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The December Narrative

December saw global equity markets continue their unprecedented streak of consecutive positive months, closing out at record highs in an 8th consecutive year of the bull market.  During the month, the DJIA added to its tally of over 70 record closes in 2017 – the most it’s had since 1995.  Synchronized global growth coupled with benign inflation, accommodative policy, and strong corporate profits pushed stocks, bonds, and commodities higher.  A significant influence during the month was the tax reform package which amounts to approximately $1.4t worth of fiscal stimulus.  Bonds overcame interest rates creeping slightly higher thanks to a further tightening of credit spreads.  2018 is setting up a what looks like a tug-of-war between improving economic conditions versus sustained low inflation with the ever-present backdrop of the catalysts brewing in Europe, North Korea, and monetary policy trajectory.

Market Anecdotes

• The tax reform bill, one of the primary driving forces behind the financial markets for the past two months, came to fruition towards the end of December.  The bill packed a bigger punch due to the front end loaded nature of the cuts – Wharton estimated companies will pay an average effective tax rate of 9% next year but in 10 years, baring changes, that will double back to 18%.
• Tax bill highlights include reduction of corporate taxes from 35% to 21%, eliminating tax-exempt nature of pre-refunded municipal bonds (23% of the market), elimination of personal exemptions/increase in standard deductions, reduction of SALT/mortgage interest deductions, reduction of individual marginal rates, and curtailing AMT exposure.
• The Fed hiked rates for a third time this year in December which was Janet Yellen’s final meeting as Fed Chair.  Of interest to markets was the non-unanimous 7-2 vote along with the discussion that the tax bill stimulus may elevate pressure to increase the pace of rate hikes in 2018.  They did, however, reaffirm their stated course for three hikes in 2018 and two in 2019.
• Still no volatility.  The S&P 500 finished the year during the longest streak without either a 3% or 5% correction on record.  Meanwhile, the 165-day trading range of 30-year U.S. Treasuries reached their tightest trading range in recorded history, a mere 31.4 basis points.
• The yield curve continued to flatten during the month as short-term yields priced in the Fed rate hike while long term yields continued to question growth and inflation outcomes.  The 10-yr UST finished the year nearly where it started at 2.4% while the 30-yr UST yield fell meaningfully from the 3.08% level where it started the year.  Both 3-month and 2-year yields moved notably higher for the month and calendar year 2017.
• Month end riots in Iran, tightening supply, and strong demand pushed oil prices above $60 for the first time since 2014.  The EIA has reported eight consecutive weekly crude oil inventory drawdowns, now at levels 13.2% lower than this time last year.
• The ECB started to trim its QE programme in 2017 and is expected to end it altogether in 2018. Even the BoJ is expected to raise its bond yield target slightly this year.  It seems there are few central banks available to pick up the monetary stimulus baton, setting up a potentially anxious year for the world’s bond markets.

Economic Release Highlights

• December retail sales came in slightly weaker than expected but were roughly the same as the past few months.  The 3m/3m rates in November (12.2%) and December (11.3%) are the strongest we’ve seen since 2009.
• CPI has started to tick higher after a serious soft patch in 2017.  December year over year headline and core CPI came in on the high end of expectations, increasing 2.1% and 1.8% respectively.
• December’s employment report was somewhat disappointing, registering 148k versus 190k expected.  A closer look however shows a BLS change in the seasonal adjustment figure for December accounted for a -133k influence on the result.
• December ISM manufacturing registered 59.7, headlined by a 14-year high for new orders.  New export orders also climbed higher to 58.5, a strong reading on overseas appetite for U.S. goods. The ISM non-manufacturing composite index declined to 55.9, missing expectations for 57.6.
• After posting back-to-back 17-year highs, the consumer confidence index cooled slightly in the December report, to 122.1 vs a revised 128.6 in November and 126.2 in October.