Economic Commentary | Third Quarter 2016

We are pleased to report that global markets rallied nicely during the third quarter: the large cap S&P 500 index increased 3.9%, the mid/small cap Russell 2000 index gained 9.1%, and the international MSCI EAFE index added 6.4%.

July’s trading opened on the heels of the UK vote to leave the European Union, which rattled investors across the world. The political fallout in the early days created a great deal of uncertainty about whom would lead the process of extricating the UK from the European Union. However, with the election of Theresa May as Prime Minister, it soon became apparent that the voters’ wishes to leave the EU would be honored. Within a couple of weeks of the selloff sparked by the Brexit vote, the S&P 500 index hit a new all-time high, a feat that was repeated no fewer than eight times during the quarter. European markets also shrugged off early concerns about the Brexit vote and performed quite well this quarter. Ironically, at a time when most investors were anxious about the UK economy’s ability to withstand “going it alone”, the country’s GDP grew an enviable 2.1% over the past year, UK consumer confidence improved, and factory output hit a 10-month high as the weak pound boosted exports.

In the US, the economy has continued to strengthen broadly: consumer confidence hit a level that hasn’t been seen since before the recession; housing demand rose while inventories tightened, leading to higher home prices; and tight labor conditions finally put upward pressure on wages. That said, weak corporate confidence continues to temper economic growth. In the most recent gauge of the Conference Board’s CEO confidence, the reading was exactly 50, which is the level which separates “good” conditions from “poor” conditions. As weak business investment has been a significant detractor from economic growth throughout this recovery, it is important that CEOs gain greater confidence in the economy’s near-term prospects. Might this come about with the removal of uncertainty caused by this most unusual of presidential elections? We certainly hope so.

The US economy is nearing the Fed’s twin goals of price stability and full employment. Fed Chair Janet Yellen has recently stated that she anticipates moderate GDP growth, additional firming in the jobs market, and inflation rising to 2% in the next few years. Though the Fed has danced around the timing of its next rate hike, which has at times seemed quite imminent, there is currently consensus that the Fed will likely raise rates in December, a full year after its first (and only) rate hike after the recession. The futures market is currently pricing in a 70% chance of a rate hike before the end of the year, up from 23% just three months ago, an indication that market participants broadly agree that there are signs of strength in the US economy.

In early August, oil traded down to nearly $40/barrel on rising production and a glut of inventory. Thereafter, reports showed dramatic declines in global inventory and prices then rose steadily before closing the quarter at $48.24/barrel. In the waning days of the quarter, OPEC finally agreed to freeze production after months of discussions, though a finalized plan may not be in place for a few months. If this agreement does end up holding, we may have already seen the floor on oil prices for quite some time.

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