Q3 2017 RECAP

October 3, 2017

The 3^rd quarter will be remembered for volatility dropping like a stone, while the Federal Reserve doubled-down on its insistence that a 3^rd rate hike was the base case. Stocks wobbled at times, but stayed on course to set new records.  Safe-havens had their moments, more than one, but faded in late September. That said, equities welcomed a pick-up in yields as affirmation the economy remains on solid ground. Chair Yellen, in congressional testimony, stated the ‘long-term’ funds rate may be lower than assumed. Important, and turned markets at mid-year. As September progressed, stocks and yields moved higher in concert. Crude oil climbed $5 a barrel to $51. The U.S. dollar stabilized – but not before Euro touched $1.20 and Yen hit 108.

If someone’s starting point was market volatility, it was all quiet on the summer front. Record lows were set and reset, a brief jump evaporated, and the VIX index closed the 3^rd quarter in single-digits – much below the long-term and even the 12-month average.

U.S. stocks and bonds were not as dormant. Equities revalued in July, declined through most of August, then regained its balance and rose in September. A tough two-months of the year (historically) closed at record highs. And, it was broad-based. In the States, large and small-caps finished on a buying note. International markets in September, doubled returns in the U.S., while Emerging Markets stayed on a higher plane, as has been the case all year. The outperformer, so far. Valuations, especially in the U.S., continues to be a concern, but synchronized growth across the globe has raised earnings, lessening concerns to some degree on historically high price-earnings ratios. Among potential risks, the central banks. In the U.S., the pace of rate increases, and reducing the balance sheet. For Europe, the anticipated tapering of government bonds, and in Japan, the expectation that QE may be forever, raising debt-to-GDP ever higher.

Treasuries had an interesting summer. The benchmark 10-year note opened and closed near 2.30%, but that was deceptive. The 3-months was marked by a ratcheting down of yields through early September, in the whirlwind of 2 major hurricanes. But then, after touching 2%, the price on the 10-year saw a sharp decline, its yield moving back into this year’s trading range. A reversal from 2017 lows could be a harbinger, or a return to normalcy. Much will depend on the incoming economic data, and recently it has beaten expectations – except for one, inflationary pressures are not yet visible. Fed chair Yellen labeled it a mystery to be solved. For now, the Fed sees inflation as held back by transitory factors, and whether that line-of-thinking holds through year-end may determine if in December the ‘dot-plot’ stays on course for 3 rate hikes in 2018 or not.

In Q4, with a new fiscal-year at hand, bond investors will focus on the present. Will a tax plan be passed this calendar year? And if the answer is affirmative, how expansive a fiscal policy? Will added federal deficit be front or back-loaded? In the end, what is non-negotiable? Corporate tax rates could see sharp drop, likely lifting profits in 2018.