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Thursday, December 14, 2017

Financial Focus - What's Stirring Below the Market's Surface?

Stocks continued their march higher last week, adding 0.4% to bring the year-to-date total return for U.S. large-caps to 20%. 2017's return makes it the third-best year of this bull market and the sixth-best year in the past two decades (which includes the tech bubble, no less). This year's gains are attributable to, in large part, to some broad fundamental trends -- the economy has gained traction, corporate earnings have risen smartly, and interest rates (even with Fed rate hikes) remain supportively low by historical standards. 

But what's happening below the surface of that 20% gain is also informative. Here are a few key takeaways:

1.       Small-caps take the lead – U.S. small-cap stocks are the best performing asset class over the past three months (+9.6%), reflecting expectations for tax reform along with encouraging U.S. economic readings. Small-cap companies are typically more domestically oriented, benefiting from an outlook for momentum in U.S. growth (GDP has risen by 3% for two consecutive quarters for the first time since 2014).
  1. U.S. stocks narrow the gap, but still trail international markets – Domestic equities have outpaced foreign stocks over the past few months as enthusiasm around U.S. growth and tax reform has offered a boost. However, developed-market large-caps (EAFE) and emerging-market equities are still leading this year, gaining 22% and 30%, respectively.
  2. Sector signals – The tech sector has built a commanding lead, gaining 38% in 2017. Meanwhile, energy and telecom are the only two sectors in the red this year. Leadership from tech reflects the market's inclination to reward earnings growth at this stage in the expansion. Twenty-percent-plus gains from the financial services and consumer discretionary sectors further signal the optimism around the economy, as they benefit from rising loan growth, higher interest rates, and stronger household spending. 
  3. Bonds beat stocks…briefly – With stocks posting gains every month for the past 13 months, and rising in 13 of the last 16 weeks, fixed income allocations have not had the opportunity or need to flex their muscle. But when stocks dipped 2.2% in mid-August (a stark example of just how low volatility has been lately), bonds rose, offering a brief reminder that the complementary relationship between stocks and bonds still exists.
  4. Muni bonds surge – Another impact from expected tax reform has shown up in the municipal bond rally, with long-term munis rising more than 2% last week and 8% so far this year. Tax-bill proposals could potentially limit future supply of municipal bonds, as tax benefits (such as the tax-exempt status of advance-refunding bonds) are adjusted or eliminated.
This article was written by Edward Jones for use by your local Edward Jones Financial Advisor, which in Prescott is Jeremy Raverty. The local Edward Jones office in Prescott is located at 1400 N. Acres, Suite 55.

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