summit financial resources, inc. · investment newsletter by noreen johnston, cfa (director of...

20171011-1140

Summit Financial Resources, Inc. Investment Newsletter By Noreen Johnston, CFA (Director of Research) Third Quarter 2017 And Daniel Cohen, CFA (Investment Analyst)

EXECUTIVE SUMMARY

The global economy is expanding at the fastest pace in years, propelled by a resurgence in trade and manufacturing. Consumer and business confidence are at peak levels, boding well for future activity. Many countries, including the U.S. and China, have experienced positive data surprises suggesting worries of a slowdown earlier in the year may have been overdone. The breadth and pace of the economic gains have created a positive environment for the capital markets and all major asset classes delivered positive results during the third quarter.

Stocks markets benefited from another healthy earnings season as well as a steady flow of positive economic data. Uncertainty over government policy and reduced expectations for rate increases continued to weigh on the U.S. dollar, boosting investments outside the U.S. Emerging markets surged past developed countries both for the quarter and year to date, due to a rise in exports and strong investment flows.

U.S. stock market volatility fell to a new low, restrained by investor optimism and declining correlations among stocks. Growth stocks, notably in the technology and health care sectors, continued to far outpace value stocks. After underperforming for much of the year, small cap stocks rallied on renewed prospects for corporate tax reform, which would favor domestically focused companies.

A resurgence in commodity prices during the quarter was a boon for both energy and industrial metals. The price of copper, a proxy for global economic health due to its widespread use in manufacturing, rose 9%.

Fixed income markets provided modest returns for the quarter. Credit risk was rewarded with high yield and emerging market debt posting the highest returns. Fixed income prices traded within a very tight range. U.S. Treasuries had the lowest volatility since 1965. Despite higher leverage and lower liquidity, credit spreads are approaching levels last seen before the financial crisis.

Global politics continued to impact the capital markets. Investors closely followed the conflict between the U.S. and North Korea and the popularity of populist, anti-trade candidates in upcoming European elections. In the U.S., government turmoil has put a broad range of policy changes on hold.

Another wildcard is the path of interest rates and inflation. The markets seem to be taking central bank leadership changes and balance sheet tapering in stride. Although inflation is below the desired level in many countries, a pick-up in wages and tightening capacity suggest it is rising or at least stable in many countries.

By many measures valuations are high across the major asset classes. Given the strength of the global economy and investor enthusiasm, the bull market for higher risk assets may continue for some time. Historically speaking, however, high valuations have consistently led to lower returns down the road. The elevated level of geopolitical risks and the impact of aging populations on savings and spending patterns could lead to unexpected outcomes in the investment markets.

Summit Financial Resources, Inc. Third Quarter 2017

2

ECONOMIC REVIEW AND OUTLOOK

Key Economic Fundamentals

0

1

2

3

4

An

nu

aliz

ed

Gro

wth

(%)

Quarterly GDP Growth

Data Source: U.S. Department of Commerce

-2

-1

0

1

2

3

2016-I 2016-II 2016-III 2016-IV 2017-I 2017-II

An

nu

aliz

ed

GD

P G

row

th (%

)

Contributions to GDP

Personal Consumption Investment Spending

Net Exports Government

Data Source: U.S. Department of Commerce

-100-80-60-40-20

020406080

100

Citigroup Economic Surprise Index

United States Eurozone

Positive values = Data above expectations, and vice versa

Data Source: Citigroup

Q2 GDP showed the U.S. economy grew 3.1%. This is the fastest pace of growth since the first quarter of 2015. Most recent International Monetary Fund forecasts call for full-year 2017 growth of 2.3%, followed by 2.5% growth in 2018. Given the difficulty in predicting the impact of Hurricanes Harvey and Irma, heightened uncertainty is inherent in near-term economic forecasts. Consumer spending was the largest contributor to GDP growth for the 15th consecutive quarter. Investment spending showed modest strength compared to recent history, while net exports were a slight positive on the heels of a weak dollar. Government spending was a negligible detractor, and has not added more than 0.1% to GDP since Q1 of 2016.

In the United States, economic data weakness (relative to expectations) moderated as Q2 progressed, with the Citigroup U.S. Economic Surprise Index rallying 65 points to close out the quarter at -7.9. Meanwhile, in Europe, data was favorable against expectations throughout the quarter, showing particular strength in the back half of September.


