3rd Quarter 2017 Market Recap

Alan McKnight, MBA, CFP®

October 18, 2017

 

While domestic and geopolitical concerns continued to make daily headlines, the major stock market indices experienced another positive quarter. The 3rd quarter extended the upward momentum, allowing equity investors to continue enjoying solid returns for 2017.

Equities just capped an eighth straight quarter of gains, the longest winning streak since the start of 2015. The S&P 500 climbed 4% as corporate earnings posted the first back-to-back, double-digit advance in six years. Despite mounting tension with North Korea, a deadly U.S. hurricane season and escalating political turmoil, the 3rd quarter of 2017 marked the eighth straight quarter in which both the DJIA and S&P 500 have risen.

Stocks reacted positively to the Fed's announcement that it would begin to normalize its balance sheet.  Investors have also been focusing on the prospects of lower corporate tax rates while attempting to digest the news of escalating tensions with North Korea and a series of devastating storms.

In the 3rd quarter of 2017, the Dow crossed the 22,000 mark for the first time. The index closed the 3rd quarter at 22,405 up 4.9%.  The S&P 500 closed up 3.9% at 2,519 while the NASDAQ closed up 5.8% at 6,496.

Markets Continue to Move Higher

New highs for equity indexes are beginning to seem like old news. This current bull market is now the second longest one in history.  Having said that, investors always need to proceed with caution and be particularly thoughtful about how they invest.  However, history shows us that in the 4th quarter of a year in which the market made highs in September (statistically the market’s worst-performing month) stocks have typically finished stronger.

Since 1928, there have been 29 Septembers in which the S&P 500 made a 12-month high. Following those 29 instances, the market rose over 80% of the time in the 4th quarter, averaging a 3.7% increase, says Doug Ramsey, Chief Investment Officer of the Leuthold Group. Additionally, 15 of those 29 September price highs were also accompanied by 12-month advance/decline line highs, as is the case now. Stocks increased an average of 5.9% in the 4th quarter in those 15 instances. Ramsey says, “We expect higher highs in the 4th quarter.”

History shows that the S&P 500 has risen seven times since 2009 in the final three months.  Many analysts feel that a bear market or significant correction in the 4th quarter is not likely.  U.S. economic growth has been accelerating and continues to come in better than expected, a bracing factor for stocks, says Keith McCullough, CEO of Hedgeye Risk Management, an independent research firm. This quarter should prove to be another strong profit season, he adds. Corporate earnings reporting starts in mid-October, and the consensus is calling for a 6% rise in S&P 500 earnings per share.

Of course, not everyone is bullish. Ten of 18 Wall Street strategists surveyed by Bloomberg see the S&P 500 ending the year at 2,500 or below. David Kostin at Goldman Sachs Group Inc. reiterated his call for 2,400, saying the start of the Fed’s balance sheet reduction will result in higher bond yields, weighing on equities.

There is also concern regarding high stock market valuations.  Currently, the S&P 500 trades at about 19 times consensus estimates of $131.38 this year, according to Thomson Reuters. That’s above the market’s long-term average of about 15. On a historic basis, this multiple is not cheap. According to Barron’s, high valuations alone don’t cause bear markets. They suggest investors also need to also see a factor change. To convince investors tomorrow that a 19 market multiple is too expensive when it isn’t today, there needs to be a material and decisive shift to the negative. They write that a 4th quarter rally isn’t assured. Absent of a big change in economic and monetary conditions, they feel the bear case isn’t strong. They share that the bull market will at some time die, but probably not in the 4th quarter. The holiday season could be a good one for equity investors.

Interest Rates

For the rest of 2017 and beyond, interest rates will remain high on investors’ lookout list.  Fed Chair Janet Yellen asserts that reducing the central bank’s balance sheet from its crisis levels should be as uneventful as watching paint dry. She also says that the Fed’s main policy tool will continue to be the federal-funds rate.  The Federal Open Market Committee (FOMC) currently has targeted for another quarter-point hike in December, from the current 1% to 1.25% target range. This may or may not happen because its counterparts abroad continue to expand their assets.

The FOMC has also penciled in three more hikes for 2018, based on its current so-called dot plots. Less certain for investors now is who will be making those calls next year. Fed Chair Yellen’s term ends February of 2018. In addition, until the Senate confirms Randal Quarles’ nomination, there will be four other vacancies on the seven-member Board of Governors after Vice Chairman Stanley Fischer retires in October 2017.

