Markets in Minutes: October 30, 2017
S&P 500 10 Year Treasury Gold World Ex-US US Dollar Commodities US Economy Stock Market Valuation
Markets in Minutes is intended to give our client partners and subscribers a quick and easy understanding of current market conditions. This update covers October 1 – October 30, 2017
Investor Learning: “Over the last few decades, investors’ timeframes have shrunk. They’ve become obsessed with quarterly returns. In fact, technology now enables them to become distracted by returns on a daily basis, and even minute-by-minute. Thus, one way to gain an advantage is by ignoring the “noise” created by the manic swings of others and focusing on the things that matter in the long term” Howard Marks, Oaktree Capital
S&P 500: +2.1% since September 30, +16.9% year-to-date. The S&P 500 continued its strong run on the back of earnings expectations and news of tax reform. Earnings have continued to be positive across most S&P sectors with the market shrugging off the impact of a string of natural disasters. Economic data remains positive, with the 3rd quarter Gross Domestic Product (“GDP”) printing at 3%. The prospect of tax cuts and continuing efforts to reduce regulation are supporting the markets despite what appears to be a worsening geopolitical situation abroad and continued partisanship at home. Both the primary and intermediate uptrends are intact.
Bonds: The 10 year treasury yield rose slightly to 2.37%, up +1.7% for the month, with some interesting gymnastics in between. In the last week of the month, yield rose as high as 2.46% as investors demanded more premium to buy treasuries given the appearance of a strengthening economy and the prospect of slightly higher rates by year end. Yields are currently low enough that long duration bonds (more than 5 years) should be examined to make sure they are in your portfolio for a specific reason. It is still a good time to compare corporate bonds with highly rated municipal bonds in both the taxable and exempt spaces.
Gold: Down -0.7% for the period after a failed breakout above $1260. Gold peaked in early September on North Korea nuclear fears and a falling dollar. Gold may have moved out of counter trend rally mode to enter a range trade as gold bugs wait for stronger inflation numbers or the next geopolitical crisis. If a spike occurs, $1260 still looks like a good place to reduce bets on higher gold prices. If gold falls below $1138 it’s likely the larger down trend will reassume control of price. As before, a sudden large scale geopolitical event is likely to cause a rapid spike in price. In my view, that spike is likely to be temporary and be a selling opportunity.
World Ex-US: +2% for the month, +20.8% year-to-date and continuing to show strength. The theme driving this is a combination of Europe recovery thanks to very low interest rate policies and lower than US valuations which analysts think leave room for what’s called PE expansion – meaning European equities can go up farther than US equities can before entering bubble territory. My view on European/Asian/Emerging market stocks/economies remains negative, perhaps incorrectly. I’m bullish on the US, and don’t like risks in emerging economies. I do not have a favorable long term view of Europe’s ability to generate real growth.
US Dollar: USD +1.6% for the period (down -7.7% year-to-date). The Buck hit the low for the year on 9/7 but began to gain strength as rumors of the Administration’s push for tax reform before year end began to circulate. When rumors were confirmed and the Legislature seemed to clear a path towards tax reform before year end, the dollar managed to break through $94, potentially setting up a run at $97. From the standpoint of earnings, it would be better for the dollar to weaken further, and unless it’s able to sustain a move above $97/$98, it’s likely we’ll see the dollar revisit the September lows and possibly fall farther down the road. The bottom line is dollar weakness has been a positive for US multi-nationals for the most of the year and we may see that continue over the next couple quarters.
Commodities: Oil was up +5.8% for the month, continuing a run to the top of the range from the $42.05 low we saw in late June. My expectation is for this rally to run out of steam soon. So far, oil has been holding solidly in the range expected for 2017 ($40 – $60/$65). I think oil will have a hard time staying above $55 a barrel before spring. The rise in oil has been a help to energy producers, but the price is still favorable to US consumers and therefore the US economy. Copper futures rose by +5.6% as the economy continued to chug along, suggesting the notion of industrial expansion is still solid.
Economy: Consumer prices rose 0.5% in September mostly on rising gas prices, with prices excluding food and energy food up about 1.7% in the last 12 months. This inflation rate is about in-line with the Fed mandate and should help keep rate raises gradual. Industrial production rose incrementally in the September reporting period and the two core components of the economy, manufacturing and services, both remain solidly in expansion mode. The official unemployment rate fell -0.1% to hit 4.1% in October. Despite that, wage inflation has remained moderate at +2.9% vs. a year earlier. This has put the US in a sort of sweet spot—moderate inflation, rising employment, low interest rates, rising GDP and corporate earnings.
Earnings: Q3 earnings season is in full swing and most companies are hitting expectations so far. The earnings expansion that began last year looks likely to endure at least through year end. This is a positive, although valuation is now a concern.
Market Valuation: Valuations are more than stretched in many sectors, and near term value is very difficult to find. Interest rates are still near historic lows and the Fed Chair, at least this one, seems to understand the risks aggressively raising rates poses to the economy. Valuations are a rising risk but with earnings still strengthening and a strong possibility of tax cuts before year end, valuations are not likely to cause a serious (or enduring) sell off. However, the market remains in a price zone that requires measurable earnings acceleration and tax cuts to sustain prices. So far at least, earnings appear to be holding up their end. If earnings stumble, the market will take notice.
Recession Probability Indicator: The most recent reading on the RPI is 12 and indicates we are not currently in recession and the investment environment is stable. CLICK HERE to learn more about the RPI.
S&P Technical Picture: The S&P is once again overbought on weekly basis for the 3rd time this year (Feb, June and now October). As before, this suggests a potential near term top. Previously overbought situations resulted in mild pullbacks that represented buying opportunities. The underlying uptrend is intact and continues to be supported by both rising earnings and low interest rates, and so any decent pullback is still a buy opportunity.
Fair Value has risen to $213.75 or so on the S&P proxy SPY, but I would not look for the index to fall that far should a correction ensue. As before, barring a nasty fiscal/policy surprise, the weight of data suggests that pullbacks more than 5% are likely buying opportunities, even in the face of geopolitical events. The intermediate term and primary trends are identified by the red arrows below, Fair Value by the thick blue line. Any of these points can present reasonable entry points for index investing from a technical, if not fundamental, standpoint.
SPY Chart (S&P 500 Proxy)
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