Common measures of US economic health continue to be positive, with 3Q-17 real gross domestic product (GDP) initially estimated at 3.0%. Surveys around consumer sentiment and manufacturing ended at multi-year highs, and retail sales posted the best month-over-month results in two and a half years. That said, Core PCE, the Federal Reserve’s preferred measure of price inflation, remained depressed at just 1.3% on a year-over-year basis. The latest meeting minutes acknowledged that recent inflation weakness may stem from “the influence of developments that could prove more persistent.”
The unemployment rate dropped to a 17-year low of 4.1% in October, with nonfarm payrolls increasing by 261,000. With revisions adding another 90,000 jobs to the initial August and September reports, the negative impact of hurricanes Harvey and Irma has been somewhat neutralized. The participation rate fell to 62%, and this measure of workforce supply has been flat year-over-year. Given that over 40% of new hires are coming from lower-paying leisure and hospitality positions, average hourly earnings disappointed with a reported year-over-year increase of just 2.4%.
The Federal Open Market Committee (FOMC) made no changes to target rates in October, however, the process of balance sheet normalization officially began with the $10 billion reduction in US Treasury (UST) and Agency MBS holdings. The Committee’s most recent “dots plot” projected another 25-basis point (bps) hike by the end of the year, and the market has seemingly adopted this view with the probability of a December adjustment rising to over 90%.
The European Central Bank (ECB) announced plans to roll back purchases of bonds beginning in January by 50% but expects to continue its quantitative easing program until at least September of next year. China’s 19th Party Congress met in October, with President Xi consolidating power as many predicted. No clear successor was identified, leading some to speculate that Xi’s rein may extend beyond convention.
The equity surge continued in October, with markets strong across the globe. In the US, the S&P 500 set a new record, surpassing the prior mark of 242 days without a 3% pullback. In Japan, the Nikkei had a 16-day streak of increasing stock prices, setting a new 21 year high in the process.
There was wide dispersion in the large cap sectors, with IT gaining +7.7% for the month (up 35.7% YTD) and Telecom down -8.69% (down -16.1% YTD). In small cap, returns were generally muted, with the Russell 2000 up 0.9% and sector returns ranging from Utilities (+3.9%) to Energy (-3.1%).
In the international markets, the emerging countries raced ahead once again, outpacing the developed markets. The MSCI Emerging Markets index was up +3.5% for the month, with most countries participating in the rally. Mexico (down -7.5%), Pakistan (down -7.5%) and Colombia (down -9.0%) were notable exceptions.
The MSCI EAFE index was up moderately in comparison at +1.5%. Japan (+4.6%) and Singapore (+5.0%) led the way, with Switzerland the significant laggard, down -1.7%.
Real estate was down for the second consecutive month, with both the FTSE NAREIT U.S. Real Estate index (-0.5%) and the FTSE EPRA/NAREIT Developed index (-0.2%) recording modest declines. The Alerian MLP index (-4.1%) reversed course in October, even as oil moved upward (+5.2%) amid lower stockpiles and decreased US rig count.
Higher inflation expectations played a role in other commodities, with gold down -0.9% for the month, and the broader Bloomberg Commodity index up 2.1%.
Amid the overall “risk-on” tone across markets, fixed income assets produced mixed results in October. The Bloombar Global Aggregate index gave back another -0.4% during the month, as US dollar strength subtracted 80 bps from the return of the underlying bonds.
With strong economic data and speculation regarding the potential nomination of a more “hawkish” Federal Reserve Chairperson, UST rates moved slightly higher across all maturities. Policy sensitive 2-year UST yields advanced steadily to 1.60%, as the market upgraded the FOMC’s resolve to follow through with its projected path of policy normalization.
The Bloombar US Aggregate index returned +0.1% in October, with government-related issues lagging the primary market’s other key sectors. IG corporate credit spreads finished 6 bps tighter, pushing through mid-2014 levels and establishing new 10-year lows. CMBS outperformed given the benefit of improving fundamentals and favorable capital market conditions. The Agency MBS complex posted a slight nominal loss given embedded interest rate sensitivity and the commencement of the Fed’s escalating balance sheet reduction program.
The Bloombar US Corporate High Yield index is benefitting from robust demand for credit, advancing another 0.4% in October. Spreads for the category were tighter by 9 bps, and it was the B-rated cohort that captured the most benefit. Careful security selection is warranted with an index level yield-to-worst below of 5.45% and average prices above par.
Despite universal gains YTD given the attractiveness of higher local interest rates and steady/improving economic fundamentals, emerging market bond returns were quite bi-furcated in October. Spread tightening allowed US dollar denominated sovereigns and corporates to advance, but increasing yields and currency weakness hurt local issues.
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