Despite the potential for seasonal weakness in September, the MSCI All Country World Index ended the month of September with a gain of 1.93%, achieving an all-time high on September 20th. In contrast to the rest of the year, emerging markets were not the primary contributor to returns as the MSCI Emerging Markets Index declined by ‑0.40% while the MSCI Europe and MSCI Japan indices increased by 3.30% and 1.96%, respectively. Unlike prior months, these gains were not primarily attributed to increases in currency. The U.S. Dollar Index increased by 1.90% from its 2017 low, which was hit on September 8th. U.S. stocks broke out of their anemic trading range with the S&P 500 Index increasing by 2.06% and the Russell 2000 Index increasing by 6.24%. The renewed strength in small-cap stocks is a good sign for market health. Historically, in a healthy and broad bull market, riskier small-cap stocks have outperformed large-cap stocks. However, this year the Russell 2000 has increased by 10.45% while the S&P 500 has increased by 13.72%. This relative underperformance was obviously worse at the end of August. At any rate, the overall stock market appears to be poised for continued growth.
While currency didn’t detract from the returns of stocks, it did take a bit out of bonds. Global bonds fell ‑0.86% in September, driven largely by the decline in foreign sovereign bonds, which fell -1.47%. Roughly 75% of that decline can be attributed to the decline of the euro and yen relative the U.S. dollar. Rising rates also played a role in an overall declining bond market with the U.S. Aggregate Bond Index declining -0.34% over the month as the 10-year Treasury yield hit a 2017 low in September before rebounding in the last weeks. The volatility of currency and rates is consistent with our long-standing preference for credit over duration as U.S. high-yield corporate bonds increased by 1.05% and emerging market corporate bonds increased by 0.68%.
The S&P 500 hit a new all-time high at the end of September, along with a new high in the advance-decline line, indicating that the increase in the index is broad based and healthy. The MSCI Europe and MSCI Japan also hit all-time highs at the end of the month along with all-time highs in their respective advance-decline lines. The only major equity markets left out of the rally were the MSCI Emerging Markets and the Russell 2000, although the latter finished its best month this year to date. What can we surmise from all this strength? We think stocks are still the best place for investors. Last month, we discussed the possibility of seasonal weakness as September and October tend to be weaker months for stock returns. Although this weakness has yet to materialize, we are not out of the woods just yet. October is typically the weaker of the two months, but the first few days of October have bucked conventional wisdom. Despite the possibility of a pullback in stocks, the overall trend is still very strong for stocks and investors should continue to overweight their positions.
Bonds were a bit more rational in September as the high-flying foreign sovereign bond market gave up some its spectacular 2017 gains. The month was weak with a loss of -1.47%, with the bond market experiencing a ‑3.56% drawdown from peak to trough. Bonds have been an area of the market that appear most vulnerable as the gains over the year have been due entirely to unsustainable currency gains despite an underlying market where interest rates have been increasing at a healthy rate. Our outlook has preferred credit over duration; the recent rebound in global rates, the specter of future inflation and the strength of the global economy all point toward the strong relative performance of credit. While investors should remain overweight stocks, we think bond positions should largely be allocated to credit.
There is an old wall street axiom that stocks climb a “wall of worry,” and 2017 seems to perfectly encapsulate the meaning of this phrase. Much of the enthusiasm for 2017 was fueled by the growth catalysts of tax reform, infrastructure spending and reduced regulations. However, nearly all those catalysts have failed to materialize and have been replaced by series of new foreign policy concerns with Russia, Iran and North Korea. Despite the lack of fiscal policy and a never-ending cycle of foreign policy hysteria, the MSCI ACWI has increased by 18.42% year to date. Much of these gains have been driven by a robust global economy that appears to be gaining in strength. Currently, 75% of global composite leading indicators are above their long-term average and the JPMorgan Global Composite PMI sits at 53.9, indicating the expectation of further economic growth. The strong PMI readings are in both service and manufacturing, indicating the strength is broad based. As a result, there really isn’t any reason to change our outlook of preferring emerging market stocks and credit over duration.