3

114

116

118

120

122

124

126

128

130

Relative Value of the U.S. $

Vs. a TradeWtd. Basket

Q1: -3.0% Q2: -2.3% Q3: -1.7%

Data Source: U.S. Federal Reserve

-1.0%

0.0%

1.0%

2.0%

3.0%

4.0%

Ye

ar O

ver

Ye

ar C

han

ge

OECD Leading Economic Indicators

Data Source: Organization for Economic Cooperation and Development

Global Growth Rates1 (%)

Q2

2017 Q3

2017 Q4

2017 2016 2017 2018

Advanced 2.2 2.2 2.1 1.7 2.0 2.0

Euro 2.3 2.3 2.3 1.6 1.9 1.8

U.S.2 3.1 2.5 1.8 1.6 2.3 2.5

Japan2 2.5 1.5 1.0 1.0 1.2 0.6

U.K.2 1.2 1.2 1.2 1.8 2.0 1.5

Canada2 4.5 2.1 1.9 1.5 1.9 2.0

Emerging 4.7 4.9 4.8 4.1 4.5 4.8

China 6.9 6.7 6.6 6.7 6.6 6.2

India 5.7 6.4 6.9 7.1 7.2 7.7

Russia 2.5 2.0 2.2 -0.2 1.4 1.4

Brazil 0.3 1.1 1.9 -3.6 0.2 1.7

World 3.2 3.3 3.2 3.1 3.5 3.6

Data Source: J.P. Morgan, International Monetary Fund, World Bank 1Q2 2017 and 2016 are actual, all others are forecasts 2Quarterly numbers are sequential annualized, others are year-over-year

The U.S. dollar troughed in early September, ending a nine-month slide. At its low, the dollar was down 8.8% on the year versus a trade weighted basket of foreign currencies. Though the downtrend reversed, the dollar still weakened by 1.7% in Q3 and closed out the quarter with a year-to-date decline of 6.8%.

Growth in leading economic indicators for the ten largest economies in the world showed widespread (albeit generally modest) improvement in economic prospects. Brazil experienced notable improvement as it continued to recover from a deep recession. Of the rest of the group, Germany and Canada were relatively strong, while India and Italy were weak.

Even with the tailwind of unprecedentedly easy monetary policy, advanced economies are expected to grow only 2.0% in both 2017 and 2018. This begs the question - how strong (or weak) would growth be without historic central bank support? Meanwhile, EM growth is expected to be 4.5% and 4.8% in 2017 and 2018, respectively, led by India and China.


4

Employment September was the first time in 84 months that nonfarm payrolls were negative, showing a loss of 33K jobs. While ostensibly concerning, the weakness can be attributed to sharp (and likely transient) employment declines in industries affected by Hurricanes Harvey and Irma, such as food services. Expectedly, weekly jobless claims jumped following landfall of the hurricanes and remain somewhat elevated. While the payroll report showed job losses, the household survey painted a more sanguine picture. This survey showed a large decrease in the number of unemployed and a significant boost to the labor force level. The result? A new post-crisis low for the unemployment rate of 4.2%. Also notable, wage growth climbed to its highest level since June 2009. Importantly, investors should be wary of putting too much stock in any data release, as hurricane effects are likely to make U.S. data very volatile in the near term.

-50

0

50

100

150

200

250

300

350

(00

0's

)

Change in Non-farm Payrolls

Data Source: U.S. Department of Labor

62.2

62.4

62.6

62.8

63.0

63.2

% o

f A

du

lt C

ivil

ian

Po

pu

lati

on

Labor Force Participation RateHighest participation

rate since early 2014


1%

2%

3%

Year

Ove

r Ye

ar G

row

th

Wages


220

230

240

250

260

270

280

290

300

310

320

(000

's)

Weekly Initial Jobless Claims

Longest streak below 300K since 1970 - 135 weeks


4.2

4

5

6

Per

cen

t

Unemployment Rate

Lowest unemployment

rate since Feb 2001


6170

2000

3000

4000

5000

6000

7000

(000

's)

Job OpeningsMost recent reading

was highest on record



5

ConsumerUndeterred by gridlock in Washington, elevated geopolitical risks, and uncertainty surrounding the Fed’s tightening campaign, the consumer remains resilient. Throughout the second quarter, consumer confidence was steady around the 120 mark and has remained above 115 for eight consecutive quarters. This is the third longest streak above 115 since the inception of the index, bested only by runs of 49 quarters and 12 quarters beginning in January 1997 and December 1988, respectively. Major stock market indices ended the quarter at record highs, which should further bolster household net worth. As of the most recent reading from Q2, household net worth was up 9.3% over the prior year to a record $96.2 trillion. The declining trend in auto sales (one of the potential warning signs relating to the consumer) abruptly reversed in September, as consumers began replacing an estimated 500,000 to 900,000 vehicles destroyed by Hurricanes Harvey and Irma. Growing student debt levels remain a concern, as do rising delinquency rates in student, auto, and credit card debt.

