Market Data for the quarter ending September 30, 2017:
• S&P 500 Stock Index: 2519, up 4.0%
• Ten-year Treasury Note Yield: 2.33%, up .03%
• Gold: $1,285 per ounce, up 3.5%
• Oil: $52 per barrel, up 13.0%
Stocks continued their rally in the third quarter of 2017, as solid earnings, global economic growth, and persistent low interest rates provided a sound underpinning for share prices. Although there was heated rhetoric regarding the North Korean nuclear weapons program, markets largely shrugged it off as empty bluster. Bond yields were little changed with continued low inflation balanced against a Federal Reserve that has expressed its intention to continue to tighten monetary policy. Yields did begin to rise in the final month of the quarter with the market beginning to anticipate growth and deficit stimulating tax cuts. Oil prices advanced substantially with global demand coming in stronger than forecasted against reduced supply from OPEC and its allies.
Our expectation is that the stock market will continue to advance in the final quarter of 2017 largely due to a continuation of the trends cited above. Primary risks in the near term to this forecast include a worsening in the North Korean nuclear situation and the US Congress struggling with the passing of tax cut legislation. Longer-term, an overly aggressive Federal Reserve and fragile Chinese financial system could derail the stock market, as well.
As described in previous market analysis, a war in North Korea would have devastating humanitarian and economic consequences. Our belief is that a war is too horrible to contemplate, so both sides will refrain from actual hostilities. There is always the risk of miscalculation, however, so war cannot be completely ruled out. A shooting war on the Korean Peninsula would risk a global recession and stocks would likely suffer heavy losses.
Domestically, although one would think it would be easy for a Republican controlled Congress with a Republican President to cut taxes, their inability to repeal the Affordable Care Act gives one pause. In September, stocks did in fact begin to pick up along with bond yields, as markets began to anticipate the passing of tax cut legislation. Our expectation is that desperately needing a legislative “win”, the Republicans will likely be able to pass tax cuts of a fairly significant magnitude. However, if the process bogs down, we would expect to see stocks suffer accordingly.
Longer-term, the Federal Reserve could threaten a continued rally in stocks if they are seen as tightening monetary policy too aggressively. The Fed has already raised their benchmark overnight lending rate by a full percentage point and has indicated that it intends to raise rates a further quarter point in December and three quarters of a point in 2018. Furthermore, the Fed will begin this month to liquidate its portfolio of long-term bonds acquired during its “quantitative easing” programs (QE). As QE was intended to stimulate the economy and markets by injecting cash into the financial system, some fear that the Fed reversing its position will smother the economy and markets when executed in conjunction with higher overnight interest rates. Although the Fed has assured the market that it will cautiously and gradually tighten policy, there is the risk that they misread economic conditions and tip the economy into recession, thus ending the rally in stocks.
Finally, the Chinese economy has become increasingly dependent on debt, an inherently fragile condition. China has been a prime mover in the global economic upturn we are enjoying, and if their financial situation were to falter, their economy would likely follow with negative repercussions for the rest of us. Previous bouts of Chinese financial instability have pressured global markets, and we have no doubt they would do so again. So far, Chinese authorities have been able to keep their economic train on its tracks, but one cannot be too confident that they will be able to do so indefinitely.
Having said all this, our expectation is that the stock market rally will continue in the final months of 2017 absent the realization of the risks cited above. When the rally does come to an end, we feel we are well positioned, as our portfolios are more heavily weighted toward defensive sectors such as healthcare, consumer staples, and utilities than is the general market. Our portfolios also generate greater dividend income than the broader market, giving added support in the event of a downturn. For the remainder of 2017, we see the stock market, as represented by the S&P 500 stock index, to trade in a range of 2400 to 2650. It currently stands at 2519. As always, do not hesitate to contact us with questions or concerns. We thank you for your business and continued confidence.