The S&P 500 and Dow Jones Industrial Average indices were a perfect 5-for-5 last week as each day brought higher prices than the day before. Most of the week’s gains came on Friday, following Thursday evening’s successful Senate vote on the budget. Importantly, the language in the bill was modified to simplify the Senate and House of Representatives’ budget reconciliation process, increasing the odds that tax reform will be implemented by year end.
Five new record closes generated respectable gains of 0.9% for the week. This, ladies and gentlemen, is what a bull market looks and feels like. It won’t always be this way, but best to enjoy the ride while it lasts. International markets were a bit choppier. Although Japan and China indices moved higher, Europe, Emerging Market and Frontier Market indexes experienced modest declines of less than 1%. As one should expect within the context of a bullish week, the prices of defensive assets such as US Treasury bonds fell, pushing yields across the maturity curve higher. However, it is worth noting that the “long bond” (the 30-year US Treasury) remains below 3%, as hints of inflation remain elusive. Precious metals, also considered a defensive asset, declined on the week (gold -1.8%, silver -2.2%), while WTI Crude rose 0.8% to close the week at $51.84 a barrel.
For more detail on weekly, month-to-date and year-to-date asset class performance please click here.
CPI X-ray – The following chart illustrates the various inputs into the Consumer Price Index, the widely followed measure of inflation. Research provider Foleynomics groups the inputs into three categories: Goods (prices are market driven and measurable), Shelter (prices derived from formulas and, because of that, lags current conditions) and Services (a mix of market prices and regulated costs). What is immediately apparent is that of September there were only two areas generating any meaningful inflation: Energy and Rent of Shelter (aka housing prices and rental prices). All other inputs to inflation are near the zero bound. Here’s the thing, the higher energy costs are related to hurricanes Harvey and Irma, and will likely back off. Also, the rate of growth of shelter prices appear to be decelerating. If this continues, one of the long-term primary drivers of inflation will be weakening going forward.
Once again, it is worth stressing that there is inflation in the economic system, but it is benign and below the Fed’s 2% annual target. Inflation readings can be volatile and we wouldn’t be surprised to see an inflationary impulse over the next couple of quarters (as has happened sporadically over the last few years), especially if tax reform gets implemented. In the intermediate term however, structural headwinds of an aging population and shrinking workforce will challenge the Fed to maintain inflation at their target of 2%.
Beauty Pageant – The contest for the next Fed Chair is heating up as the self-imposed deadline of early November draws near. The frontrunners, Jerome Powell, John Taylor, and current Fed Chair Janet Yellen have all interviewed recently with President Trump. For a President that has owned or co-owned three beauty pageants (Miss U.S.A., Miss Teen U.S.A. and Miss Universe) and hosted a competitive reality-TV show (The Apprentice), Mr. Trump knows a thing or two about competitions….and how to keep the audience tuned in. While there are no talent or bathing suit competitions associated with the decision-making process around the next Fed Chair, President Trump has done a fantastic job of keeping the markets in suspense about who will assume the lead position in the world’s most powerful central bank. Depending on who the President meets with or remarks about in press conferences, the market swings to either a hawkish (bond prices down, yields up) or a dovish (bond prices up, yields down) stance. An online odds maker, PredictIt, placed Jerome Powell in the lead on Friday. Mr. Powell’s monetary policy views are considered to be fairly close to current Fed Chair Janet, but he may be less stringent when it comes to regulations on banks. As such, choosing Powell would result in continued dovishness at the head of the Fed (remember, Trump is a “low rates guy”), while at the same time allowing President Trump to replace someone appointed by former President Obama.