Covenant Weekly Market Synopsis for September 29, 2017

October 2, 2017

The market is boring… equity indices click higher seemingly every day to set new records. But, of course, this is the type of boring investors like. The alternative to a boring market can take many forms from a violent move lower to choppy waters in which markets move sharply higher and lower on successive days. Perhaps the worst kind of boring would be the exact opposite of what we have today, a slow, grinding decline where each day is met with new market lows – the market’s version of water torture. Since our current reality is the happy kind of boring, let’s enjoy the ride. In other words, be patient, but not complacent (as described further in the Patience & Complacency section below).

The revised estimate for Q2 GDP improved by 0.1% to 3.2% real, annualized growth; the highest quarterly growth rate since Q1 2015. Even as past growth was ratcheted up, current inflation continues to wane. The Fed’s favored measure of inflation, year-over-year Core Personal Consumption Expenditures (PCE) declined to 1.3% and has been trending lower since late 2016. Europe also saw disappointing inflation data for September, causing some to question whether the European Central Bank will, or should, curtail their bond-buying program. While similar questions have been raised about the Fed’s forecast rate hikes in the absence of inflationary pressures, Chair Yellen has, thus far, done her best to make the case that deflationary pressures are transitory. As such, she has struck an uncharacteristically hawkish stance that the Fed will raise rates in December and three times in 2018. Of course, her term ends early 2018 so she may be watching the Fed decisions from the sidelines.

Equities ended the week, month and quarter higher. In some cases much higher as investors continue to ride the favorable wave of improving global economic growth combined with ultra-accommodative monetary policies from the world’s major central banks. Fixed income investments suffered as yields moved higher toward the back half of the quarter in response to the anticipated tax plan and the Fed’s monetary policy decisions and forecasts. Indeed, after a fairly smooth July and August, rates on the 10-year jumped 0.22% in September to 2.33%. That may not sound like much, but it represents a 10.2% increase for the month and the largest since November 2016 (when the yield jumped 33% to 2.38%). Higher rates are good for savers putting new money to work in fixed income investments, but not as pleasant for those who are already invested as the price of bonds moves inversely to the yield.

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

The Reformers – On Wednesday, the Big Six revealed the long-awaited tax plan, or at least a framework for it. The Big Six are the President’s National Economic Council Director Gary Cohn, Treasury Secretary Steven Mnuchin, Senate Majority Leader Mitch McConnell, Senate Finance Committee Chairman Orrin Hatch, Speaker of the House Paul Ryan and House Ways & Means Chairman Kevin Brady). The framework’s lack of details appears to be part of a strategy to keep lobbyists in the dark about which tax loopholes will be eliminated, thus reducing their influence while Congressional tax committees fill-in the details.

Gigabytes of electrons have already been spilled speculating on what the tax plan will look like and what it means for low, middle and high-income earners. But it’s too early to understand all the impacts the plan will have on any group or on us as individuals. That being said, FTN Financial assembled a clean list of what is known and unknown at this point about the tax plan. I’m sure you can pick out some individual things you like and don’t like… I know I can.

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Patience & Complacency – In a year of records (new highs in markets, new lows in volatility), here’s one more for the books. Through September, the largest drawdown (i.e. the maximum decline in the market from a recent peak) in the S&P 500 for 2017 has been less than 3%. Should the market hold its current pattern, 2017 will set the record for the smallest maximum drawdown of all time.

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Source: @michaelbatnick

The lack of market volatility, new records and increasingly rich valuations have caused many market analysts and pundits to suggest a significant pullback is in the offing. The fact is, while inevitable, no one knows when it will occur. It could be next week, next month, next year, or beyond. Because no one truly knows when this will occur the best thing investors can do is be patient, but not complacent. It is a fine line between the two, as both appear to involve doing nothing. An investor that has built in “circuit breakers” to their portfolio, securities and/or asset classes that will react positively (e.g. fixed income, hedges, alternative investments) to a market pullback can afford to be patient. Taking comfort that even as the equity portion of their portfolio continues to grow with the market, the entire portfolio will not be at risk when the market turns. However, the complacent investor who has not tended to his portfolio allocation should consider getting a little less patient.

Be well,

Jp.