Domestic equity markets continued their upward trend during the third quarter of 2017, with the S&P 500 Index returning 4.5%. This represents the 8th consecutive quarter of positive gains for the index, which has also been positive in 18 out of the last 19 quarters. Strong corporate earnings reports early, coupled with a late rally in response to the GOP’s tax reform plan, drove the upward momentum. Although news during the quarter was dominated by the series of hurricanes and natural disasters that struck the U.S., the market as a whole was largely unaffected.
Growth-oriented stocks outpaced their value-oriented counterparts, adding to their significant advantage for the year thus far; although, value stocks were able to recover some momentum during the final weeks of the quarter. Small-cap stocks outperformed large-cap stocks during the quarter, with the Russell 2000 Index returning 5.7% compared to the Russell 1000 Index at 4.5%. Technology was the best performing S&P sector with an 8.6% gain during the quarter, while Consumer Staples was the worst performing, down 1.3%.
International equity markets collectively outperformed the domestic markets. Emerging markets were the strongest performer, with the MSCI EM Index returning 7.9% (USD) for the quarter, noting Brazil, Russia, and China as the top performers within the index. Developed markets also performed well, with the MSCI EAFE Index returning 5.4% (USD). International performance during the quarter can be attributed to strong economic growth, solid corporate earnings, and a rise in oil prices. An increase in the strength of many major currencies against the U.S. dollar also contributed.
The yield on 10-year Treasury notes fell from 2.3% to a 10-month low of 2.1% early in September, then rebounded to 2.3% by the quarter’s end. The 2-year Treasury note finished the quarter just below 1.5%, the highest level in almost 9 years, causing the yield curve to flatten. Boosted by investor demand for higher yields, as well as generally healthy fundamentals, emerging markets debt was the best performing fixed income sector, with the BBgBarc Emerging Markets Index returning 2.3% during the quarter. The Federal Open Market Committee (“FOMC”) left rates unchanged during the quarter. Current expectations are for a rate hike in December, followed by three increases in 2018. At its September meeting the FOMC officially announced plans to begin unwinding its $4.5 trillion balance sheet, beginning in October.
The initial estimate of third quarter GDP is 3.0% annualized growth, beating consensus expectations. A rise in inventories, strong consumer spending, increased nonresidential investment, and a narrowing net export deficit all contributed to the better-than-expected economic growth. One of the few weaknesses noted in the report was a 6% decrease in residential investment. The global economy also continued its relatively steady, synchronized expansion, supported by export-oriented sectors and manufacturing activity.
Job gains averaged 91,000 per month during the quarter, despite losing 33,000 jobs in September as a result of the ferocious hurricanes that struck Texas, Florida, and neighboring states. The unemployment rate fell from 4.4% to 4.2%, reaching its lowest level since January 2001, while the labor force participation rate increased slightly from 62.9% to 63.1%.
Headline inflation rose from 1.6% to 2.2% during the quarter, whilst core inflation, which excludes food and energy, remained flat at 1.7% for the fifth consecutive month. Much of the increase in headline inflation can be attributed to a hurricane-related 6.1% increase in energy prices.
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