Market Data for the quarter ended September, 2016:
• S&P 500 Stock Index: 2168, up 3.3%
• Ten-year Treasury Note Yield: 1.61%, up 0.12%
• Gold: $1,317 per ounce, down 0.6%
• Oil: $48 per barrel, unchanged
The US stock market rose moderately in the third quarter against a stable economic backdrop and continued low interest rates. Perhaps most importantly, the Federal Reserve decided against raising overnight interest rates at its September meeting. The threat of what many see as a premature rise in overnight interest rates was pushed back until December, thus temporarily alleviating a risk factor that had been weighing on markets.
Moving forward, the market is presented with several risk factors. The election for President has started to concentrate minds in the market. A Trump presidency would risk throwing the global economy into a recession with his draconian anti-trade policies, to say nothing of the possibility of wider geopolitical instability. The market is currently discounting a Clinton presidency, but if that were to change, we would expect markets to react negatively, perhaps significantly so.
While the threat of an increase in overnight interest rates has been likely been pushed back until the Federal Reserve’s December meeting, the market may not be prepared to deal with an increase in interest rates at that time absent a pickup in economic and corporate earnings growth. While the economy has been improving steadily, growth has hardly been robust. A rise in short-term interest rates could strengthen the dollar, thus suppressing US exports and inflation. This would have a depressing impact on growth of an economy that is already growing at a subdued rate.
Although recent economic data has been encouraging, the Chinese economy is still carrying a disconcerting load of corporate and municipal debt. A significant weakening of the Chinese economy could imperil the global economy by negatively impacting its supply chain in emerging markets that make up an increasing share of global economic activity. As roughly half of S&P 500 corporate revenues are earned overseas, this would deliver a blow to the US stock market and wider economy.
A final risk that gained salience over the course of the quarter was the parlous condition of the European banking system. European banks are over-indebted, unprofitable, and/or saddled with bad loans. Germany’s largest lender, Deutsche Bank, has come under speculative attack for its perceived weak financial position. While the European financial system is seen by many as to be more resilient than prior to the financial crisis of 2008, some doubt the ability of European policymakers to take the proper actions if the situation were to deteriorate. A failure of a major European bank, such as Deutsche, would have wide ranging consequences throughout the global financial system and could lead to significant losses in stocks.
The stock market can rise further if the risks detailed above do not materialize. If one or more do, we would expect heightened volatility and lower share prices. In the face of this, we will continue to execute our strategy of quality, value, diversification, and patience. If you have any questions or concerns regarding your portfolio, please do not hesitate to contact us. For the remainder of the year we anticipate the stock market as represented by the S&P 500 to trade in a range of 2050 to 2250. It closed the third quarter at 2168.