October 6, 2017

Highlights:

  • Global equity markets continued their advance propelled by continued momentum in global growth sentiment.
  • 3rd quarter began similar to the two prior quarters with U.S. large cap growth and emerging market stocks leading the advance.  Commodity prices also advanced on the improving global growth outlook as well as the recovery in oil prices to above $50/barrel.
  • U.S. technology stocks far outpaced the rest of the U.S. market with a 7.8% advance as investors cheered a 14.8% year-over-year growth in 3Q reported earnings (based on reported earnings through 10/27/2017).
  • The materials sector also performed well (up 3.9%) as chemicals and miners are enjoying the continued up-cycle in global economic growth.
  • The U.S. dollar continued its recovery versus major trading partner currencies as the DXY advanced 1.6% for the month and is up 3.5% from the YTD lows in early September.  The renewed strength could reflect diverging central bank policies as both the European and Japanese Central Banks are not following the U.S. Federal Reserve’s lead in tapering emergency monetary measures enacted after the 2008 financial crisis.
  • The yen’s weakness notwithstanding, Japan (in U.S. dollar terms) led all major regions in October followed by the broader Asian region. The broader Asian region (Taiwan, South Korea) also benefited from U.S. tech leadership.
  • China convened its 19th National Congress, a twice-a-decade meeting, which further cemented President Xi Jinping’s hold on Communist party leadership.  More bullish investors expect China to continue its long-term secular growth while implementing structural and economic reforms to better address poor capital decisions and address excess leverage.
  • If the global economy is late in the cycle and due for a downturn, don’t tell Wall Street.  For all of 2017, sell-side analysts are projecting earnings growth of 9.3% on top of revenue growth of 6%.  Analysts also expect earnings to grow 10.3% through 2Q2018 on top of revenue growth of 6.3%.
  • Fixed income was largely flat although risky credit sectors performed well as credit spreads dipped to 3-year lows.  The 10-year US Treasury Yield rose to 2.38% but remains below 2017 highs (2.40-2.45%).
  • Despite narrow credit spreads that suggest a benign environment for default risk, fixed income investors are pricing in a less sanguine view of the next leg of the business cycle as the 2-10 year term premium narrowed to 0.78%, near the YTD lows.
  • A flattening yield curve could reflect expectations that short-term interest rate hikes by the Federal Reserve will eventually weigh on future economic output.  It may also indicate low expectations of meaningful tax legislation being passed before year-end.  The underperformance of U.S. small versus large caps appears to also confirm this sentiment.
  • As global equity markets advance, risk premiums have been squeezed tighter.  According to Bloomberg consensus estimates, the S&P 500 trades at 19.4x multiple to next 12-months earnings and 21.6x trailing 12-months earnings.  A 19.4x multiple translates to 5.15% earnings yield which is less than a 3% premium to 10-year Treasury Yields.

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