Current economic events
U.S. economic data began to display the impact from recent hurricanes given the softness in August retail sales and industrial production. These shortfalls have led models from the Atlanta and New York Federal Reserve (Fed) to trim approximately 0.8 percent from third quarter gross domestic product (GDP) forecasts. Prior to the hurricanes, economic data had been turning stronger, as evidenced by July’s record high in job openings of 6.17 million, which was released last week. As we transition to hurricane recovery, the recent headwinds should ease and turn to tailwinds of rebuilding and the solid economic trends seen prior to these disasters should remain in place.
Soft August economic data from China is causing some concern amongst market participants regarding the global synchronized economic growth cycle. Money supply growth, energy production, fixed investments, industrial output and retail sales all softened relative to July readings. In our view, this slowness likely reflects the management by the government of the economy heading into the Communist Party conference rather than a rollover in activity. With leadership and policy clarified post-conference, we anticipate the economic trend will be clearer later this year.
Contributed by: Robert L. Haworth, CFA – Senior Investment Strategy Director
Equities remain remarkably resilient despite North Korea’s provocative military exercises and soft retail sales data.
- The popular broad-based equity indices advanced between 0.8 percent and 2.3 percent last week, with 10 of 11 S&P 500 sectors posting gains (only the Utilities sector declined). Broad-based returns among indices and sectors are typically indicative of a market that is poised to trend higher.
- The narrative bolstering equity prices remains largely unchanged. Earnings are rising on the heels of synchronized global growth, inflation remains restrained and interest rates are low. And, for investors searching for yield, equities remain an attractive alternative.
- We continue to believe that equities are in a muddle-along zone leading up to third quarter earnings in mid-October. The disconnect between rising stock prices and falling yields, flattening yield curve, political wrangling and low expectations for fiscal policy are among items expected to weigh on equity returns into year-end. The Fed’s comments on interest rates and inflation will likely impact sentiment this week. Third quarter earnings season unofficially begins during the week of October 9 when companies within the banking sector begin releasing third quarter results. At present, consensus expectations are genuinely sanguine, with third quarter revenue and earnings estimated to increase roughly 4.5 percent and 14.5 percent, respectively, according to Bloomberg. Higher earnings are needed for valuation support, with the S&P 500 trading at roughly 21.5 times and 19 times trailing 12-month and 2017 estimates, respectively.
- Our published year-end price target for the S&P 500 is 2,550, which is the midpoint between a range of 2,500 and 2,600, 2 percent above Friday’s close of 2,500 with the high end of the range being 4 percent above Friday’s close.
Contributed by: Terry D. Sandven — Chief Equity Strategist
Fixed income markets
Last week, rates rose as high as 2.2 percent on the 10-year U.S. Treasury after reaching lows near 2 percent in recent weeks. Investors appear to be seeking safety due to concerns over natural disasters and geopolitical risks. Steady-to-stronger inflation data was released across the globe, including in the United States, increasing the odds the Fed will be able to pursue an additional rate hike in December while the perception of increasing odds of comprehensive tax reform further encouraged investors.
With central bank target rates on the rise and inflation appearing to rebound, bond prices may come under further pressure as longer-term yields rise. A number of major central banks now appear to be turning the corner to pursue higher interest rates after years of low rates to stimulate growth. The Bank of Canada increased the benchmark rate last week in a move that surprised many while the Bank of England signaled they may increase rates at the next meeting. The Fed is expected to hold rates steady at the meeting this week, but expectations for a December hike have risen after the release of higher inflation data last week. Additional focus will be on the Fed’s median “dot plot,” an indication of each member’s expectation for year-end and longer-term rate targets. Current dots imply one more hike this year and three additional hikes each in 2018 and 2019. Some expect a modest reduction in the 2019 and even 2018 rate path to acknowledge the low inflation environment. The Fed is also expected to formally announce they will begin to gradually reduce the size of their balance sheet in October. In isolation, a reduction in the balance sheet will likely place minor upward pressure on rates in coming quarters, but the more material impact is likely to occur when global central banks become net sellers, in aggregate, which is unlikely to occur until late 2018 or 2019.
Performance remains strong in riskier segments of the bond market, such as high yield and emerging market debt (which tend to be more correlated with stocks than with low risk bonds). The synchronized global expansion, combined with low volatility and low inflation, has contributed to low defaults and high valuations. While we do not anticipate a material near-term increase in defaults, any increase in volatility or investor uncertainty would likely push spreads wider. While these asset classes may be appealing to investors seeking increased yield, we believe maintaining the majority of fixed income exposures in higher quality bonds, such as investment grade corporate and municipal bonds, will help ensure adequate portfolio level diversification.
Contributed by: William J. Merz, CFA – Portfolio Strategist
Real estate markets
Publicly traded Real Estate Investment Trusts (REITs) lagged the S&P 500 over the past week by approximately 0.7 percent and now trail the broader market by 8 percent for the year. The return of “risk on” and investors leaving safe-haven assets led to the drop in real estate-related assets.
The increase in inflation expectations and corresponding increase in interest rates also hurt infrastructure assets, in general. Utilities experienced a negative total return of 2.2 percent over the past week after having rallied 8 percent over the past two months.
Contributed by: Kevin T. Weigel, CFA – Portfolio Strategist
The return of “risk on” also hurt other safe-haven assets, such as precious metals. Gold has declined 3.5 percent from the recent highs and silver has declined by almost 5 percent. Silver declining faster than gold in the past week has moved the gold/silver ratio to 76 ounces of silver to buy one ounce of gold. That ratio was as low as 32 in April 2011. Since the beginning of 2000, the ratio has averaged 62 and silver now appears 1.5 standard deviations cheap to gold.
Contributed by: Kevin T. Weigel, CFA – Portfolio Strategist
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This information represents the opinion of U.S. Bank. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.
Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.
Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.
Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults). There are special risks associated with an investment in commodities, including market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors.
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