Third Quarter 2017 Market and Economic Review
The third quarter of 2017 saw advancing global equity markets, continuing the positive trend that we have seen throughout the year.
Large US companies, measured by the S&P 500 index, increased 3.8% in the third quarter and are up 12.5% year-to-date. Company earnings and revisions upward in worldwide growth continue to look favorable as markets continue a strong 2017. After a volatile second quarter, small US companies, measured by the Russell 2000 index, increased 5% in the third quarter of 2017 and are up 9.9% year-to-date.
Global stocks continue to advance on the year, supported by strong factory data from China and Japan. European stocks edged higher, with the STOXX Europe 600 index up around 1.8% over the third quarter and 7.4% year-to-date. Russia is the only major European market that has fallen this year, down 1.4%, primarily due to volatile commodity prices and political tensions with the US.
On the fixed income side, both short- and long-term Treasury yields increased slightly during the third quarter. However, the 10-year and 30-year Treasuries fell to year-to-date lows in early-September, spurred by mixed economic indicators, gridlock in Washington, and geopolitical risk surrounding North Korea.
Uncertainty regarding North Korea’s missile testing and their standoff with the U.S. has turned a few trading sessions into hiccups. Investors are not treating this as a major issue yet, however any type of military confrontation could cause global market volatility. As diplomatic measures continue to be utilized, worldwide agreement to new sanctions shows that even the closest trade partners of North Korea are willing to take steps to prevent them from obtaining nuclear weapons.
At their third-quarter FOMC meeting, the Federal Reserve took a welcome break from increasing short-term interest rates after three straight quarters of raising rates going back to last September. Since lowering rates is a tool to fight recessions, it is important that the Fed takes us off of the medicine when the economy is performing well. That way they have tools available if another recession hits and the Fed can avoid creating any market bubbles by keeping rates too low, for too long.
The Fed also announced the beginning of the end of another remedy, stating it will gradually start normalizing its $4.5 trillion balance sheet that ballooned under quantitative easing programs during the financial crisis. The Fed indicated it would start reducing holdings by $10 billion in October and would raise that amount gradually over the next few months to $50 billion per month. The process may take 4-5 years before we get back to pre-financial crisis levels.
Fed Chair Janet Yellen’s term expires in 2018, and it is unlikely that President Trump will re-appoint her. It remains to be seen whether a new chair will take policy in a different direction.
In a recent report, the Fed pointed out that the recent hurricanes will temporarily boost headline inflation, but they do not expect it to "materially alter the course of the national economy over the medium term." Some financial analysts expect this year’s hurricane season to dent third quarter GDP growth due to damage in Florida, Texas, and Puerto Rico, but only in the short-term. Alternatively, politicians seem encouraged to pass infrastructure and support bills for the areas adversely affected by the bad weather. When done right, infrastructure bills have the positive effect of generating GDP growth.
GDP growth in the second quarter of 2017 was 3.1% annualized, while the Atlanta Federal Reserve’s GDP Now forecast model estimates 2.7% GDP growth in the third quarter. This is encouraging, as 3% GDP growth is a key level to get the US economy back to its economic potential, as measured by potential GDP.
As was the case in our prior market review, one of the key questions for the rest of 2017 is the extent to which different bond and equity markets can withstand a gradual reduction in monetary stimulus.