Market Strategy Radar Screen Weekly August 28, 2017

 Let’s Give Them Something to Talk About

Comments from Yellen, Draghi, Cohn, and Trump gave the markets much to mull and digest

Stocks stateside last week bounced between gains and losses from the mid-point of the week after a strong rally on Monday and Tuesday driven by rising hopes for tax reform stalled after the president, while making a speech at a political event, appeared to call for a government shutdown if money wasn’t allocated for a border wall with Mexico.

Investors regained their composure on Friday and positive sentiment for a chance of tax reform returned and the broad market closed higher on Friday, up 0.72% on the week. It was the benchmark’s first weekly gain in two weeks. The S&P 400 (mid caps) and the Russell 2000 (small caps) moved higher as well rising 0.99% and 1.45%, respectively on the week. The mid and small caps outperformed large caps as hopes grew (based on remarks from within the Administration) for the likelihood for tax reform. (Mid and small cap stocks have underperformed large caps for most of this year as investors turned skeptical about the chance that tax reform as well as other stimulus items on the administration agenda would see the light of day).

As mid-term elections in 2018 grow closer on the horizon, we would expect those items on the White House’s agenda tied to stimulating the economy that are the least politically contentious (a tax cut if not tax reform; infrastructure spending; and a tax holiday to encourage repatriation of US multinational profits held abroad) will have a good chance to find political support from both sides of the aisle. Results at the polls since election day 2016 and so far this year have in our view signaled a strong desire among voters for action over gridlock and an end to the legislative stagnation in the halls of Congress.

While we expect nearer-term political rhetoric is likely to increase in volume, recent history suggests the political bark may be worse than the political bite.

No Surprises from Jackson Hole

The Kansas City Federal Reserve’s annual conference in Jackson Hole, Wyoming that took place last week provided a platform for Fed Chair Janet Yellen and the ECB’s President Mario Draghi. Anyone expecting earth shaking news from either central banker was disappointed as the respective chairs of the two central banks basically reiterated policy the market has long been privy to.

Bonds posted a modest rally last week with the US 10-year Treasury yield easing some to end the week at a yield of 2.17% or down around 11.4% in yield from a level of 2.45% at the start of the year.

As of last Friday the Fed funds futures indicated a 37.4% implied probability of a Federal Reserve rate hike in December. That’s higher than two weeks but sharply lower from a 94.1% change priced into the futures curve at the beginning of this year (see figure below).

Comments in the financial press of late have indicated that the bond market is less worried about the possibility of change in Fed leadership in February when Fed Chair Yellen’s first term is up. The word in the market seems to say that if President Trump were to nominate White House advisor Gary Cohn to the Fed Chairmanship that it would be acceptable to investors with expectations that he’d call for little change in policy.

Assessing Harvey’s Effects

As we went to press on Sunday night concerns remained elevated as to the effects of Hurricane (and now Tropical Storm) Harvey on the city of Houston and the surrounding area.

The storm had already led to record flooding across a city that is no stranger to tropical storms.

State officials, meteorologists, and emergency managers were saying that the downpour in the aftermath of the hurricane could last for days and that the cost to human life, and the local, regional and national economies would take some time to determine.

President Donald Trump approved a major disaster declaration, and the EPA (US Environmental Protection Agency) waived certain fuel requirements for gasoline and diesel supplies in Texas after the storm struck.

While the storm has near-term implications for both the local and regional economies, the size of the US as well as the size and the diversity of the Texas economy indicate that the storm will have less impact on the markets than some reports from the front of the storm have suggested.

In our view the US stock market is reflective of both the domestic and the global economy. As a result, even hurricanes of enormity such as Katrina and Sandy whose damages totaled $108 billion and $75 billion respectively, though tragic on the personal level as well as traumatic for the local economies were digested and discounted by the markets and the national economy relatively quickly.

The US economy (the largest in the world in excess of $18 trillion annually) and US equity markets have proven in the past to be resilient when facing damage done by hurricanes and other natural disasters. We expect them to respond similarly to the current storm.

At the local level, housing, construction, consumer products, health care, as well as the insurance sector can suffer near term from the damaging effects of the storm but as has been the case historically, they are likely to benefit from the recovery process after the storm has passed.

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