The stock market continued its slow, steady climb to new heights in the third quarter. The S&P 500, with dividends, added 4.5% in the quarter for a yearly gain of over 14%. The Dow Jones Industrial Average climbed over 5% for the quarter and is up over 15% this year. Technology stocks again outperformed and helped the Nasdaq rise 6% in the quarter for a 2017 gain of 20%. Small company stocks roared back to life in September boosting the Russell 2000 index to a 10% gain for the year. Bond performance has been subdued with the aggregate index appreciating 3% through the end of the quarter.
Nothing Seems to Spook the Market
In last quarter’s newsletter we stressed that the only factor that could move the market this year was politics. Wall Street has kept a keen eye on Pennsylvania Avenue ever since President Trump took up residence: there has been a strong correlation between the stock market’s performance and the news cycle coming out of D.C. And yet, in the words of Nobel Prize-winning economist Richard Thaler, “nothing seems to spook the market.” Such was the case in the third quarter, as negative developments, be they domestic or international, caused little more than a couple of blips on the market’s march higher.
August was the most volatile month of the year as a host of difficult issues arose for the President and the country to navigate. North Korea under Kim Jong Un continued to agitate by launching test missiles, with one passing over our ally Japan. President Trump responded that the United States would answer any escalation with a fire and fury like the world has never seen before. The market dropped on this unanticipated bellicosity, but it recovered soon after. The other brief bout of volatility came after the President’s CEO councils-symbolic groups of corporate CEOs brought together to brainstorm policy-disbanded in the wake of Mr. Trump’s equivocation in regard to the Confederate monuments protest in Charlottesville, Virginia. The market, albeit for only a day, lost confidence in the ability of the administration to usher its reform agenda through Congress. Again, however, the market recovered quickly and stock indexes were able to eke out minor gains in the volatile month of August.
Neither the threat of nuclear war with a lunatic nor the domestic discord of battling street mobs has spooked the market. Hurricanes Harvey and Irma failed to elicit any response from stocks and investors have already become accustomed to repeated Republican flops in attempting to repeal any pieces of Obamacare. The market persisted in the third quarter because investors are trading on the fundamentals of our economy and of the global economy as well. Economic activity here at home is expanding at a moderate pace and looks likely to improve (see below). Meantime the IMF has forecast world economic growth to expand at a 3.6% rate this year and 3.7% next year. International stock indexes-from emerging markets to Europe-have risen dramatically but are still below their all-time highs and have room to advance even further. Nothing has spooked the market because none of the fundamentals of the economy have changed for the worse. Investors are acting reasonably in not overreacting to unpredictable what-ifs.
Return of the Trump Bump
The third quarter saw the return of the so-called “Trump Bump.” Investors, having previously grown frustrated with the administration’s blundering of policy and messaging, were reinvigorated upon the unveiling of the Trump administration’s tax reform plan. Proposed tax cuts for corporations and pass through entities spurred investors to take another look at small capitalization stocks. Small caps shot up in the immediate aftermath of the election last year and have lagged much of this year as Wall Street second-guessed Trump’s ability to get much of anything done. Similarly, as seen on the table nearby, the Trump trades into financial stocks (betting on rising interest rates), industrials , and materials (betting on federal infrastructure spending) had wavered much of the year until the tax reform plan renewed investor confidence in September.
The Market Calm
2017 has been an unusually calm year for the stock market, and the third quarter was no different. Aside from some politics-prompted minor volatility in August, markets coasted and were able to post positive performance in each of the three months of the quarter. Volatility has been nearly nonexistent. On a day-to-day basis the S&P 500 has had daily price movement of 1% or more (in either direction) only eight times this year. The last time the index experienced so few 1% moves through September was in 1972. To put this in perspective, the average number of such moves for the index is 52 times per year.
Calm markets induce anxiety particularly when, as now, stock prices drift higher and higher. Surely, say the experts, investors are missing some essential piece of bad news or, instead, are willfully ignoring it in their euphoric, continuous spree of buying stocks. The consistent shattering of index record levels, even if arrived at only gradually, is untenable, they say, and indicates trouble on the horizon.
