Time for a Market Rotation?

Market Observations

Equity markets continued their advance globally during the third quarter. In our opinion, improved corporate earnings, fairly good economic data and low interest rates have continued to support high—and growing—equity multiples around the world. Despite hurricanes and the war of words between the United States and North Korea, market volatility remained within a low, fairly tight range during the quarter.

Growth-oriented stocks, which became the momentum trade early in the year, led the market higher during the third quarter. However, value stocks overtook growth stocks in September, which could mark the beginning of a rotation. The value indices were driven by the energy sector, which was the best-performing segment globally in September as the price of crude rose from a low in the second quarter and hit bull-market territory in the third quarter.

Similarly, international and emerging-market stocks led the equity advance for the quarter as the MSCI EAFE index returned 5.4% and the MSCI EM index returned 7.9%, outpacing the S&P 500 index return of 4.5%. However, September favored U.S. stocks, a reversal of what had occurred year-to-date through August. Additionally, in the United States, we saw small- and mid-cap stocks outperform large-cap stocks.

The 10-year Treasury finished the month yielding 2.33% after beginning the quarter yielding 2.30%. The yield got as low as 2.06% on Sept. 8 before bouncing back on anticipation that inflation could pick up. Additionally, the U.S. dollar’s slide, which is down 8.9% year-to-date as per the U.S. Dollar Index, stalled in September. Instead, the U.S. Dollar Index rose 0.4% in the month of September, indicating that the dollar was strengthening. The weakening dollar throughout the year was due to concerns about continued slow growth and the lack of fiscal policy coming out of Washington D.C.

The rotations taking place within the equity markets in September seem to have been driven by a reemergence of the reflation trade. An increase in the probability of another Federal Reserve rate hike in December, the unwinding of the Fed’s balance sheet and Congress beginning work on a potential tax overhaul could signal the beginning of a rotation to new market leadership. The prospects for an upcoming rate hike helped to increase Treasury yields and strengthen the U.S. dollar. Potential for corporate tax reform and increasing rates have boosted the financial sector, which stands to benefit from a steeper yield curve. Small-cap stocks could benefit most from a corporate tax cut. These events are similar to the reflation trade that began to take shape following the November presidential election. That reflation trade, however, ended up being short-lived as the Trump administration and Congress encountered gridlock when trying to enact legislation.

If the Trump administration and Congress have success implementing tax reform, and if there is enough economic growth to spur inflation and further Fed rate hikes, the reflation trade could have legs this time around.

Disclaimer

Sources: Factset, Bloomberg Financial Services, Zephyr StyleAdvisor, Morningstar Inc.

The returns for the simulated portfolios represent performance of hypothetical allocations and do not represent results of actual accounts. The performance of actual accounts will vary. Performance results for hypothetical allocations have inherent limitations. Such returns do not factor in the effects of economic and market conditions then in existence on the investment manager’s decision-making process if the manager were actually managing client money which would have changed the allocation and results. Additionally, hypothetical allocations are subject to the fact that they were determined with the benefit of hindsight based on the actual performance of the individual manager or index.

Definitions

Indices are unmanaged and presented for comparison purposes only. Please note that the returns displayed for indices do not take into account any of the costs associated with buying and selling individual securities. Individuals cannot invest directly in an index.

Bloomberg Barclays US Aggregate Index (Treasury, Agency, Securitized – MBS, Credit – Corporate). The Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed-rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass-through), ABS and CMBS (agency and non-agency).

Bloomberg Commodity Index - The Index tracks prices of futures contracts on physical commodities on the commodity markets. The index is designed to minimize concentration in any one commodity or sector. It currently has 22 commodity futures in seven sectors.

BofA ML High-Yield Master Index - a capitalization-weighted Index that provides a broad measure of the performance of the non-investment grade US domestic bond market. The Index is limited to US domestic and Yankee markets. Bonds must have greater than 1 year remaining to final maturity, at least $100 million face outstanding, be US dollar pay, have a fixed coupon schedule with a credit rating below investment grade not in default.

