Who says September is bad for stocks?

Brian Nick

Article Highlights

Quote of the week

“Then I began to fall so low/ Lost all my good friends, I had nowhere to go/ I get my hands on a dollar again/ I'll hang on to it 'till that old eagle grins." - Nobody Knows You When You're Down and Out (1923)

The Lead Story: The dollar’s rebound hampers Treasuries

After falling steadily for more than six months, the U.S. dollar has regained some ground versus other major currencies, thanks in large part to hawkish comments from Fed Chair Janet Yellen. (Fed tightening typically raises U.S. bond yields, making U.S. fixed income more attractive and supporting the U.S. dollar.)

In a September 26 speech, while acknowledging that a gradual pace of monetary tightening was “prudent,” Yellen nonetheless cautioned against waiting too long to raise interest rates again. Her remarks appeared to reinforce the Fed’s signal from its last meeting that a December rate hike was still in the cards, boosting the market-implied probability of such a move to 70% (on September 7). We agree with the market’s view and expect a third 25-basis-point (0.25%) hike by year-end. 
The dollar got a midweek lift after the Trump administration outlined its plan for overhauling and simplifying the nation’s tax code. While short on details, the proposal includes market-friendly changes such as lower corporate tax rates and incentives for business investment. Here, though, we believe the odds of Congress passing such an ambitious bill are only around 20% this year and 50% next year.

Dollar-positive sentiment weighed on U.S. Treasuries. The yield on the bellwether 10-year note, which moves in the opposite direction of its price, headed higher during the week. It closed at 2.34%  on September 29, slightly above where it began the quarter. For the week through September 28, returns for non-Treasury fixed-income sectors were mixed, led by high-yield corporate bonds. Year to date through September 28, this asset class has gained nearly 7%. Investment-grade (IG) bonds have also fared well, returning more than 5% year to date, and are poised to benefit further during the fourth quarter, when we expect low supply, combined with steady demand, to boost prices.

In other news: Small caps relish the dollar’s resurgence

Small-cap stocks cheered the dollar rally, with the Russell 2000 Index hitting a record high en route to a 2.8% gain for the week. Smaller companies, which tend to have low exposure to exports, are more insulated from revenues denominated in foreign currencies. Moreover, they stand to benefit from tax reform given their higher effective tax rates. The predominantly large-cap S&P 500 Index (+0.6% for the week) also ended September—historically a rough month for stocks—on an up note with yet another record close. The index has now advanced in 10 consecutive months.

In Europe, the STOXX 600 Index returned 1.2% in local currency terms for the week, but the dollar’s ascent trimmed that gain to just 0.03%. The euro slipped in the wake of Germany’s election results, which saw Angela Merkel secure a fourth term as chancellor  but emerge with a smaller working majority. A rightwing populist party garnered about 13% of the vote—enough for representation in Germany’s parliament—which could lead to weeks of complex negotiations as Merkel seeks to form a new governing coalition.

Below the fold: Inflation remains MIA, home buyers must pay and pay, and consumers are doing OK

If the Fed expected prices to perk up substantially in August, it was sorely disappointed, based on the latest reading of its preferred inflation barometer, the PCE price index. Core inflation, which excludes food and energy prices, rose just 0.1%. Over the past 12 months, this  measure has increased just 1.3%, well below the Fed’s 2% target.

Meanwhile, it was more of the same on the housing front. Home prices kept climbing, with the S&P/Case Shiller 20-City Composite Index jumping 0.7% in July and 5.8% over the past 12 months. A combination of robust demand for homes and falling inventory has contributed to decreased affordability for many would-be buyers. In unwelcome news for the supply-starved housing market, new-home sales fell 3.4% in September, to an eight-month low.

As for consumers, spending rose 0.1% in August, in line with expectations. Adjusted for inflation, though, spending fell for the first time since January. Despite the late-summer hurricanes, consumers remained resilient, according to the University of Michigan’s sentiment gauge and The Conference Board’s index.

U.S. manufacturing flexed its muscles in August, as orders for durable goods (e.g., aircraft, machinery, computer equipment, and other big-ticket items) topped forecasts by leaping 1.7% in August. Core capital goods, a key measure of business investment, registered their eighth advance (+0.9%) in the last nine months.

Lastly, according to the government’s third and final estimate, U.S. GDP expanded at an annual rate of 3.1% in the second quarter, its fastest pace in two years and higher than the previous estimates of 2.6% and 3.0%.

The Back Page: Anticipating a narrower income gap

This month’s release of the Fed’s triennial Survey of Consumer Finances highlighted broad-based income gains, as workers benefited from an improving U.S. economy. Over the three-year period ended December 2016, GDP grew by an average of 2.2% per year, unemployment fell from 7.5% to 5.0%, and inflation rose by just 0.8% per year, on average, leading to greater purchasing power for consumers. Among the 126 million families surveyed, salaries increased across all income levels, with the median income rising by 10%, to $52,000.

Perhaps not surprisingly, the biggest raises went to the wealthiest 10%, whose median annual pay rose from $231,000 to $251,500, adding to an income gap that’s been widening since the 1970s. All told, the top quintile of earners saw their compensation grow by 9% during the three years—triple the rate of the lowest 20%. In 2015, the Center on Budget and Policy Priorities reported that the concentration of income in the U.S. had reached its highest level at the top than at any point since the 1920s.
There are signs, though, that this income disparity may have peaked in 2015, as “green shoots” are appearing for those receiving lower wages. Workers without a high school diploma, for example, saw far bigger percentage gains (+15%) in their pay during the three-year period than college grads did (+2%). If today’s economic recovery continues to spread beyond top earners, we could see further wage growth in low- or medium-paying occupations, which made up nearly half the new jobs added through the second quarter of 2017. That could potentially lead to a narrowing of the income gap.
This material is prepared by and represents the views of Brian Nick, and does not necessarily represent the views of Nuveen LLC, its affiliates or other Nuveen staff.
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