This pessimistic critique of the supposed irrationality of stock market investors, however, fails to take account of the foundations underlying this year’s “melt up.” Rather than be distracted by hypotheticals, investors have taken an active role in participating in a growing domestic and global economy. And instead of euphoria, the stock market’s rise reflects a reasoned hopefulness-after all, we haven’t observed a daily S&P gain of over 2% in nearly a year; hardly euphoric buying. The fundamentals of the economy are adequate and improving and the stock market’s stable climb higher may merely reflect this improvement.
Key Economic Indicators
Gross Domestic Product
For the first time since 2015 GDP growth came in over 3% for the second quarter. Personal consumption, government spending, and increased exports (thanks to a weaker dollar) helped to push GDP to 3.1%. Domestic manufacturing is booming, as activity within the sector hit a 13-year high in September. Such expansion bodes well for the economy overall going forward and is a hint that the growth malaise of the past eight years may finally be abating.
Not all cylinders of the economy are firing, though, as consumer spending continues to disappoint. Nevertheless, retailers and consultants are predicting that lifted consumer spirits (see below) will lead to robust sales through the end of the year. GDP growth through the third quarter will likely take a hit as the effects of Hurricanes Harvey and Irma are felt. The Federal Reserve Bank of Atlanta estimates 2.7% growth while the New York Fed sees growth of just 1.5%. The first official reading comes out October 27th.
Consumer Sentiment
American consumers maintained their confidence and positive outlook on the economy through September. Whereas last year we emphasized the resilience of the stock market amidst jarring turbulence, this year it is the average consumer who has proven to be resilient. Notwithstanding an unpredictable president, increased political polarization, North Korean missiles, and extreme weather, both consumer sentiment and consumer confidence remain elevated. Indexes keeping track of these “animal spirits,” these intangible gut feelings that are a necessary element to economic growth, are recording levels not seen since the tech boom of 2000. Whether these animal spirits are able to translate to increased spending we will see through this fourth quarter and the crucial holiday season.
Employment Situation
American consumers maintained their confidence and positive outlook on the economy through September. Whereas last year we emphasized the resilience of the stock market amidst jarring turbulence, this year it is the average consumer who has proven to be resilient. Notwithstanding an unpredictable president, increased political polarization, North Korean missiles, and extreme weather, both consumer sentiment and consumer confidence remain elevated. Indexes keeping track of these “animal spirits,” these intangible gut feelings that are a necessary element to economic growth, are recording levels not seen since the tech boom of 2000. Whether these animal spirits are able to translate to increased spending we will see through this fourth quarter and the crucial holiday season.
Looking Forward
Our outlook for the fourth quarter is positive though we reiterate that risk is ever-present, particularly when it seems like nothing can stop stocks from going higher. The fundamentals look good: employment is full and wages have finally started to grow as a result. This combination has bolstered consumer attitudes toward the economy and, taken together with the rising stock market, could spur renewed spending thus leading to more expansive and substantial economic growth. Importantly, global growth is outpacing our own after years of slumping. We think this will provide further stimulus to our economy going forward. We remain confident that our unique investment process-unemotional investment software aiding our administration of diversified portfolios-will help to guide us through any unforeseeable volatility that might spook the market.
Vince Westerman and David Millet
The Westerman Group, LLC
114 East Aurora Rd., Suite 100, Sagamore Hills, Ohio 44067
THE WESTERMAN GROUP, LLC is a Registered Investment Advisor
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No investment strategy or methodology can guarantee profits or protect against losses. Investment risk includes the uncertainty and volatility of potential returns for a portfolio or an individual investment over time. Investment risk is inherent in every individual portfolio and no computer model or modeling program used or relied upon in making investment choices for a portfolio can eliminate risk. A computer modeling program may not reflect actual risk and return parameters applicable to any particular portfolio or investor. Actual investment decisions made on the basis of a computer generated model or modeling program may be materially different from expected or intended results, and any computer modeling program is subject to errors in the program and system failures at any time.
Sources
http://www.bea.gov (GDP data
http://www.bls.gov (employment data)
http://www.google.com/finance (index returns)
http://www.sca.isr.umich.edu (consumer sentiment)
Atlanta Fed GDPNow: Forecast for 2017: Q3, FEDERAL RESERVE BANK OF ATLANTA, October 2, 2017.
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