Déjà Vu All Over Again
By John Stoltzfus,
Chief Investment Strategist
What Are the Markets Telling Us?
Relative asset class performance last week signals rotation remains in progress among equities.
International equity performance picked up again to broadly beat US stocks by a fairly wide margin last week even as US markets managed to edge higher.
From our perch on the market radar screen it looked to us that an increase in political noise around the administration’s tax reform proposal had introduced questions on the likelihood of the proposal getting to see the light of day anytime soon—if ever.
By week’s end the dollar was weaker (against all ten of the G-10 currencies and 18 of 24 emerging market currencies), the 10-year Treasury yield had slipped (to 2.27% last Friday from 2.36% the prior Friday) and the S&P 500 was outperforming the Russell 2000 and the S&P 600 (small caps) for the week and from the start of the fourth quarter.
A relatively strong headline CPI number (up 2.2% in September from a year earlier) showed food and energy provided a boost to consumer price inflation, while the core figures (excluding food and energy) remained subdued at 1.7% YoY, the same as in August. With food and energy prices boosted by storm-related shortages and distribution disruptions tied to the hurricanes (a near-term effect expected to ease in time), the core CPI signaled reflation remained modest.
Retail numbers looked strong but similarly were taken to reflect the effects of storms and thus boosted by replacement shopping by home owners and businesses.
A positive offset to the effects of the storms came from the University of Michigan’s preliminary consumer sentiment index for October which jumped to 101.1—its highest level since the beginning of 2004. Sentiment for October exceeded consensus expectations for a flat reading from the prior month (95.0). The read on sentiment likely helped provide some relief even as growth remained modest and tax reform appeared further in the distance than it had in a while.
We suggest investors remain patient while politicians negotiate the issues surrounding tax reform. We see 2018 mid-term elections as potential catalysts for politicians from both sides of the aisle to find enough points to agree on to deliver at least a tax cut for corporations and a smaller tax cut for individuals. The electorate has spoken via their votes to all parties akin to the adage, “Don’t just stand there—do something!” Gridlock will likely subside to the extent that some action on taxes will be taken.
“We believe last week’s decline in the financials had less to do with disappointing results in any one particular name and more likely was related to reduced expectations for reflation in the economy”
In the meantime Q4 earnings season has gotten under way and stocks look poised to deliver enough surprises to warrant equities’ further upside in the weeks ahead.
Earnings season got under way last week as several of the major banks reported results that were mixed—reflecting the differences among the companies reporting. The financial sector’s performance was the second worst performing of the underlying benchmark’s eleven sectors last week—declining just under 1%. We believe last week’s decline in the financials had less to do with disappointing results in any one particular name and more likely was related to reduced expectations for reflation in the economy. Banks had rallied ahead of Q3 earnings season on prospects that banks and finance firms would be among the biggest beneficiaries of tax reform with their businesses predominantly based in the US and having fewer ways of reducing taxes than other sectors have.
A 30th Anniversary on October 19th
This week investors will likely be reminded repeatedly of the 30th anniversary of the stock market crash of October 19, 1987. Having experienced that day as an investment professional we will never forget the day the Dow Jones Industrial Average dropped more than 22% in one day. At the time we worked for another firm on the Street a few blocks west of the NYSE (New York Stock Exchange).
We can recall thinking, “this isn’t supposed to happen… wasn’t the Glass-Stegall Act of 1933 supposed to prevent something like this?” But it did happen. At the center of the crash of 1987 was a confluence of factors that included monetary policy, market interest rates, the dollar, commodities, stocks and bonds. US GDP in 1987 was a little over $8 trillion compared to over $18.5 trillion today. The world was in an earlier stage of globalization—yet to be turbo charged and refined by modern technology.
We also recall that in an office of over 50 investment professionals at 5 World Trade Center there were only two television sets. We remember that in 1987 while there were weekly and even daily financial news shows on television, there were no dedicated financial news channels as there are today. Real time financial news was hard to come by back then.
We also recall many other details from that day but suffice it to say technological developments in business and in the consumer space have changed so dramatically since then that one might say comparing today’s access to news and specifically market information and data to that time is akin in our opinion to comparing an early Model T-Ford to a 2017 Chevy Corvette.
From a cyclical low of 776.92 on August 12th 1982 the Dow Jones Industrial Average had risen to a then record level of 2,722.42 on August 25th of 1987.
From that level the benchmark had moved lower over the proceeding months into October.
The yield on the US 10-year Treasury moved from 7.22% on December 31, 1986 to a high of 10.23% on October 15, 1987 (an increase in yield of over 40%).
On the 19th of that month the index fell 508 points (22.6%) to close at 1738.74. A recovery process began thereafter that led to the market exceeding its prior cyclical high of 2,722.42 from August of 1987 in late August of 1989.
The Dow Jones Industrial Average has since that era enjoyed better times and weathered what we would consider even more severe times.
Last Friday the Dow Jones Industrial Average closed at 22,871.72 and the 10-year Treasury yield stood at 2.27% slightly under where it started the year at around 2.45%.
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