David Nelson, CFA
The market put in a strong month on the heels of a good earnings season along with strong economic data supporting the recent move. Investors have 3 hurdles to cross between now and year’s end.
- Justice Department – Just how far does the indictment of Paul Manafort and the guilty plea of George Papadopoulos extend into the White House and will it derail market friendly initiatives. According to press reports most working in the White House have hired lawyers so it’s fair to assume there is concern. One thing is for certain the investigation is far reaching and isn’t going to be over anytime soon. For now the market reaction is benign but of course all that might change if the tenor of the investigation changes.
- Tax Reform – What I put out in recent posts bears repeating. It isn’t theory anymore, U.S. markets are clearly pricing in some measure of tax reform and if it fails there will be a reset. It’s impossible to speculate as to what final legislation would look like but recent leaks point to a potential phase in of corporate tax cuts not fully being implemented until 2022. That alone would force investors to roll back estimate assumptions for next year. Remember a 20% corporate rate adds about $15 to S&P earnings so any big disappointments here changes the calculus. If I was a bookmaker in Vegas I’d give the odds of actual legislation even money.
- The Fed – It’s down to the final three. The President has narrowed his choice for Fed chair to Powell, Taylor and Yellen herself. Yellen is still in the running so likely a push. Powell is thought to be an extension of Yellen’s approach so again very little reaction would be expected. The wild card from my perspective is Taylor. He would be embraced by conservatives but it’s important to note that his quantitative rules based approach to fed policy would demand a fed funds close to 3% well above current rates just north of 1%. Market reaction might be harsh if investors felt the pace of tightening was likely to accelerate quicker than expected. Remember, the Fed is about to start the unwind of a nearly $4.5 Trillion balance sheet.
While the above are all concerns the other side of the debate argues that growth around the world is accelerating. In a recent note Goldman’s David Kostin points out that Global GDP for Q3 looks to come in about 4.4% up from 4% in the 2nd quarter. That’s certainly good news for U.S. multi-nationals. It’s important again to remember that 40% of S&P 500 revenue is derived from overseas.
Last week we had a trifecta of good news on the economic front. Durable goods came in at 2.2% well above the 1.2% expected. New home sales at 667k was a big beat and finally the advanced number for Q3 GDP was 3% above expectations and a surprise given the devastating storms in the South. Finally, Tuesday’s PMI came in at the highest levels since 2011 and consumer confidence was a blowout at 125.9.
Dancing with the same partners
From a sector standpoint Alpha Select has been very consistent with one notable exception. We’ve had consistent overweight’s in Financials and Technology. After spending most of the year with close to nothing allocated in Energy the models started picking up a turn in the fundamentals in the sector with a focus on refining and chemical companies a few weeks ago.
Looking out to the end of the year and beyond the Fed will still play an important role. Current Bloomberg consensus puts the odds of another rate hike this year at close to 90%. It’s important to remember that if the Fed lives up to their promise they will be also begin the process of letting the balance sheet run off. None of this is news so for now markets have already priced it in.
We’re coming into the home stretch with the 2017 finish line in sight. There is no off season for the markets so the process is an ongoing one with a new set of challenges and opportunities around every corner.