According to MarketWatch, “the most important fact to emerge from the most recent FOMC meeting is that the panel further lowered its estimate of the long-term neutral federal-funds rate by a quarter-point, to 2.75%.” They also wrote, “the diminishing effect from foreign central banks on the Fed’s balance-sheet reduction points to bond yields remaining lower for longer, which is consistent with a low-growth U.S. economy.” 

Minneapolis Fed President Neel Kashari (a non-voting member of the Fed’s policy-setting committee) on Monday October 2nd urged Fed policy makers not to raise interest rate again until inflation hits the central bank’s 2% annual target. While speaking at a moderated Q&A at the Fed’s El Paso, Texas, branch, Dallas Fed President Rob Kaplan (a voting member) said the Fed should be “patient” with monetary policy and that the central bank should wait to see a rise in inflation to justify a rate hike.

For the final quarter of 2017 and continuing in 2018, interest rates will be monitored carefully.

Global Concerns

Geopolitical unrest remains.  Political gridlock and further interest rate movement can also be impactful on the U.S. and world investment markets. As always, if you are planning on making any investment changes, it is helpful to discuss these changes and your personal situation with us.

U.S. equities remain historically highly priced, and that opens the possibility that they are susceptible to a swing in the other direction. U.S. Treasury rates remain low, and there are many additional factors that can directly create an uncertain and cautious perspective with investors including:

  • Policy gridlock and the potential roadblocks that President Trump’s administration will face when attempting to pass tax reform. The markets have certainly priced a stimulus plan into the equation, but the Trump administration has yet to have any significant legislative victories.
  • Geopolitical unrest, especially with North Korea.
  • And potential terrorist attacks (foreign and domestic).

Market Outlook

According to Fidelity Investments, current conditions have been a good backdrop overall for most assets.  They feel that moving forward, investors are watching for progress toward tax reform and tax cuts.  In fact, they are advising that the potential exists for an upside surprise in sentiment if tax progress occurs.

Dirk Hofschire, Senior Vice President of Asset Allocation Research with Fidelity Investments, thinks that there's not a ton of optimism now and low expectations about if Washington D.C. is really going to be able to pass major tax reform. This means there's some potential for an upside surprise in sentiment if you do see some progress from Capitol Hill. Hofschire’s guess on the tax outlook is that he thinks, “there’s a really strong political imperative; it’s a priority for both the White House and congressional Republicans to get something done on taxes. I do think it'll be messy in the near term but I think that there will be hopes over the next few months and very possible that we will get some tax relief at some point. This is likely to extend into 2018 before we know for sure.  It may not be a real game changer for the economy overall or where we are in the business cycle, but if we did see something happen, especially something like lower corporate taxes, it would be a more positive outlook for earnings and something positive for investors from a sentiment perspective to hang their hats on.”

Now that the 3rd quarter is over, it’s time to look ahead.  Typically, the 4th quarter sees quite a bit of investor activity. The U.S. is preparing for budget battles from both political and corporate arenas. There are also the 4th quarter announcements of: hiring and firing for the next fiscal year, money manager positioning for year-end, and the all-important holiday shopping season. 

The seasonal movements of equities are also a factor to consider. Since 1928, September has historically been the worst month of the year. However, in 2017 it brought little in the way of weakness. October has historically been the worst performing month of the 4th quarter, while November and December have both been kind to investors. That said, 2017 brings the 30th anniversary of the Crash of ’87, which could spook some investors. However, many analysts are entering the month of October with a fairly optimistic outlook. For the first three quarters, 2017 has been marked by historically low volatility, and there doesn’t appear to be an imminent catalyst for a challenge to that status.  Investors still should be on guard because a potential military escalation of the war of words between President Trump and North Korea’s Kim Jong Un could change that landscape quickly. 

In the meantime, thus far this year we have only seen 5% of trading days with a move in the S&P 500 of greater than +/- 1%; by far the lowest level since 1982, when intra-day data began to be recorded. In addition, for the first time in a dozen years, there have been no +/- 2% days this year. Stayed tuned!

What Should Investors Do?

Theories abound as to why the 4th quarter could be often the best one for equity bulls. They include the fact that fund managers need to catch up with returns, holiday spending could spread cheer, and sometimes investors celebrate the January effect in December.

