- U.S. equities performed mostly higher in September as the Dow Jones Industrial Average increased 1.9%, the S&P 500 gained 0.4%, and the Nasdaq declined by 0.8%.
- The U.S. economy grew by 4.2% in the second-quarter showing the fastest pace in four years.
- The Federal Reserve raised interest rates a quarter percent to 2.25% in response to positive economic data.
- Geopolitical trade disputes are still in focus for investors, particularly U.S.-China negotiations.
Equity markets continued to move the upside throughout the 3rd quarter. We expect that upward progress to slow and could potentially see markets correct as recent gains are digested and investors look forward to US mid-term elections. A drop in the equity market indices should be viewed as a correction within an ongoing bull market. This may occur pre or post the mid-terms elections (as we write this the correction is here) but will be much more a result of rising long-term rates and little to do with the elections themselves.
While we believe we are closer to a peak in short term interest rates, we do expect long term rates to continue to rise in the face of stronger than expected domestic economic growth. We expect interest rates on long term US Treasuries to rise to between 3.5 to 4%, contained inflation should prevent rates from rising much above those levels over the next year. The speed with which interest rates rise will be a much more determining factor as to how deep a correction we experience in the equity markets.
We continue to maintain a negative view on long term bonds and recommend fixed income investors either shorten maturities or seek alternatives for their fixed income needs. This has been our position for the past couple of years. In terms of equity markets over the last quarter, we have increased cash levels in our portfolios, but we continue to recommend the redeployment of those cash balances on any corrections as we look forward to 2019. In the absence of any major economic or geopolitical negative news we remain optimistic on domestic equity markets and negative in the fixed income sector.
The summary of sector performances in the month of September were positive. Investors were optimistic, U.S. equities performed mostly higher as the S&P 500 showed its best quarterly performance since 2013 gaining 7.2%--a sixth-consecutive monthly gain at 0.4%. The Dow Jones Industrial Average increased by 1.9%, a record close since January, accomplished through the help of Industrial stocks outperforming index counterparts. The Tech sector was weaker, driving the Nasdaq to end its five-month winning streak with a 0.8% decline.
Geopolitical trade disputes are still in focus for investors. Advances in Industrial stocks are correlating to the increasing uncertainty of trade talks between the U.S. and China. Despite the breakdown in trade talks between these two large economies, successes were achieved between other trading partners on the global stage. Investors witnessed the drama of bilateral trade talks between the U.S. and Canada result in a replacement of NAFTA with the USMCA agreement on the last day of September. In addition to this development, the U.S. signed a trade deal with South Korea and is making progress in trade talks with Japan and the European Union.
The U.S. domestic market outperformed international markets in the month of September. China’s Shanghai Composite fell to its lowest level since 2014 in the early part of the month but rebounded to rise 3.5%. The Japanese Nikkei also increased to 5.5% witnessing its best performance in over 27 years. Emerging markets finished the month flat in response to higher oil prices and foreign currencies after falling sharply at the early part of the month. European markets also increased slightly as advances in the U.K. and France pushed the Euro STOXX 600 to achieve 0.9% in the third-quarter.
The Fed was in focus in September as the Federal Reserve raised rates in response to positive economic data. This is the third rate-hike for the year of 2018. Treasury yields jumped, facing their worst month since January. The benchmark 10-year yield finished the month at 3.06% increasing from 2.86% at the start of the month. We should note that the benchmark reached a high of 3.10% in September but backed off following Powell’s press conference.
Economic indicators in the domestic market offered investors reasons to be upbeat. The U.S. economy grew by 4.2% in the second-quarter showing the fastest pace in four years. Sentiment records were beaten in the areas of consumer confidence and small business optimism. The labor market continued to display strength as weekly jobless claims declined to 48-year lows and average hourly earnings increased by 2.9% year-over-year in August. Finally, U.S. manufacturing in August also expanded at the fastest pace in over 14 years.
On the energy front, OPEC members did not increase crude oil production causing Brent crude to increase to $80/barrel and WTI crude followed suit rising 4.9% in September. Despite fears of global supply shortages inflicted by U.S. sanctions on the oil producing nation of Iran, OPEC maintained current production levels.
Source: Wells Fargo Advisors. Monthly Market Commentary, October 3, 2018.