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Despite significant geopolitical tension, especially regarding North Korea and the escalating standoff over its nuclear weapons program, and a number of widespread natural disasters, the bull has forged on with markets giving little more than a shoulder shrug of doubt. In fact, the S&P 500 Index has only had eight daily swings of over 1% this year—a remarkably low number considering the global backdrop. Through the end of the third quarter, the S&P 500 Index was up over 14% for the year (more than 4% of which was gained in the third quarter alone). It feels like we’re constantly saying that it is, yet again, trading at record highs. The rest of the world has also fared well these past few months, with developed and emerging markets both outperforming the US in the third quarter. Notably, this summer marked ten years since the start of the financial crisis in 2007. And while the economy is still very much a work in progress, several fundamentals are normalizing and/ or improving and offering real support to a rising stock market and growth in GDP. It appears the bull isn’t going anywhere for the time being, and investors perceive the odds of a recession to be pretty low. We understand that our clients are worried about the market consistently reaching new heights (43 highs this year, to be exact), and that worry is certainly warranted. We’re still cautious ourselves (just consider it our nature at this point), but optimistic nonetheless. Here’s what’s been happening in the world to feed our view:

Global Economic Growth
The MSCI World Index has hit new highs this quarter, a reflection of continued synchronized global growth. In fact, according to economist David Rosenberg, all of the 45 countries that are tracked by the Organization for Economic Cooperation and Development are positioned to expand this year. Several countries have continued their policies of monetary stimulus, and it’s certainly having a positive impact on business as we witness countless corporate expansions, acquisitions, mergers, and other deals. There seems to be more positive data released every day from various countries, even in Europe and Asia. The geopolitical issues in Asia are not to be taken lightly, nor is the fragile political backdrop in Europe, but the economic data is painting a pretty positive picture of the regions, particularly regarding exports in emerging markets and healthy manufacturing data in much of the eurozone. 

It's Still All About Earnings

The market’s forward P/E multiple is unusually high, suggesting an expensive stock environment. What we’ve been saying for a while now remains true: earnings are of utmost importance in justifying stock prices as we head into the fourth quarter of 2017 and through the start of next year. The second quarter of this year saw most companies exceed analyst expectations, and the third quarter should turn out to be positive for earnings, as well. While there’s a chance Q3 numbers will be eaten into by Hurricanes Harvey and Irma, the flip side is that rebuilding in the aftermath of the hurricanes should have a positive impact on economic growth in the fourth quarter. And for what it’s worth, from an economic and market perspective, we seem to have gotten back on the horse a lot quicker this time than after Hurricanes Katrina and Sandy. So, investors are looking ahead with optimism. Higher oil prices, as well as other commodities’ strength (namely copper), should also contribute to positive earnings data in the coming months. Consumer confidence is in record high territory, which should hopefully bode well for the holiday season.

The Fed's Take

Now that the unemployment rate has held low around what many think is the new normal, the Federal Reserve Bank believes our economy has strengthened enough to withstand quantitative tightening (or a reversal of the easing we’ve experienced for years) to return to normalized monetary policy. However, the X factor continues to be prices, which economists look to as an indicator of inflation. 

The Fed would like the Consumer Price Index (which measures what prices Americans pay for all types of goods) to read above 2%, but the index has spent much of the year trending lower before picking up substantially in August and likely September, too. Therefore, the Fed is sitting patiently and giving itself a lot of flexibility in timing. In terms of interest rates, the Fed last raised rates for the fourth time in June (by 25 basis points), but it’s been relatively uneventful on the Fed front since then. It’s looking like the next fed funds rate hike, if it happens at all, will shape up to be in December, although it will ultimately depend on whether the economy continues to grow as the Federal Open Market Committee members think it will. We’ll continue to monitor the Fed closely, as history has shown that its actions could play a role in triggering the return of the bear market, or a correction at the very least.  

Domestic Politics Offer Reserved Hope

We’ve grown quite accustomed to business as usual in our domestic politics: Congress’ and the White House’s inability to agree on much. But the impact of such tends to extend further into the economic sphere this time of year when the budget is a top priority for lawmakers. As a surprise to some, President Trump’s plans to cut taxes are gaining a bit of real traction, now that he and some Republican lawmakers have created a blueprint to overhaul the tax code. It is definitely lacking in detail (and is being criticized for such), but it holds true to Trump’s campaign promises of cuts to both individual and corporate tax rates, as well as a simpler code with only three income brackets. Not only will the tax plan face a tough crowd across the aisle, but it will likely face some opposition among its own Republicans, as well. The majority party has struggled to see eye-to-eye this year, particularly on the topic of repealing and replacing the Affordable Care Act. As we said after the election last November, the proposed tax cuts would certainly stimulate economic growth if put into effect, but we are still very much in the rhetoric phase and are therefore reserving our optimism. Additionally, it’s possible (if not probable) that this kind of pro-business hype for the future is being priced into the market now, so the impact of any sort of letdown on this front should be considered. 

Approaching Year-end

We know from years past that with the fourth quarter often comes change and volatility in the markets, whether from elections or political agendas, corporate earnings, holiday retail sales, weather, or other factors. However, given that this year has been relatively tame from a volatility standpoint, even considering all of the geopolitical tension and natural disasters we’ve experienced, we wouldn’t be surprised to see continued resiliency in the markets. However, in the event something large-scale and significant were to occur to shake the markets (action from North Korea, for example), we’ll be poised and ready to respond appropriately in our client portfolios. Complacency is the real enemy in this kind of environment. As we’ve articulated before, we actively trimmed back our asset weights to neutral a few months ago in an effort to reduce our exposure to the stock market, and for now, we remain confident in our allocation. There are still names and sectors that are well positioned for growth, despite relatively high valuations, especially given the strength of earnings so far this year.

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