Covenant Weekly Market Synopsis for November 3, 2017

November 5, 2017

The two big news events last week with regards to the economy had little immediate impact on financial markets: House Republicans introduced their tax bill and Jerome “Jay” Powell was nominated as the next Fed Chair. Neither event moved markets significantly, with the exception of a decline in the prices of homebuilder stocks who are expected to see lower demand for expensive properties as a result of limits on mortgage interest deductions for loans in excess of $500,000. Now is when the real fun begins as lobbyists, who were previously kept in the dark about the contents of the bill (along with the rest of us), will descend upon D.C. to try to convince lawmakers to protect their special interests. Since the Senate still has to approve the bill, it is safe to say that the contents of the bill are subject to change and the final version will likely look very different than what was revealed on Thursday.

The Big 3 stock indices (Dow Jones, S&P 500 and Nasdaq) closed the week at record levels. Having charged through the historically perilous months of September and October, the mighty bull has worked up a lather and is poised for a strong finish in the more seasonally friendly holiday months. Speaking of which, domestic equities got off to a quick start in the first three days of November, recording gains of 0.5%. Developed markets ex-US moved higher by about the same, though Japan stood out with a jump of 2.4%. Yields on US government bonds declined, as the yield curve continues to flatten. The disparity between equity gains (implying stronger growth ahead) and a flattening yield curve (implying weaker growth in the future) is a conundrum of which much has been written. I would suggest that a contributing factor is demographics, as aging Boomers seek to protect their retirement nest eggs in the safety of bonds (supporting this thesis, the amount of cash flowing into fixed income vs. equity mutual funds/ETFs is roughly 2:1 on a YTD basis). Crude gained a little better than 2%, closing the week at $55.54 a barrel (the highest level since June 2015).

For more detail on weekly, month-to-date and year-to-date asset class performance please click here.

Winning – October marked the twelfth month of consecutive gains for the S&P 500 (inclusive of dividends). An unlikely, but impressive run in which the index has generated a total return of 23.6%. How have other major market indexes performed over this timeframe? Pretty darn well as historically low interest rates combined with a globally synchronized improvement in economic growth have created a goldilocks environment for stock appreciation.

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Changing Labor Market – The Great Recession destroyed between 7 million and 9 million jobs. Though estimates vary by data source, the fact is an astounding number of jobs were lost impacting families nationwide, some of whom are still feeling the pains of unemployment or underemployment.  However, the Great Recession did not destroy jobs homogenously, rather it was those jobs requiring the least amount of education that bore the brunt of the pain.  Although unemployment is at historic lows, the job recovery has been extremely uneven.  A recent report by business consulting firm Accenture and Harvard Business School lays bare the gritty details of how the Great Recession has transformed the job market and gutted available jobs for those with a high school diploma or less education.  As the chart below shows, there was actually net positive job growth through the Great Recession for the more educated populace (Bachelor’s degree or higher). 

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As the Great Recession transitioned into the Great Recovery, job growth in this educated sector accelerated generating more than 8.4 million new jobs through 2016.  By contrast, the less educated cohort lost 5.6 million jobs and have only gained 80,000 in the recovery – essentially the opportunities that existed for this cohort have vanished, replaced by automation or filled by better educated workers.  Those in between a high school diploma and a college degree are somewhere in the middle, but have at least experienced net positive job growth of roughly 1.3 million.   

The employment disparity helps explain a few notable trends:

  • Continued high unemployment in the former manufacturing regions of the country.
  • Income disparity between the educated and uneducated contributing to the rise of populism.
  • The increasing levels of student debt as would-be workers recognize they need more education to be hired.  Unfortunately, these tend to be the laborers that can least afford an advanced degree, but are forced to incur debt to compete for jobs.

Perhaps this situation will change if the unemployment rate continues to drop, further tightening the labor market and forcing managers to be less choosy about who they hire.  On the other hand, technological advances in robotics and Artificial Intelligence augur for continued destruction of low-skill jobs.  If not addressed, this portion of the labor pool will be a drag on economic growth and society, requiring a social safety net to provide assistance with food and shelter.  A potential solution is for companies to offer employees apprenticeships in which workers are paid to learn specific, necessary skills without incurring debt.  The benefit to companies would be a highly productive employee base available at a relatively low cost.  It’s just a thought.

Be well,

Jp.