posting a total return of -6.84% in October (yet it remains in positive territory YTD, up 3.01%). Small caps and developed international fared slightly worse than US large cap equities, posting monthly returns of -10.86% and -7.96% respectively. Factors contributing to the sell-off included pre-mid-term election jitters, concerns over the impact of rising interest rates, potential future effect of tariffs on company profitability and global growth concerns amid trade wars. International equities were further impacted by the currency translation effects of a strong US Dollar, which was up 2.28% during October.

Sell-off does not look like the start of a bear market. We view the sell-off as a normal pullback within the context of an extended bull market, and not the beginning of a bear market. Strong fundamentals continue to support this view: company earnings have been positive during the Q3 reporting season with continued robust share buy-back activity, and US real GDP growth and economic indicators remain upbeat, coupled with historically low unemployment. Additionally, the retail sector should benefit from the upcoming holiday sales season (November & December), during which sales have increased by an average rate of 3.9% over the past five years, according to the National Retail Federation.

    • LARGE CAPS LAGS SMALLER CAPS YTD:
      Dow Jones 3.41%
      S&P 500 3.01%
      Russell 2000 -0.60%
      NASDAQ 6.71%

      GROWTH OUTPERFORMING VALUE YTD :

      Large Cap 7.77% vs. -2.01%
      Mid Cap -2.23% vs. -3.38%
      Small Cap 1.08% vs. -2.42%
       

Best performers: Year to date through the end of October, Technology (+11.02%) and Health Care (+8.83%) have been the best performing sectors. Both sectors have outperformed the broader S&P500 index, despite the October pull back. Health care stocks have outperformed on the back of an anticipated divided Congress, which would likely benefit spending in the health care sector. Technology continues to outperform on the back of strong growth in sales, earnings and key performance metrics.

Worst performers: Materials (-11.95%) and Industrials (-6.50%) have been the worst performing sectors year to date. Notable contributors to the underperformance in these sectors include Mohawk (-54.79% YTD) and GE (-42.12% YTD) the latter of which has suffered as a result of continued missed earnings, the ousting of its beleaguered CEO John Flannery, and a slash to its dividend to shore up cash for operations and debt service.

FIXED INCOME SUMMARY

The 10-year Treasury yield increased slightly to 3.14% for the month of October. With better US economic data offset by more volatile US equities, bond prices declined slightly in October (which caused yields to rise). On a policy level, we expect the Fed to continue its path of tightening interest rate policy as it considers one more rate hike this year (in December) and 2-3 rate hikes in 2019.

The 10-year Treasury yield closed above 3% for 32 consecutive days as of the end of October. The fixed income markets seemed to have gotten the message that the Federal Reserve is serious about raising short term rates given the strong job growth in the U.S. We think this upward bias on rates will continue if economic fundamentals continue to improve. Inflation seems to remain under control for now.

U.S. fixed income investment performance is mixed with the Barclays Aggregate (or “Agg”) Index down 2.65% YTD and the U.S. High Yield Agg up 1.1% YTD. Municipal bonds as measured by the Muni Agg are down 1.28% YTD. U.S. Corporates have declined by 3.99% so far. Internationally, the Euro Aggregate has shown a decrease of 5.75% YTD. Fixed income markets have seen quite a bit of headwinds with rising rates.

 

  • Year-to-Date Index Returns (as of 10/31):

    Index YTD Returns
    Barclays Aggregate -2.65%
    Barclays Euro Agg -5.75%
    Barclays U.S. High Yield 1.11%
    Barclays Municipal -1.28%