Citigroup Non-USD World Government Bond Index (WGBI) – The Citigroup Non-U.S. Dollar World Government Bond Index is an unmanaged, market-capitalization-weighted index that tracks 10 government bond indices, excluding the United States

FTSE NAREIT All REITs Index – is a market capitalization-weighted index that and includes all tax-qualified real estate investment trusts (REITs) that are listed on the New York Stock Exchange, the American Stock Exchange or the NASDAQ National Market List. The FTSE NAREIT All REITs Index is not free float adjusted, and constituents are not required to meet minimum size and liquidity criteria.

MSCI World ex-USA - The MSCI World ex USA Index captures large and mid-cap representation across 22 of 23 Developed Markets (DM) countries excluding the United States.

MSCI Emerging Markets - The MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) designed to measure equity market performance in global emerging markets.

Russell 1000 Index – a stock market index that represents the highest-ranking 1,000 stocks in the Russell 3000 Index, which represents about 90% of the total market capitalization of that index.

Russell 2000 Index - The Russell 2000 index is an index measuring the performance approximately 2,000 small-cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. The Russell 2000 serves as a benchmark for small-cap stocks in the United States.

Risks

Investing in securities is speculative and entails risk. There can be no assurance that the investment objectives will be achieved or that an investment strategy will be successful. The use of leverage, short sales and derivative transactions, investment in foreign or illiquid securities, and potentially limited diversification, could cause significant losses.

Special Risks of Real Estate Securities

Real estate investing may be subject to a higher degree of market risk because of concentration in a specific industry, sector or geographical sector. Real estate investing may be subject to risks including, but not limited to, declines in the value of real estate, risks related to general and economic conditions, changes in the value of the underlying property owned by the trust and defaults by borrower.

As with any investment, there are risks associated with investing in bonds. These include risks related to interest rate movements (interest rate risk and reinvestment risk), and the risk of credit quality deterioration (credit or default risk). These risks need to be evaluated and effectively managed if the client is to achieve the potential benefits of investing in fixed income securities.

Interest Rate Risk. Interest rate risk is the risk that market interest rate fluctuations result in a decline in the security’s price between the time the investor buys it and the time (before maturity) at which he or she sells it. (The bond’s price will decline when rates rise and vice versa.)

Reinvestment Risk. Reinvestment risk is the risk that the cash flow received from a bond may be reinvested at a lower rate of return. Short-maturity bonds and callable bonds are the instruments most frequently associated with reinvestment risk. Callable bonds may subject the investor to reinvestment risk. Such bonds allow the issuer to repay the principal (with accrued issuer the flexibility to refinance the debt if rates are low or declining. The timing of bond calls occurs precisely when investors do not want to receive their principal back, i.e., when they can only reinvest at either lower rates or in lower-quality securities. To compensate them for this reinvestment risk, investors in callables typically demand (and get) a higher interest rate as compared to non-callables.

Credit or Default Risk. Credit or default risk is the risk that the issuer may be unable to make timely principal and interest payments on the bond. It is the critical determinant of a fixed income security’s quality.

High Yield Fixed Income Risk. High yield fixed income securities are considered to be speculative and involve a substantial risk of default. Adverse changes in economic conditions or developments regarding the issuer are more likely to cause price volatility for issuers of high yield debt than would be the case for issuers of higher grade debt securities. In addition, the market for high yield debt may be less attractive than that of higher-grade debt securities.

Past performance does not guarantee future results.

© 2017 All rights reserved. This report is intended for informational purposes only. All information provided and opinions expressed are subject to change without notice. The information and statistical data contained herein have been obtained from sources we believe to be reliable. No part of this report may be reproduced in any manner without the written permission of Oppenheimer Asset Management or any of its affiliates. Any securities discussed should not be construed as a recommendation to buy or sell and there is no guarantee that these securities will be held for a client’s account nor should it be assumed that they were or will be profitable. The Consulting Group is a division of Oppenheimer Asset Management. Oppenheimer Asset Management is the name by which Oppenheimer Asset Management Inc. ("OAM") does business. OAM is an indirect, wholly owned subsidiary of Oppenheimer Holdings Inc., which is also the indirect parent of Oppenheimer & Co. Inc. ("Oppenheimer"). Oppenheimer is a registered investment adviser and broker dealer. Securities are offered through Oppenheimer. 1946566.1