Covenant Weekly Market Synopsis for October 27, 2017

October 30, 2017

In what was shaping up to be a down week for domestic equities, blowout earnings announcements in the technology sector by Amazon, Alphabet (aka Google) and Microsoft on Thursday afternoon catalyzed a strong rally on Friday.  The S&P 500 jumped 0.8% on the final day of the week, which by all accounts is a good day, but pales in comparison to the tech imbued Nasdaq Index which rose 2.2%.  Friday’s rally pushed weekly gains on the S&P up 0.2% and 1.1% for the Nasdaq — both indexes closed at all-time highs.  Speaking of highs, Jeff Bezos is reported to have made $7B on Friday (Amazon stock appreciation).  That single day’s reward is higher than the International Monetary Fund’s (IMF) 2017 projected GDP for nearly 50 countries, placing Bezos’s one-day windfall somewhere between the annual national output of Guinea and Tajikistan.  Considering his total worth (some $93B), “Bezosistan” would rank about 63rd (of 191 countries) on the IMF’s list of annual economic output, between the GDP of Ukraine and the Slovak Republic.  Simply remarkable.

In international markets, European (+0.8%) and Japanese (+1.2%) stock indices were the best performers for the week, while Emerging Markets fell -0.8% (even though Chinese stocks gained +2.3%).  Like last week, defensive oriented assets were in low demand as the prices of US Treasuries declined (causing an upward shift in yields across the curve).  Precious metals also moved lower: gold (-0.6%) and silver (-1.0%).  WTI Crude, staged a strong rally gaining 5.3% for the week (to $54.19 per barrel), boosted by comments from Saudi Prince bin Salman in support of continued supply-side controls. 

In other important news, the House Republican tax reform bill will be unveiled this week on Wednesday (Nov 1) providing the long-awaited first view by the public look at the plan.

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


Good, But Not Great+ – The US economy expanded at a real annualized rate of 3% in the third quarter, a solid 0.4% above consensus expectations.  While we have characterized growth in the real economy since the Financial Crisis as “Good, but not Great”, two quarters in a row of 3% growth (in Q1 annualized real GDP expanded by 3.1%)is worthy of an upgrade to “Good, but not Great+”.  As the chart below highlights, lower consumption (the blue shaded portions of the bars) from the previous quarter was offset by growth in inventories (red) and an increase in net exports (grey – thank you cheaper US Dollar).   On a year-over-year basis, GDP growth was a more subdued 2.3%.


Sources:  Bureau of Economic Analysis and FTN Financial


About the consumer… consumer spending rose only 2.4% in Q3, well off the 3.3% pace of Q2.  Some of the decline in consumer spending may be related to weather disruptions (i.e. hurricanes), but overall the consumer remains in a precarious spot.  A decelerating rate of Personal Income growth and a plummeting savings rate don’t make particularly fertile ground upon which higher consumption levels organically sprout.  Remember, absent accelerating income growth, consumption levels can only grow through a drawdown in savings accounts or increased borrowing – neither of which can go on indefinitely.  In fact, savings as a Percentage of Disposable Personal Income has been declining from a recent high of better than 6% in 2015 to only 3.4% as of the end of September (the long-term average savings rate is closer to 7%).


Source: Federal Reserve Bank of St. Louis

Above trend growth may stick around for a few more quarters, especially if domestic tax policy is modified.  Yet, the relatively weak positioning of the consumer, to our way of thinking, will weigh on economic growth thereafter (consumption is approximately 70% of the economy).  Therefore, we believe Good, but not Great+ growth is only a transitory economic pulse and that the economy will slip back into the Good, but not Great growth theme within a few quarters.    


Quitting:  It’s hard to do.  Especially when you’ve been at something for a long time (with the possible exception of golf, in which building frustration over an extended timeframe can ultimately make quitting rather easy… but I digress).  Take global central banks and ultra-accommodative monetary policies.  The Fed was the first to try and quit back in 2013 and it was painful.  The primary side effect was a spike in interest rates known as the “Taper Tantrum” when the yield on the 10-year Treasury shot from 1.6% to 3% in four months.  Having learned their lesson from that nasty episode, central bankers have been more circumspect when it comes to withdrawing stimulus measures implemented following the Financial Crisis.  The Fed telegraphed very clearly and very early what their balance sheet reduction program would look like.  Thus far, it has gone smoothly.  But we are only in the first month and while the Fed has reduced the amount of bonds they are buying by $10B per month, it is a rather trivial amount compared to their total balance sheet of $4.5 trillion.

On Thursday of last week, in a widely anticipated announcement, the ECB laid forth their plans for tapering their bond purchases (note the ECB is not yet at the point of reducing their balance sheet a la the Fed, they are just slowing its expansion).  The ECB will be cutting bond purchases in half starting in January, reducing monthly purchases from €60bn to €30bn.  While no definitive timeframe was provided for ending their purchase program, ECB President Mario Draghi implied it will continue into 2019. In an effort to avoid another Taper Tantrum, Draghi bookended the announcement by indicating interest rates could remain at their current low levels “well past” the end of the bond purchase program.  Clearly the market was looking for the ECB to be a little more aggressive, as the Euro declined 1.4% against the US Dollar and yields on European bonds moved lower.  This is a particularly difficult situation for European banks who are carrying negative yielding bonds on their balance sheets and will continue to do so for another two years at least.  

After nine years of ultra-accommodative monetary policy, the unintended consequences (including widening of the wealth inequality gap and the rise of Populist political candidates globally) continue to reverberate through the system.  Given the magnitude of government borrowing and the extended timeline for reversing Quantitative Easing on a global scale, the final chapter of this story is a long way off.

Be well,