Third Quarter 2017 Update

October 6, 2017

Key Points

• The global economic environment is strengthening, as many regions of the world are experiencing accelerating growth
• The Federal Open Market Committee announced it would begin the process of normalizing its balance sheet in October by not replacing maturing securities
• Expectations for tax reform are high, and modestly rising corporate profitability is providing justification for record stock prices
• In spite of the seeming “Goldilocks” environment, risks do remain

The Global Economy

The US economy continues on a solid growth trajectory, despite the negative short-term impacts of Hurricanes Harvey and Irma, the continued uncertainty over various policy initiatives in Congress, and the nuclear brinksmanship with North Korea. The Bureau of Economic Analysis reported its third estimate of second quarter 2017 gross domestic product (GDP) of +3.1%, up slightly from the prior estimate, and also higher than the first quarter’s +1.2% reading. The employment situation improved over the prior quarter, with an average of approximately 185,000 jobs added each month. At the same time, the unemployment rate ticked up to 4.4%. The Federal Open Market Committee (FOMC) kept its interest rate policy unchanged, with a fed funds rate target range of 1.00% – 1.25% and announced it would begin the process of normalizing its balance sheet in October by not replacing maturing securities.

The global economic environment is strengthening, as many regions of the world are experiencing accelerating growth. The Eurozone economy grew at a 2.2% annual rate in the second quarter, which follows a strong showing in the first quarter. A surge in exports was the primary driver of the region’s growth. Asian economies have experienced mixed results, with China producing adequate growth, but emerging economies in the region not faring as well. Economists are forecasting that China should generate 6.7% GDP growth for 2017. Latin American economies such as Brazil and Peru are beginning to accelerate, while inflation remains under control.

Below, we’ve highlighted broader market returns for the 3rd quarter and year-to-date time periods:

Source: Thomson Reuters, Envestnet

Fixed Income

Fixed income securities’ prices continued to be affected by several important factors, including the Federal Open Market Committee’s (FOMC) widely anticipated decision to begin reducing its balance sheet; a steadily improving economy; rising stock prices; the threat on the Korean peninsula; and an environment of partisan bickering in Washington. Although the FOMC left its interest rate policy unchanged this quarter, it did announce that it would begin the process of unwinding its balance sheet in October. Because the move has been widely anticipated, the formal announcement ultimately had little impact on bond prices. Even though there was some volatility in prices within the quarter, prices and yields ended September at approximately the same levels as in June.

The shape of the Treasury yield curve flattened modestly in the quarter, but on balance was little changed. Yields on short- to intermediate-term maturities edged slightly higher, while those on long-term issues were substantially unchanged. Inflation expectations inched higher, with the Fed’s gauge of five-year forward inflation expectations rising slightly from its 1.75% level of June 30.

Equities

Equity markets also continued their march higher in the quarter, tacking on to the strong returns since the presidential election. Continuing to drive returns during the quarter were steadily improving economic data, accelerating corporate profitability, and anticipation of a tax reform package that would include material tax cuts. These factors contributed to the ongoing low volatility financial market landscape, with the Chicago Board Options Exchange Volatility Index—better known as VIX—remaining at historically low levels.

International stocks slightly outperformed US equities for the quarter. European economies continued their resurgence, after several years of sub-par results. In addition, China’s growth has held steady, even as the country goes through a process of structural reforms. With that as a backdrop, international stock indices were almost universally higher.

Summary

Despite bitter divisions in Washington, flashpoints in North Korea and Iran, and a devastating hurricane season, the US economy continues to churn ahead. It remains the third-longest economic expansion on record, and the consensus among economists is that there is little on the horizon to indicate its steady path will face obstacles in the near term. Expectations for tax reform are high, and modestly rising corporate profitability is providing justification for record stock prices. Interest rates remain low, inflation continues to be benign, and the subdued market reaction to the FOMC’s initiation of balance sheet normalization have combined to create a low volatility environment. Unlike the past several years, the global environment is now contributing positively, with the Eurozone picking up steam, and other regions enjoying a positive outlook.

In spite of the seeming “Goldilocks” environment, risks do remain. As we mentioned last quarter, with the market at all-time highs, volatility at historic lows, and valuations extended (at least in the eyes of some market analysts), stock prices could be susceptible to an unforeseen outcome, either on the policy side or on the earnings front. In addition, if tensions with North Korea go beyond mere rhetoric, volatility is likely to spike, and stock prices may suffer a setback. On balance, we believe investors have reason to be cautiously optimistic.

Information provided is for informational purposes only and should not be construed as investment advice. The views expressed are current only as of the publication date, are based on information that St. Clair Advisors believes to be accurate, and subject to change without notice. All investment decisions must be evaluated as to whether they are consistent with your investment objectives, risk tolerance and financial situation. St. Clair disclaims any liability for any direct or incidental loss incurred by applying any of the information in this publication. Indexes are unmanaged and one cannot invest directly in an index. Past performance is no guarantee of future results.

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