Please find the next blog in our monthly series that provides timely market data as well as perspectives on the current state of the economy and the global financial markets.
Themes of mild inflation, moderate growth, low unemployment and persistently low volatility are shared around the globe, even as North Korea continues its provocative pursuit of nuclear capability. In the US, Hurricane Harvey’s impact will be felt in the short run, particularly as it relates to the energy markets and productivity, although expectations are high that Houston recovers well. Congress took its summer recess, but returns to work needing to address the rapidly approaching debt ceiling and desiring to achieve meaningful tax reform. Backward-looking economic signals continue to be positive, with 2Q-17 real gross domestic product (GDP) revised up to 3.0%, exceeding the market’s expectations. The latest report on personal consumption expenditures (PCE) continued the recent trend of moderate increases. Year-over-year spending on goods and services has advanced by 2.7% on a real basis, which captures true demand growth. Core PCE, the Federal Reserve’s preferred measure of price inflation, ticked down to 1.4% on a year-over-year basis.
The unemployment rate notched up to 4.4% in August, even as the participation rate held steady and nonfarm payrolls expanded by 156,000 jobs. Combined with downward revisions for the prior two months, reported new hires missed the consensus estimate of economists by 65,000. Wage growth had been expected to rise modestly, but continued at the lackluster pace of 2.5%. In a recent speech, Federal Reserve Governor Lael Brainard commented on the apparent flattening of the Phillips curve, which would suggest that a strong job market alone should not stoke fears of inflation.
The Federal Open Market Committee (FOMC) did not meet in August, and Chair Yellen’s speech at the annual Jackson Hole summit focused on the benefits of financial market regulation rather than monetary policy. Most observers still expect the Fed to initiate its balance sheet reduction program, commonly referred to as quantitative tightening (QT), at the upcoming meeting on September 19/20. The odds of a concurrent rate hike are effectively 0%.
International macroeconomic data continued to show strength, increasing the probability that the European Central Bank (ECB) will soon begin discussing how and when to dial back quantitative easing (QE). President Draghi has acknowledged positive growth signs, but has also alluded to the potential adverse impact of a strong Euro on export-driven economies going forward. The market is currently not expecting meaningful policy tightening by either the ECB or the Bank of Japan (BoJ) until 2019. China’s Purchasing Managers’ Index (PMI) remained stable, and independent GDP tracking figures produced by Capital Economics have been converging with official government reports.
The equity markets took a bit of a breather in August, even as year-to-date (YTD) appreciation remains quite strong domestically and abroad. Although the forward-looking landscape appears less stable as valuation levels, policy uncertainly, and geopolitical risk grab headlines, these factors have generally not been the best near-term indicators for investors. The volatility futures markets are still quite low relative to their past averages, despite episodic moves higher throughout the month. A potential North Korean conflict creates left-tail risk, but the most recent comments from Washington DC have favored strong diplomacy over previously aggressive tones.
The S&P 500 index narrowly avoided its first monthly decline since before the US election, finishing up slightly (+0.3%) in August. Enduring two of its three worst days of 2017, both down more than -1.5%, the domestic benchmark managed to end well above the intra-month lows. As the market discerns potential winners and losers, there was a healthy divergence in returns among various sectors. In the large cap space, IT (+3.2%) and Utilities (+2.7%) were strong, offsetting Energy (-5.7%) and an abrupt reversal in Telecom (-3.1%). In the small cap space, Russell 2000 growth stocks (-0.1%) held up better than value stocks (-2.5%), with the broader universe being down 1.3% overall. The small cap market continues to trade with a higher sensitivity to uncertainty in the legislative agenda.
In the international markets, MSCI EAFE index was essentially flat overall and performance was consistent across the major regions. On the other hand, emerging market equities continued their strong run of 2017, with the MSCI Emerging Markets index up another 2.3%. MSCI Emerging Markets Asia was the laggard in terms of regions, but still managed a decent 1.4% return. MSCI Emerging Markets Eastern Europe (7.5%) set the pace, with MSCI Emerging Markets Latin America (4.7%), and MSCI Emerging Markets Europe, Middle East and Africa (4.4%) also strong.
Real estate posted moderate returns, as measured by the FTSE NAREIT US Real Estate index (+0.6%) and the FTSE EPRA/NAREIT Developed index (+0.2%). The Alerian MLP index (-4.9%) reversed course from the prior month, as hurricane-related disruptions in Houston impacted pipeline and processing volumes. More directly within the energy complex, oil was down sharply (-5.9%) but gasoline futures spiked double-digits given reduced refining capacity. The safe-haven bid for gold continued (+4.1%), and the Bloomberg Commodities index finished up overall (+0.4%).
Diverging from somewhat neutral equity outcomes, fixed income assets continued to appreciate throughout August. The broad Bloombar Global Aggregate index posted a gain of +1.0%, bringing the benchmark’s YTD total return to an impressive level of +7.2%. With the US dollar sliding back to early-2015 levels, the resulting positive impact of currency translation for US-based investors remained a benefit. That said, this factor accounted for less than 10% of the unhedged benchmark’s monthly return, and it was a risk-off decline in yields across the developed markets that drove results. Given historically depressed yields, ending the month at just 1.50%, prospective returns become more challenging.
The US Treasury (UST) yield curve resumed the flattening pattern that has dominated most of the year. With weak inflation data causing the market to discount future FOMC rate hikes, the policy sensitive 2-year UST yields drifted modestly lower and closed the month at 1.33%. The move in longer-term rates was more pronounced, with the 30-year bond closing very near its YTD low at 2.73%.
As policymakers grapple with cross-currents of low inflation, reasonably solid economic data and elevated levels of consumer sentiment, the implied probability of an additional Fed rate hike before year-end has fallen to approximately 30%. The FOMC’s next meeting will be key to watch, as it will include revised economic projections and a new “dots plot”. Pre-meeting signaling is expected to reduce the chance of surprise, but any unanticipated hawkishness from the Federal Reserve would likely drive an adjustment in both rates and risk assets.
The Bloombar US Aggregate index returned +0.9% in August, with high-quality government and asset-backed securities leading the way. Although ongoing heavy supply weighed on results, the Bloombar US Corporate Investment Grade index gained just under +0.8% for the month. Credit spreads finished 8 basis points (bps) wider, but remain near 10-year lows. The Bloombar US Corporate High Yield index essentially broke even in August, with overall spreads moving wider by 26 bps. Emerging market bonds (particularly local currency issues) extended their impressive YTD rally, driven by the attractiveness of higher interest rates and steady/improving economic fundamentals.
Disclaimers: The data contained in this report is provided from Asset Consulting Group (ACG). This is not an offer to buy or sell securities. No investment process is free of risk and there is no guarantee that the investment process described herein will be profitable. Past performance is not indicative of current or future performance and is not a guarantee. In preparing these materials, we have relied upon and assumed without independent verification, the accuracy and completeness of all information available from public and internal sources. Gryphon Financial Partners shall not in any way be liable for claims and make no expressed or implied representations or warranties as to their accuracy or completeness or for statements or errors contained in or omissions from them. This was created for informational purposes only. Gryphon Financial Partners, LLC is a Registered Investment Adviser.