80

85

90

95

100

105

110

115

120

125

130

Consumer Confidence Index

Data Source: The Conference Board

-7.5%

-5.0%

-2.5%

0.0%

2.5%

5.0%

7.5%

12

13

14

15

16

17

18

19

Year

ove

r Ye

ar G

row

th

Mill

ion

s o

f V

eh

icle

s

Monthly Auto SalesSeasonally Adjusted Annual Rate

Data Sources: Bloomberg

0%

5%

10%

15%

Year

Ove

r Ye

ar G

row

th

Household Net Worth


3%

4%

5%

6%

7%

8%Student Debt as a % of GDP

Data Sources: U.S. BEA and U.S. Federal Reserve

Business Activity Business strength accelerated as the second quarter progressed. Factory activity surged to a 13-year high in September as the ISM manufacturing index reached 60.8. The service sector, which accounts for 86% of employment in the U.S., was also extremely strong in Q2. In fact, September’s ISM non-manufacturing index registered its strongest reading since August 2005. This was the 92nd straight month of expansion. While industrial production exhibited growth in Q2, the most recent reading was relatively weak due to disruption from Hurricane Harvey. Sectors impacted most by the Hurricane were mining, refining, organic chemicals, and plastics. Harvey was also likely to blame for a rather sharp fall in capacity utilization.


6

46

48

50

52

54

56

58

60

62In

de

x Le

vel

U.S. ISM Indexes

Non-Manufacturing Manufacturing Expansion

Data Source: Institute for Supply Management

74

75

76

77

78

79

80

-4

-3

-2

-1

0

1

2

3

4

5

Cap

acit

y U

tiliz

atio

n (%

)

Ind

. P

rod

. YO

Y G

row

th (%

)

Industrial Growth and Utilization


Real Estate On the surface, the housing market appears strong. Existing home sales remain near post-crisis highs, the NAHB Index indicates strength, and price gauges show consistent growth. Underneath the surface, however, the market is suffering from a mismatch of supply and demand. Demand is very strong on the low-end, but supply is tight and prices are too high for many would-be buyers. Builders are reluctant to break ground on cheaper homes due to prohibitively high building costs. Meanwhile, demand for high-end homes is tepid. High-end homes spend a historically long time on the market and those that sell often do so at steep discounts. Evidence of a softening housing market is observable in the Pending Home Sales Index, which has been negative for five out of the past six months. Also, new home sales have been trending lower since March and August’s figure was the weakest reading in nine months. To be sure, the housing market bears watching, as its health is important to the U.S. economy.

3

4

5

6

7

8

9

10

11

12

13

3.0

3.5

4.0

4.5

5.0

5.5

6.0

Mo

nth

s o

f Su

pp

ly

An

nu

aliz

ed

Sal

es in

MM

's

Existing Home Sales and Inventory

Data Source: National Association of Realtors

-4%

-2%

0%

2%

4%

6%

Mo

nth

ove

r M

on

th G

row

th

Pending Home Sales IndexSeasonally Adjusted

Data Source: National Association of Realtors

0

10

20

30

40

50

60

70

80

Ind

ex

Leve

l

National Association of Home BuildersHousing Market Index

Data Source: National Association of Homebuilders

400

450

500

550

600

650

An

nu

aliz

ed

Sal

es in

000

's

New Home Sales

Data Source: U.S. Census Bureau


7

CAPITAL MARKETS REVIEW Returns

3rd Qtr 2017

YTD 2017

Cash and Fixed Income

U.S. Treasury Bills 0.3% 0.6% Barclays U.S. Aggregate Bond 0.8% 3.1% Barclays Municipal Bond 1.1% 4.7% Barclays Global Agg. ex. U.S. 2.5% 8.7%

Hedge Funds and Alternatives

Bloomberg Commodity 2.5% -2.9% DJ US Real Estate 1.1% 7.1% HFRI FOF Composite 2.2% 5.5%

Data Sources: Morningstar & Hedge Fund Research, Inc.

