The U.S. large-cap benchmarks closed modestly higher last week, while the small-cap indexes scored more substantial gains. These advances brought most of the indexes to new intraday highs on Friday, but the narrowly focused Dow remained a bit below the peak it established the previous week. The performance of the small-cap Russell 2000 was particularly notable, as it finally managed to surpass the intraday high it had reached in late July. On a sector basis, tech stocks were especially strong, helped by a rebound in Apple shares and strength in semiconductor stocks. Consumer staples and utilities shares lagged.

With the third-quarter earnings reporting season set to begin in a couple of weeks, traders generally appeared to remain focused on the political and economic environment. A further escalation in North Korean tensions last weekend weighed on sentiment when trading opened Monday. Stocks quickly regained their footing, however, helped in part by the unveiling of the Republican tax reform plan on Wednesday. Specifically, traders appeared to react positively to President Trump’s description of plans to lower the top tax rate, eliminate the alternative minimum tax, and treat foreign corporate profits currently accumulated overseas as already repatriated. The announcement of the tax plan seemed to foster at least a temporary revival in the “reflation trade” of late 2016, which saw small-caps and value stocks lead the market higher. Indeed, the Russell 2000 Index recorded its best daily gain on Wednesday since the previous November.

The devastation resulting from recent natural disasters also drew market attention. The Mexican earthquakes and Hurricane Maria have added $10 billion to insurance losses in the third quarter of 2017 on top of over $50 billion in losses from Hurricanes Harvey and Irma. Some analysts think that these latest catastrophes may act as a tipping point for the property and casualty marketplace as combined events will likely push third-quarter 2017 losses close to those experienced after Hurricane Katrina in the third quarter of 2005. Insurance losses in the first quarter of 2017 ran high as well, so 2017 is likely to break all-time industry catastrophic loss records.

While many details of the Trump administration tax plan remained undecided – and its ultimate passage far from certain – expectations that the plan would also add to the federal deficit and result in increased issuance of U.S. Treasury paper helped push longer-term U.S. Treasury yields higher last week. On Thursday, the yield on the benchmark 10-year U.S. Treasury note touched its highest level since July before decreasing a bit. Some solid economic data may have also contributed to the increase in long-term yields. Durable goods orders rose solidly in August, with a significant increase in core capital goods orders pointing to an increase in business confidence in investment.

In Europe, the STOXX Europe 600 advanced about 1.1 percent last week, as the Trump administration’s tax plan helped spur gains in European markets too. German stocks, as represented by the DAX index, were up about 1.6 percent last week following the country’s election on September 24. Angela Merkel won a fourth term as German chancellor, but her centrist coalition lost ground while the nationalist AfD party became the first far-right party to enter parliament since the 1950s. Initial fallout from the election included the announcement that Finance Minister Wolfgang Schäuble, one of the leading advocates of further European integration as well as fiscal austerity, would be leaving his post. In Spain, stocks were volatile as the country prepared for a contentious referendum on independence for Catalonia.

Yields on most eurozone government bonds increased, tracking moves in U.S. Treasuries following the announcement of potential tax reform in the U.S. Ten-year German bunds briefly rallied early last week following the German election. In economic news, Eurostat, the European Union’s statistical office, reported that prices rose 1.5 percent for the 12-month period ended in September, the same annual rate recorded in August. The inflation rate remains below the European Central Bank’s 2 percent target. In separate reports, eurozone economic sentiment rose more than expected in September, and UK retail sales surpassed forecasts and reached their highest levels in two years.

In Asia, Japanese stocks posted modest gains for the week while the yen weakened. Prime Minister Shinzo Abe dissolved the lower house on September 28 and has called a snap election, which is slated for October 22. The move, announced at a press conference on Monday, was not a surprise for traders because rumors of the election had been circulating for two weeks. Abe said that he would run on a platform that included strengthening Japan’s economic foundations, a tough stance on the missile threat from North Korea, and increased spending for education.

In China, policymakers appear to be serious about deleveraging the financial sector, an effort that has been gathering steam for several months. Many analysts had believed China’s policymakers would be tough on financial sector tightening until the economy started to slow below the politically sensitive 6.5 percent gross domestic product growth threshold, at which point they would start to ease up on tightening measures. China’s economy reportedly grew at a surprisingly strong annualized rate of 6.9 percent in the first half of 2017, putting it on track to meet its official 6.5 percent annual growth target. But looking ahead, some analysts think that 6.0 percent annual growth will be the “new politically acceptable” lower bound. Chinese stocks traded off as a consequence.

