Locally based CPA firm since 1956

U.S. equities notched a modest loss for the month of September with the S&P 500 Index dropping -0.12%. That puts the Year-to-Date gain in the S&P 500 at 6.08% and the 3rd quarter performance at a gain of 3.31%.

The Markets – What drives the market heading into the final quarter of 2016? Earnings are always the driver long term and headlines are the driver of short-term swings. As investors we tend to filter out the short-term headline news and focus on longer term prospects for growth. The question then becomes whether we expect to see a turnaround in economic growth. While we believe growth will remain relatively slow, we do believe economic growth should accelerate. The labor market is expanding, wages are rising, housing is improving, the consumer sector remains healthy and we expect manufacturing to recover. This trend will not likely occur in a straight line, and periods of weakness will certainly emerge. Indeed, manufacturing data declined in April after expanding from January to March however, that data has shown improvements as recently as this week.

As economics improve, or remain steady, we should see more cash on corporate balance sheets. Excess cash may allow a company tremendous flexibility. It can reinvest in its business by purchasing new equipment or hiring new employees. Or the company could return cash to investors by increasing dividends, buying back stock or reducing debt. Over time, companies with greater amounts of free cash flow tend to outperform the broader market.

We do believe we are in the midst of an important shift in market leadership from the current momentum trade into something else. Specifically, we think it’s possible that free cash flow will become the “new momentum.” If we are correct, we should see a slight leadership change from the growth stock over to the value stocks.

The Election – As the election approaches, we are receiving a lot of commentary regarding how the markets will react. We hate to sound complacent, but “ho-hum,” “yawn.” At the end of the election period, it really will not matter. I am reminded of a Dire Straits song, “Iron Hand” in which singer-song writer Mark Knopfler states, “Same old fears and same old crimes, we haven’t changed since ancient times.”

The Fed – The Federal Reserve chose to leave rates unchanged. With their dual mandate of managing inflation and maximizing employment they have struggled with managing long-term interest rates. Without inflationary pressure there seems to be little reason to raise rates. We believe inflation will be virtually non-existent for some time. With the changing demographics here in the U.S., the wave coming in from Generation Y is filled with tech-savvy and multi-tasking brilliance. It tends to create a deflationary force that helps to offset rising costs in other areas, and foil more old government reporting. The good news is that the United States, far and away, is the best situated developed economy in the world as it relates to growth in the future – driven by strong replacement level birthrates.

Headlines – Wells Fargo & Co., the world’s most valuable bank up until this week, may have given a gift to those in Washington who are trying to boost Wall Street regulation. The timing of the scandal over fake accounts, opened to meet bonus targets, means that banks’ arguments against a proposed pay rule meant to limit risky behavior are unlikely to receive a welcoming ear on Capitol Hill.

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