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Commentaries

PMC Weekly Review - November 3, 2017

A Macro View: October Monthly Recap

Domestic equity market returns were positive in October, with gains tilted to the larger cap and growth-oriented indices. The US market’s advance was driven by a combination of positive earnings growth, continued positive economic statistics, and anticipation of the Administration’s tax reform/tax cut plan.

By the end of October, roughly two-thirds of the S&P 500 had reported third-quarter earnings, with a combined year-over-year EPS growth of nearly 7% (roughly 5% ex-energy companies)1. The forward P/E ratio on the S&P 500 Index was 17.9 at the end of the month versus roughly 16.6 a year ago.

On the economic data front, the University of Michigan Consumer Sentiment Index jumped to a 13-year high of 101.1 in October, as those polled were both more satisfied with their current economic position and more hopeful about the outlook in the near future. This sentiment also appeared in the retail sales data for September, up 1.6%, the largest increase in more than two years. A significant portion of the gain, 0.6%, was from auto sales, which were boosted by households replacing cars and trucks damaged in the August hurricanes. The national employment picture continued to look rosy, as initial unemployment claims hit a 44-year low in mid-October, though the claims from the U.S. Virgin Islands and Puerto Rico are likely still inaccurate, given the lingering damage from Hurricane Maria. Late in the month, the initial third-quarter GDP estimate came in at a 3.0% annualized rate, just 0.1% lower than the second quarter, despite the August storms. During the third quarter, business investment was up 3.9%, and consumer spending was up 2.4%.

Finally, GOP leaders in both the House and Senate continued working on a plan for an ambitious reworking of the US tax code. The key point for the equity markets is a significant reduction in the corporate tax rate, rumored to be capped at 20% in the new plan. Also expected to be included is a “tax holiday” for companies repatriating overseas earnings, which would benefit large multinational companies if passed. The first in a long series of steps to get the tax reform package passed was completed in the final week of the month, as both houses passed a $4.1 trillion budget “resolution.” The resolution does not have the force of law, but it does provide a parliamentary vehicle the GOP can attach the tax reform bill to, and using the reconciliation process allows it to pass the tax reform bill without being subject to a filibuster in the Senate.

Within this context, domestic equities were higher for the month, as the Russell 1000 Growth Index gained 3.87%, but the Russell Top 200 Growth Index was up even more, 4.22%. The value indices ranged from +80 basis points for the Russell Midcap Value Index to just +13 basis points for the Russell 2000 Value Index. Among large caps, the Information Technology and Financials sectors drove most of the Index’s return, offset by modest losses in the Consumer Staples, Energy, and Healthcare sectors. The Bloomberg Commodity Index as a whole was up 2.14% for the month, as the rally in energy and industrial metals more than offset weakness in the precious metals and agricultural sectors. The Dow Jones U.S. Select REIT Index was down 1.09% for the month.

International equity markets were also positive for the month (in local currency terms), with Japan and the other Asian markets outperforming the US, and Europe as a whole slightly underperforming. Japan’s snap election during the month handed a large majority to Prime Minister Shinzo Abe’s LDP, ensuring continuity in the country’s economic plans. Manufacturing and non-manufacturing business sentiment indices both were up in the month as well. Europe’s big policy event of the month was the ECB’s decision to extend its QE purchases by another nine months, but to modestly reduce the amount purchased each month. Economic data for the Eurozone continued to be positive, as the initial estimate of third-quarter GDP was 0.6%, and unemployment for September fell to an eight-year low of 8.9%. The Japanese TOPIX Index was up 5.4% for the month, bringing its year-to-date gain to 18.6%. The MSCI Europe Index was up 0.47% for the month, but country-to-country returns varied widely. Germany and France showed modest gains around 1.5%, while Spain was essentially flat, and Italy was down 1.4%. The MSCI Emerging Markets Index posted a gain of more than 3.5% for the month, with strength in China offsetting losses in Russia and Latin America.

Domestic fixed income markets largely posted a very modest return in October. A long slate of positive economic news slowly pushed short- and intermediate-term rates higher during the month, while tame inflation readings limited the increase in long-term rates. This continued the yearlong flattening of the yield curve, as the front end of the Treasury curve rose 9-13 basis points, and the long end was up just 2-3 basis points. As has been the case for most of the year, the corporate bond market, both investment grade (+40bps) and high yield (+42bps), posted the strongest returns in the month, as spreads continued to grind tighter, and the higher coupon income offset the rise in interest rates. CMBS, particularly non-Agency CMBS, had a relatively strong month as well, up 39 basis points. The international fixed income markets were down slightly on a local currency basis due to a strong move in the dollar for the month. The Global Aggregate ex USD Index was down 75 basis points in October but was up 70 basis points once the currency impact was hedged out. Emerging markets also were substantially affected by the strength of the dollar, with the Emerging Markets USD Index up 38 basis points and the Local Currency (Government) Index down 1.56% on an unhedged basis.

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1 JPMorgan October Market Review

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