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Domestic stocks closed a quiet — felt like summer — week on Friday with the market’s recent upward momentum intact, although continued geopolitical uncertainty limited buying appetite with major indexes near records. North Korea returned to the forefront after the country’s foreign minister Ri Yong Ho said late Thursday at a United Nations meeting that his country might consider a nuclear bomb of “unprecedented scale” in the Pacific. While geopolitical tensions have been elevated, some analysts think the stock market has become desensitized to the threats posed by conflict on the Korean peninsula.

The major indexes closed last week generally mixed overall. The large-cap benchmarks were flat to modestly higher, with both the S&P 500 and the narrowly focused Dow Jones Industrial Average setting record highs early in the week before falling back a bit. The tech-heavy Nasdaq also hit new highs but ended the week down moderately. The smaller-cap benchmarks performed best for the week but stayed below the peaks they established in late July. Interest rate-sensitive utilities and real estate names performed poorly for the week as U.S. Treasury yields increased, and consumer staples shares also lagged. Energy stocks fared well as oil prices hit a three-month high, aided by increasing demand from refineries in the Gulf of Mexico coming back online. Financials also recorded solid gains on the increase in rates.

Some traders think that political developments continue to play a large role in driving sentiment, but there is no decisive directionality. Volatility was muted, and trading volumes remained subdued. Markets did not appear to react to President Trump’s strong words about North Korea on Tuesday, and the new threats in response from North Korea early Friday morning appeared to have only a limited impact when trading opened in New York, as noted above. Likewise, new Republican efforts to pass a health care bill (which took a hit Friday when Sen. John McCain (R-AZ) announced that he would not support the latest bill) seemed to have little broad impact, although health care services stocks — particularly those of companies heavily reliant on Medicaid clients — fell sharply on Tuesday before recovering somewhat.

Traders also kept a close eye on the Federal Reserve’s policy meeting on Wednesday, but the results of the meeting were largely in line with expectations. The Fed kept rates steady but announced that, beginning in October, it would reduce the amount of payments on its reinvested bond holdings. The Fed had little impact on stocks but yields on the benchmark 10-year U.S. Treasury note briefly touched their highest levels since early August following the meeting. An increased chance that the Fed will raise rates at its December meeting was partly behind the increase in yields, but some positive housing data may have also been a factor, with both August housing starts and new housing permits coming in above expectations.

The pan-European Stoxx 600 Index closed Friday a bit higher on the week. Eurozone economic data continued to show modest but steady improvement. Driven by strong results in France and Germany, the eurozone composite purchasing managers’ index, a common measure of economic activity, exceeded expectations and reached a four-month high. Consumer prices in the eurozone increased 1.5 percent year-over-year in August, the highest inflation reading since April and a modest increase over the prior month. Inflation is rising gradually, although it remains below the European Central Bank’s 2 percent target rate. Eurozone consumer confidence improved more than expected in September, according to the European Commission, and reached its highest level since April 2001.

German government bond yields largely tracked U.S. Treasuries directionally as Germans prepared to go to the polls on Sunday in federal elections. Ten-year German government note yields were somewhat higher for the week, finishing at around 0.45 percent. Angela Merkel’s Christian Democratic Union is widely expected to return as the largest vote-getting party, but pundits are uncertain if she will be able to garner the absolute majority necessary to form a government without coalition partners.

In Asia, Japanese stocks posted solid gains last week while the yen weakened and closed near ¥112 per U.S. dollar, which is about 4.2 percent stronger than at the end of 2016. After what had been a good week to that point, Chinese stocks fell on Friday after S&P cut its credit rating for China a notch to A+ from AA- over the country’s rising debt risk, an embarrassing setback for China’s government as it tries to preserve the appearance of economic stability before a key leadership transition next month. The decision marks S&P’s first ratings cut for China since 1999 and the second sovereign downgrade for China this year after a similar move in May by Moody’s.

“The downgrade reflects our assessment that a prolonged period of strong credit growth has increased China’s economic and financial risks,” S&P announced in a statement. Though China’s government has lately stepped up measures to curb rising corporate leverage that could stabilize risk in the medium term, “we foresee that credit growth in the next two to three years will remain at levels that will increase financial risks gradually,” the agency added.

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Domestic stock benchmarks carved out another round of records on Friday to close out a good week, with a big assist from rallying telecommunication and bank shares, as Wall Street shook off North Korea’s latest missile launch. A great Monday, seen by many as something of a relief rally, set the tone for the week as multiple major benchmark indexes reached record highs multiple times. Monday’s burst of optimism came after the initial reports of damage from Hurricane Irma were not as severe as some pre-U.S. landfall estimates had projected. Stocks across the range of market capitalizations enjoyed similarly strong performance for the week.