Some feel that with the stock market hitting yet another series of record highs, some investors may be inclined to take the money and run.  Another possibility could be that investors will start to worry about the rally's sustainability.

Long-term money manager and entrepreneur Laszlo Birinyi has been sharing his thoughts on the stock market.  As a panelist on Louis Rukeyser’s Wall Street Week, he was voted into that show’s Hall of Fame. Birinyi is bullish andcurrently disagrees with some of the most popular bear arguments floating around, like the stock market is too expensive.

Analysts at Schwab feel the term “cautiously optimistic” seems appropriate, although admittedly overused. With no shortage of pundits looking for a correction, they feel that the “wall of worry” stocks like to climb is still intact. They say, “ultimately, we believe the next cyclical bear market will come when stocks begin sniffing out the next recession, likely still in the distance, and/or if the Fed is forced to tighten monetary policy more quickly than what’s currently baked into assumptions. In the meantime, our advice is to remain diversified and disciplined, and stay focused on long-term goals, not always exciting, but historically tends to be profitable.”

So far in 2017, stocks have climbed higher, bond yields have remained low and volatility has not been an issue. Investors have not experienced any dramatic up or down swings in 2017. However, that does not mean investors should become complacent! 

J.P. Morgan Asset Management feels that, “overall, despite all the political noise, markets continued to focus on the improving economic fundamentals. While the world worried about North Korea, markets cheered rising company earnings and improving global growth.”  They add that, “It’s not at all unusual for equity returns to be very strong in the later stage of an economic expansion. While no expansion lasts forever, we think this one has further to go and that investors should enjoy the good times while they last. However, they should watch particularly carefully for any signs that the currently rosy global growth picture is starting to deteriorate.” 

As we have said, today’s current fixed rate returns might not help most investors reach their financial goals so they will probably need to include equities in portfolios. We are carefully monitoring equity markets and interest rates so we can best communicate with clients.

What About Market Volatility?

Market volatility is a part of investing and instead of being worried about potential volatility, it is best to be prepare for it.

During times that call for caution, it is always wise to create realistic time horizons and return expectations for your own situation and to adjust investments accordingly.  We try to understand your personal commitments so we can categorize your investments into short-term, intermediate-term and long-term. 

The 4th quarter is typically an active one, and we don’t think this one will be any different.  Solid economic growth and good corporate earnings could allow the bull market to continue, but investors may experience periods of negative volatility and/or market pullbacks. During times like these investors should to stay focused on their long-term objectives.

This is the ideal time to ensure that you fully understand your time horizons, goals, and true tolerance for risk. Looking at your entire picture can be a helpful exercise in determining your strategy. We always welcome the opportunity to discuss any updates to your thoughts or situation.

If it has been more than a year since your last financial review, please give Jan Berkholtz a call at our office to schedule an appointment with your adviser so we can make sure everything is in order.   If you feel the need to discuss your situation before our next scheduled review, please call our office at (770) 951-9001.

Alan McKnight, MBA, CFP® is Vice President of Kays Financial Advisory Corporation.  He has over 20 years of experience working with retirees and pre-retirees.  He also serves as an Adjunct Faculty Member and Professor of Finance.  Currently he is a doctoral candidate at the University of Florida and is conducting research in the area of stock mispricing anomalies caused by intangibles such as customer satisfaction. His research interests also include Investments, Securities Analysis, Behavioral Finance, Asset Allocation, and Risk Management. He can be reached at (770) 951-9001 or at amcknight@scottkays.com.

This report and Mr. McKnight’s comments are provided as a general market overview and should not be considered investment or tax advice or predictive of any future market performance. Any security mentioned in this report may not be suitable for all investors. No investment mentioned in this newsletter constitutes a recommendation to buy, sell or hold a particular investment. Such recommendations can only be made on an individual basis after an assessment of an individual investor’s risk tolerance and personal circumstances. Past performance of any investment mentioned is not a guarantee of future performance. Statements regarding the investment concerns and merits of any company and fair market value computations are strictly the opinion of Kays Financial Advisory Corporation. Employees of KFAC and KFAC clients may have positions and effect transactions in the securities of the issuers mentioned herein.

Sources: Bloomberg.com; Barron’s; Fidelity.com; Morningstar.com; Schwab.com; Jpmorgan.com; Marketwatch.com; Thebalance.com; MSN.com; Fromthegrapevine.com, APFA, Inc 2017, Forefield.com.