Q3 in Review:
Markets continued to climb steadily throughout Q3 from July thru September despite obstacles from Chinese tariffs and the ongoing Emerging Markets crisis. The Dec SP500 futures contract marked a new all-time high on Sept 20th at 2947.00. The Dow Jones Industrial Average futures contract also marked an all-time high the following session at 26,820. A historic quarter nonetheless. Markets were driven by the Q2 GDP estimates which came in at a multi-year high of 4.2%. Markets drafted further support from the August Non-Farm Payrolls data that showed rising wages for the American worker (+0.4% vs +0.3% prior m/m & +2.9% vs 2.7% prior y/y). Relating to our quantitative and fundamental process, the aforementioned data is consistent with a pick-up in Growth and Inflation A very buoyant formula for US equity prices.
Moving forward into year end, our predictive models suggests that that we could begin to see some signs consistent with a deceleration of US economic growth on m/m and y/y basis. The Q2 & Q3 economic data, coupled with a contracting 2-year yields vs 10-year yields (yield spread), and ATHs in equity values, and rising wages, is consistent with late economic cycle behavior.
Federal Reserve Open Market Committee 9/26/18
The FOMC met on Wednesday 9/26 to discuss its future plans for US Monetary Policy. The meeting concluded that it was appropriate to raise its benchmark interest rate by 0.25% to a target range of 2.00-2.25%. This was widely a consensus view in the market. Furthermore 12/16 Fed officials were in favor of another 0.25% increase at the December FOMC meeting. The Fed also removed the word accommodative when referring to US Monetary Policy relating to the US Economy. In other words, the Fed is NO LONGER ACCOMMODATIVE towards the US Economy and Markets. The meeting yielded no real surprises and was widely viewed as a hawkish meeting towards US Monetary Policy.
We continue to express the opinion that the backwards looking economic data and market price action seen in Q3 is consistent with late expansion cycle behavior. The base effects that we look at moving forward has the US Economy exhibiting a growth slowing and inflation slowing environment when compared on a year over year basis. We have this market cycle outlook well into Q1 of 2019. The interest rate cycle in the US is now 3 years old, and as aforementioned, the Fed is no longer accommodating to market conditions. The Fed has signaled to the market that 1 more rate hike in 2018 is likely, and as many as 3 more (per the Feds dot plot) are expected in 2019. This is consistent with market expectation, and we are of the belief that a hawkish Fed is priced into interest rate markets. Remember, the Fed is reactive to the cycle and not proactive, or in other words, the data will change before the Feds policy does. As always, we remain subservient to the incoming economic data, and will change the above thesis if proven to be incorrect.