3rd Qtr 2017

YTD 2017

Domestic Equities

Wilshire 5000 4.6% 13.7% S&P 500 4.5% 14.2% Russell 2000 5.7% 10.9%

International Equities

MSCI ACWI ex. U.S. 6.3% 21.5% MSCI EAFE (Developed) 5.4% 20.0% MSCI EM (Emerging) 7.9% 27.8%

Equity Markets

-5%

0%

5%

10%

15%

20%

25%

30%

35%

Domestic StocksPerformance by Capitalization

Russell 1000 (Large Caps) Russell Mid Cap (Mid Caps) Russell 2000 (Small Caps)

First Quarter Second Quarter Third Quarter

Data Source: Morningstar

1%

2%

3%

% o

f To

tal M

kt C

ap

U.S. Margin Debt

Data Source: Bloomberg and The New York Stock Exchange

-5%0%5%

10%15%20%25%30%35%

International Equity Markets(Price return only)

MSCI EAFE (Developed) MSCI EM (Emerging)

First Quarter Second Quarter

Third Quarter

Data Source: Morningstar

10.9

10

15

20

25

30

35

CBOE Volatility Index

Quarterly Average Long-term Average

Lowest on record

Data Source: Chicago Board Options Exchange


8

Fixed Income Markets

2.0

2.2

2.4

2.6

2.8

U.S. 10 Year Treasury Yield (%)

Down 5 bps in Q1

Down 9 bps in Q2 Up 2 bps in Q3

Data Source: U.S. Department of the Treasury

3

4

5

6

7

8

9

10

Spre

ad

Ove

r Tr

easu

rys

(%)

High Yield Debt Spreads

Spread over Treasurys 15 Yr. Avg.

Spreads compressed 23 bps in

Q3 and are currently 2.2%below the 15-year average

Data Source: BofA Merrill Lynch

Alternatives

140

160

180

200

220

240

260

280

300

Ind

ex

Leve

l

Commodities(CRB Core Commodity Index)

Up 5.0% in Q3

Data Source: Thomson Reuters

42

44

46

48

50

52

54

56

U.S

. Do

llars

WTI Oil Price

Q1: -6.0%

Q2: -8.9% Q3: +12.3%

Data Source: US. Energy Information Administration

Disclaimers: This commentary was written by Noreen Johnston, CFA, Director of Research and Daniel Cohen, CFA, Investment Analyst at Summit Financial Resources, Inc. and Summit Equities, Inc., 4 Campus Drive, Parsippany, NJ 07054. Tel. 973-285-3600, Fax: 973-285-3666. Securities and Investment Advisory Services offered through Summit Equities, Inc. Member FINRA/SIPC, and Financial Planning Services offered through Summit Equities, Inc.’s affiliate Summit Financial Resources, Inc. Sources of Performance: Morningstar®. Indices are unmanaged and cannot be invested into directly. The investment and market data contained in this newsletter is not an offer to sell or purchase any security or commodity. Standard & Poor's 500 Index (S&P 500) is an unmanaged group of securities considered to be representative of the stock market in general. The Wilshire 5000 Index is a market capitalization-weighted index of the market value of all stocks actively traded in the United States. The index is intended to measure the performance of all U.S. traded public companies having readily available price data. The MSCI Emerging Markets Index is an index created by Morgan Stanley Capital International (MSCI) that is designed to measure equity market performance in global emerging markets. Emerging markets are considered risky as they carry additional political, economic, and currency risks. Real Estate Investment Trusts, REITs, are securities that invest in real estate directly, either through properties or mortgages. REITs receive special tax considerations and typically offer investors high yields, however, have liquidity constraints. The Barclays Capital U.S. Aggregate Bond Index is a market capitalization-weighted index comprising Treasury securities, Government agency bond, Mortgage-backed bonds, corporate bonds, and some foreign bonds traded in the U.S. Fund Category Performance is not inclusive of possible fund sales or redemption fees. Investment grade bond analysis included bonds with ratings of AAA, AA, A, and BBB. Municipal and Corporate Bonds are backed by the claims paying abilities of the issuer. TIPS are inflation-indexed securities issued by the U.S. Treasury in an effort to widen the selection of government securities available to investors. Past performance does not guarantee future results. Information throughout this Newsletter, whether stock quotes, charts, articles, or any other statement or statements regarding market of other financial information, is obtained from sources which we, and our suppliers believe to be reliable, but we do not warrant or guarantee the timeliness or accuracy of this information. Neither we nor our information providers shall be liable for any errors or inaccuracies, regardless of cause, or the lack of timeliness of, or for any delay or interruption in the transmission thereof to the reader. Opinions expressed are subject to change without notice and are not intended as investment advice or a guarantee of future performance. Consult your financial professional before making any investment decision.

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summit financial resources, inc. · investment newsletter by noreen johnston, cfa (director of...

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