Investment & Economic Update | September 30, 2017

October 5, 2017|Kathleen Lakritz

The Economy: Economic expansion in its ninth year

The U.S. economy grew at a 3.1% annualized rate in the second quarter of 2017. The current economic expansion has now entered its ninth year of recovery, which is the third longest on record. The path of this expansion has been bumpy, with various soft patches along the way. Recent data is reflecting a slight uptick in activity.

Despite the fits and starts, the economy’s multi-year progress has added jobs and has pulled the unemployment rate down to 4.4% in August 2017 (down significantly from the peak unemployment rate of 10% in 2009). While the employment data has improved, Federal Reserve officials are disappointed that inflation has stayed below their target levels for a robust economy. Federal Reserve Board Chair Janet Yellen has been challenged by the persistence of inflation that is viewed as too weak and has remained below their target rate of 2%.

The U.S. economy is currently benefiting from an upturn in global activity and strong consumption. The outlook for the remainder of the year has been clouded due to weather-related disruptions from hurricanes in Florida, Louisiana and Texas.

The Stock Market: Stocks continue to rally to record highs

The momentum of the stock market rally that was ignited after the election of Donald Trump as president has continued into the third quarter of 2017. Stocks continued to reach new highs in the third quarter, becoming the second strongest bull market in history.  (The current bull market now trails only the 1987-2000 bull market in terms of strength.)

The popular S&P 500 Index (large company stocks) gained 4.48% in the third quarter, bringing the nine-month year-to-date gain to 14.24%. Other stock market benchmarks such as mid, small company and international stocks also appreciated similarly, resulting in nine-month year-to-date returns of 9.40% for the S&P MidCap Index, 8.92% for the S&P SmallCap Index and 14.66% for international stocks (as reflected in the MSCI Europe Australia Far East Index). Note that international stocks had lagged the U.S. benchmarks for nine years in a row, until this year’s outperformance.

While stock prices have reached record levels and valuations have moved up, the prospect of higher earnings has kept the market going and has provided resilience to weak economic reports and political challenges. While equity valuations may be stretched relative to their own history, when comparing stocks to other asset classes, such as bonds and cash, stock market valuations appear more reasonable. As in any market environment, equity investors should be prepared for price volatility. History shows that stock investments are rewarding for long-term investors with a diversified portfolio mix that reflects their stage in life and risk tolerance.

The Bond Market: The Fed holds rates steady, but will shrink its bond portfolio

The Federal Reserve policymakers left the benchmark federal funds rate unchanged in September at its range between 1.00% and 1.25%. The Fed had previously raised the fed funds target rate by a quarter percentage point four times since late 2015 as follows: December 2015, December 2016, March 2017 and June 2017.

The Fed’s plan is to keep a year-end rate increase on the table and begin to reduce holdings of bonds it had purchased after the financial crisis of 2008-2009. The unwinding of the Fed’s bond portfolio is meant to be a step toward the normalization of monetary policy, with a goal to allow interest rates to gradually move up from artificially low levels.

The yield on the two-year Treasury note ended September 30, 2017, at a 1.47% yield, up from its yield of 1.20% at the beginning of this year. However the 10-year Treasury yield fell to 2.33% on September 30, 2017, down from its yield of 2.45% at the beginning of the year. Economists attribute low inflation expectations (driven in large part by declining crude oil prices) as a factor keeping longer-term yields down.

Whether or not we see another rate hike yet this year is uncertain, but expectations remain high that 2018 could see several rate increases, particularly if there is a rebound in the core inflation rate, which is currently only 1.9%.

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Tags: Investments