An active month saw both the House and the Senate narrowly passing tax reform measures, while the President formally nominated the next Fed Chair. Tax reform is not a done deal, as Congressional leaders will attempt to come up with a compromise that will suit both chambers. Valuations and volatility, or the lack thereof, seem to be priced for successful and meaningful tax reform on the corporate side of the ledger. While Jerome Powell is viewed as the “continuity candidate,” a notable degree of turnover at the Fed happens to coincide with the unwinding of what is, arguably, the largest monetary policy experiment of all time.
The US economy continues to display solid fundamental trends, with 3Q-17 real gross domestic product (GDP) revised upward to 3.3%. A common survey measuring current consumer confidence reached its highest level since November 2000. Expectations for future growth are more modest, and this aligns with moderate weakness in monthly manufacturing and production data. Analyst estimates for 4Q-17 GDP are in the 2.0% to 2.5% range. Core PCE, the Federal Reserve’s preferred measure of inflation, advanced a bit, but remains below target at 1.45% on a year-over-year basis.
The Federal Open Market Committee (FOMC) made no changes to target rates in November. Though inflation continues to be somewhat perplexing, an upward adjustment at the December 12-13 meeting is virtually consensus, and markets are now signaling two additional rate hikes in 2018. Minutes suggest financial conditions are generally favorable, even as it’s difficult to judge positioning of the economic cycle (mid/late).
November’s jobs report was very solid, with payrolls beating expectations and prior months revised upward. With a streak of 86 consecutive monthly gains, the unemployment rate remains very low at 4.1% and the participation rate is steadying at 62.7%. Nonfarm payrolls increased by 228,000 overall, bringing the average for the year up to 174,000 per month. Professional and business services was up in November, continuing its growth, with 548,000 jobs added over the past 12-months. Average hourly earnings remain tepid for a maturing cycle, with wages increasing just 2.5% year-over-year.
The equity surge continued in November, with markets strong across regions and styles. In the US, the S&P 500 (+3.1%) repeatedly set new highs, with any notable dip in the market perceived as a buying opportunity. Large cap sectors were strong across the board, with Telecom (+5.9%) and Consumer Staples (+5.4%) leading the way. Year-end profit taking and some initial signs of rotation caused Materials (+0.7%) and IT (+0.9%) to lag.
In small cap, returns were also strong, due significantly to increased expectations of tax reform. Within the sectors, the negative outlier was IT (-1.2%), with Consumer Discretionary (+7.1%) and Consumer Staples (+6.9%) outperforming the broader Russell 2000 index (+2.9%)
Positive growth data abroad contributed to US dollar weakening, which benefited international markets. Emerging countries paused in their significant advancement for the year, while the developed markets continued their slow and steady pace. The MSCI Emerging Markets index was up +0.2% for the month, with South Africa (+9.0%) leading the way, while Brazil (-3.1%) and Taiwan (-3.3%) held the index back.
The MSCI EAFE index was up moderately at +1.1%. Japan (+3.0%) set the pace in November, despite additional missile tests by North Korea. Most of the Eurozone was up in line with the index, although Belgium (-2.0%), Denmark (-1.6%), Ireland (-1.6%), Norway (-1.8%), and Sweden (-3.3%) all retreated. The UK traded virtually flat.
Real estate rebounded nicely in November, with both the FTSE NAREIT US Real Estate index (+2.6%) and the FTSE EPRA/NAREIT Developed index (+2.8%) up significantly. The Alerian MLP index (-1.4%) was down again, even as oil advanced (+5.6%) to its highest level since mid-2015 given agreements to extend production cuts through 2018.
Commodities continued to be mixed, with gold (+0.2%) following oil higher for the month, but weakness in industrial metals and agricultural/livestock weighing down the broader Bloomberg Commodity index (-0.5%).
Through all the events of November, fixed income markets seemed relatively unfazed. The Bloombar Global Aggregate index gained +1.1% during the month, with modestly positive underlying bond returns being supplemented by 96 bps of additional return resulting from US dollar weakness versus a broad basket of foreign currencies.
A record run in equities is yet to spark inflation-related concern on the long end of the UST curve, even as ongoing points of economic strength make a December rate hike by the FOMC a near certainty. Policy sensitive 2-year UST yields advanced steadily to 1.78%, while the 30-year bond yield actually fell. The slope of the UST curve, as measured by these key points, dipped below 1% for the first time since 2007. Be it caution or complacency, the flattening trend is notable.
The Bloombar US Aggregate index returned -0.1% in November, with government-related issues mixed versus the primary market’s other key sectors. IG corporate credit spreads could not hold recent 10-year lows amid heavy supply stemming from industrial M&A, but rallied back into month end and closed just 2 bps wider. Consumer-centric ABS outperformed.
The Bloombar 1-15-Year Municipal index dropped -0.8%. Progress with tax reform likely increases volatility and alters near-term supply expectations for the category. Notably, both versions of the proposed tax bill seek to remove the exemption for advance refundings (opportunistic refinancing) across all issuing sectors. Private activity bonds, including non-profit hospitals, airports, and private universities, may also face some risk going forward. As issuers race to market with deals ahead of any change, municipals broadly underperformed UST as managers repositioned to take advantage.
The Bloombar US Corporate High Yield index produced a loss of -0.3% in November, with spreads widening modestly despite the ongoing search for yield. That said, emerging market bond returns were universally positive and built upon YTD gains. With both yields and spreads in these higher-beta sectors in rarified air, careful security selection is warranted.
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.