Aside from risks that are hard to avoid, such as an escalation in North Korea, the issues facing this market seem clear and, fortunately, quite tame. As global central banks begin to unwind their various easing programs, it will likely put upward pressure on rates. Higher rates will eventually be an impediment to growth, especially when we consider that much of the earnings growth, particularly in the developed world, has been facilitated by financial engineering of corporate balance sheets. Inflation appears to be on the horizon once again and if the gradual increase in rates doesn’t keep it under wraps, then unexpected inflation could also become an issue for market growth. Finally, valuations are extended. While the value of assets tends to be a terrible timing mechanism, we think at some point it will matter.
One final silver lining: if growth-oriented policy fails to materialize in the near term, it may be a blessing in disguise. With unemployment at 4.37%, the economy is at or near capacity. Additionally, with a low interest rate environment, the Federal Reserve has very few levers to pull if the U.S. should slip into recession. Tax cuts and infrastructure spending would be excellent methods to help dampen a future recession, but, if implemented today, would leave no monetary or fiscal levers to pull in the event of an economic slowdown.
The OSIRIS-REx spacecraft completed its slingshot around Earth in the last week of September and returned some stunning photographs of our planet. Because of the slingshot, it is now travelling at a speed of 19,000 miles per hour toward the asteroid Bennu. This multiyear project is the first attempt by NASA to collect a sample from an asteroid and return it back to Earth. The hope is to learn more about the composition of asteroids, which will help in the continued development of asteroid collision avoidance programs. The mission is expected to last seven years and is a mere 390 days into its important mission.
Investing involves risk, including possible loss of principal. The value of any financial instruments or markets mentioned herein can fall as well as rise. Past performance does not guarantee future results.
This material is distributed for informational purposes only and should not be considered as investment advice, a recommendation of any particular security, strategy or investment product, or as an offer or solicitation with respect to the purchase or sale of any investment. Statistics, prices, estimates, forward-looking statements, and other information contained herein have been obtained from sources believed to be reliable, but no guarantee is given as to their accuracy or completeness. All expressions of opinion are subject to change without notice.
Nic Millikan and Nathan J. Rowader are registered representatives of ALPS Distributors, Inc.
Advance-decline line is a technical indicator that plots changes in the value of the advance-decline index over a certain time period.
Alerian MLP Infrastructure Index is the leading gauge of large- and mid-cap energy master limited partnerships (MLPs). The float-adjusted, capitalization-weighted index includes some of the most prominent companies and captures approximately 75% of available market capitalization.
Bloomberg Barclays EM Sovereign Bond Index is a rules-based market-value weighted index engineered to measure the fixed-rate local currency sovereign bonds issued in emerging markets as identified by Bloomberg.
Bloomberg Barclays Global Treasury ex-USD Index is an unmanaged index composed of those securities included in the Barclays Global Aggregate Bond Index that are Treasury securities, with the US excluded while hedging the currency back to the US dollar.
Bloomberg Barclays U.S. Aggregate Bond Index represents securities that are U.S. domestic, taxable and dollar denominated. The index covers the U.S. investment-grade, fixed-rate bond market, with index components for government and corporate securities, mortgage pass-through securities and asset-backed securities.
Bloomberg Barclays U.S. Corporate High-Yield Bond Index covers the USD-denominated, noninvestment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high yield if the middle rating of Moody’s, Fitch and S&P is Ba1/BB+/BB+ or below.
Bloomberg Barclays U.S. Credit Index is an index composed of corporate and non-corporate debt issues that are rated investment grade (Baa3/BBB) or higher.
Bloomberg Barclays U.S. Mortgage Backed Securities (MBS) Index tracks the mortgage-backed pass-through securities of Ginnie Mae (GNMA), Fannie Mae (FNMA) and Freddie Mac (FHLMC).
Bloomberg Barclays U.S. Municipal Bond Index covers the USD-denominated, long-term tax-exempt bond market. The index has four main sectors: state and local general obligation bonds, revenue bonds, insured bonds and pre-refunded bonds.
Bloomberg Barclays U.S. Municipal High Yield Index measures the noninvestment-grade and nonrated U.S. dollar-denominated, fixed-rate, tax-exempt bond market within the 50 United States and four other qualifying regions (Washington D.C., Puerto Rico, Guam and the Virgin Islands).
Bloomberg Barclays U.S. Treasury Index is an unmanaged index of public obligations of the U.S. Treasury with a remaining maturity of one year or more.
Bloomberg Barclays U.S. Treasury Bond 1-3 Year Term Index is an unmanaged index of public obligations of the U.S. Treasury includes public obligations of the U.S. Treasury with a maturity between 1 and up to (but not including) 3 years.
BofA Merrill Lynch U.S. Core Fixed Rate Preferred Stock Index consists of investment-grade, fixed and fixed-to-floating rate U.S. dollar-denominated preferred securities.
CBOE Volatility Index is a popular measure of market risk and is constructed using the implied volatility of S&P 500 index options.
Consumer price index (CPI) is an index number measuring the average price of consumer goods and services purchased by households. The percentage change in the CPI is a measure of inflation.
Credit Suisse Emerging Market Corporate Bond Index consists of U.S. dollar-denominated fixed-income issues from Latin America, Eastern Europe and Asia.
Dow Jones Global ex-U.S. Select REIT Index measures the performance of equity real estate investment trusts (REITs) and real estate operating companies (REOCs) traded globally, excluding the U.S.
Dow Jones U.S. Real Estate Index measures the performance of the real estate industry of the U.S. equity market.
JPMorgan Global Manufacturing Purchasing Managers’ Index is a composite index that serves as a global economic indicator by measuring different business conditions in 24 countries, including global manufacturing output, new orders and employment across the global manufacturing sector.
MSCI ACWI (All Country World Index) is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global developed and emerging markets.
MSCI EAFE (Europe, Australasia and Far East) Index is a stock market index that is designed to measure the equity market performance of developed markets outside of the U.S. and Canada.
MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance in the global emerging markets.
MSCI Emerging Markets Infrastructure Index captures the global opportunity set of companies that are owners or operators of infrastructure assets.
MSCI Japan Index is a free float-adjusted market capitalization index that is designed to measure the equity performance of 85% of Japan’s large- and mid-cap segments.
Max drawdown is the percentage of loss that an asset incurs from its peak net asset value to its lowest value.
NASDAQ-100 is a modified capitalization-weighted index that includes the largest nonfinancial U.S. and non-U.S. companies listed on the NASDAQ stock market across a variety of industries, such as retail, healthcare, telecommunications, wholesale trade, biotechnology and technology.
NYSE Advance/Decline Indicator is a technical indicator that charts the difference between the number of advancing stocks and declining stocks on the NYSE in a given market on a given day.
NYSE New Highs/Lows is a technical indicator that charts the highest and lowest prices over 52 weeks of NYSE stocks in a given market on a given day.
Russell 2000 Index measures the performance of the 2,000 smallest companies in the Russell 3000 Index. The Russell 3000 Index represents approximately 98% of the investable U.S. equity market.
S&P 500 Financials Index comprises those companies included in the S&P 500 that are classified as members of the GICS® financials sector.
S&P 500 Index is an unmanaged index of 500 common stocks chosen to reflect the industries in the U.S. economy.
Sharpe ratio is a ratio developed by Nobel laureate William F. Sharpe to measure how a fund performs relative to the risk it takes.
Standard deviation measures the degree to which a fund’s return varies from its previous returns or from the average of all similar funds.
U.S. Dollar Index is a measure of the value of the U.S. dollar relative to six major world currencies: the euro, Japanese yen, Canadian dollar, British pound, Swedish krona and Swiss franc.
Valuation is the process of determining the value of an asset or company based on earnings and the market value of assets.
VIX (the ticker symbol for the Chicago Board Options Exchange Volatility Index) is a popular measure of market risk and is constructed using the implied volatility of S&P 500 index options.
Yield is the interest or dividends received from a security and is usually expressed annually as a percentage based on the investment’s cost or on the U.S. government’s debt obligations.