Tech bellwether Apple announced the 10th anniversary version of the iPhone on Tuesday. Apple’s press event had little impact on the broader tech sector, and the company’s stock declined modestly on the day of the introduction before recovering to finish the week little changed. Apple shares had gained almost 40 percent in 2017 through the beginning of the week.

On Thursday, core inflation was up by a more than expected amount…and that got everyone talking. The Department of Commerce reported that the consumer price index (CPI) rose 0.4 percent in August, breaking a recent string of lower-than-expected monthly inflation readings. Most observers think that this solid CPI number supports the Federal Reserve’s view that the recent inflation soft patch was transitory. A rate hike at the Fed’s December policy meeting now seems to be roughly a 50:50 proposition. Higher interest rates last week (see below) supported bank stocks. Higher long-term interest rates allow banks to generate more interest income from lending, helping to boost their profits.

The inflation news got the market’s chattering class returned to that golden oldie, “the Fed is behind the curve.” They may be right, of course, but it may also be just a routine jolt higher to a measure that, overall, has been “surprising” economists for years.

From Bloomberg:

Inflation may finally be getting back on track to reach the Federal Reserve’s goal, as the U.S. cost of living accelerated following a weak stretch of readings, Labor Department data showed Thursday.

The 0.2 percent rise in the core gauge ends a five-month streak of weaker-than-expected readings, and may soothe some concerns that inflation is slowing more broadly, though it will take more readings to determine whether the pickup can be sustained. The increase in the lodging category indicates the earlier decline in the sector was transitory.

Energy prices rose by the most since January and may reflect some impact from Hurricane Harvey. CPI data is collected throughout the month, and since the storm occurred in late August, the Bureau of Labor Statistics expects most of the data to come from before the storm, BLS economist Steve Reed said Wednesday. Data collection was disrupted in two of the 87 U.S. urban areas where prices are gathered.

As always, we cannot be anything close to sure. But it surely is too soon to making portfolio changes as a consequence.

U.S. Treasury yields increased last week, with much of the selling pressure coming at the beginning of the week as demand for safe-haven assets waned on North Korea and Hurricane Irma news. The strong August CPI report compounded the sell-off, particularly in shorter maturities that are more sensitive to increases in the federal funds rate, by boosting the odds that the Fed will raise rates at its December policy meeting. Prices of fed funds futures contracts at the end of last week showed that traders were pricing in an approximately 50 percent chance of a rate hike in December.

European equities ended last week higher too, as auto and tech stocks gained and favorable economic news provided a lift for key indexes. Eurozone statistics agency Eurostat reported that wages in the region rose 2 percent year-on-year in the second quarter, when the eurozone grew at its fastest pace in two years. Banks and mining stocks headed lower, reflecting some shifting by investors out of riskier assets into safer havens. On Friday, a morning rush hour explosion at a southwest London Underground station, labeled by police as a “terrorist incident,” dragged down travel and leisure stocks most notably, though a broad swath of sectors tumbled following the explosion.

The major Japanese stock market benchmarks posted solid gains last week. The widely watched Nikkei 225 was up 3.29 percent on the week. The yen closed the week at 110.66 versus the U.S. dollar, a gain of 2.54 percent against the prior week. However, the yen has declined 5.44 percent against the dollar YTD. Elsewhere in Asia, China’s latest batch of monthly indicators showed that the country’s economy unexpectedly slowed in August, offering more evidence that it has entered a slowdown after a sluggish July. Large cap Chinese stocks were still up a bit last week.

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Domestic stocks recorded modest losses last week. Energy stocks were strong early in the week as crude oil prices advanced, while health care, utilities, and real estate stocks ended the week with some positive momentum. Consumer discretionary, financial, and tech names lagged. Mid-cap shares were particularly weak and ended the week the furthest off their recent peaks, down roughly 4.3 percent from their record highs earlier this summer.

The markets took a big hit on Tuesday after the holiday weekend. Lots of ideas were floated as to why the markets reacted to circumstances that were not new and had not caused a major reaction previously. Pick from a typical parade of horribles: an increasing likelihood of military conflict between North Korea and the U.S., including the possibility of nuclear showdown; the lack of political consensus on raising the debt ceiling; the economic impact of hurricanes Harvey, Irma, Jose and whatever the next one after that is called. Maybe it was the disappointing jobs report the previous Friday. Perhaps it was summer ending, and everyone back at their desks and lighting up out of a plethora of caution. All or none of those could have been “the” reason, if a reason exists. As ever, I am skeptical of assigning any reason to the random nature of short-term market movement.

Sentiment may also have been dampened by a speech by Minneapolis Federal Reserve Bank President Neel Kashkari, who stated that recent Fed rate hikes have been detrimental to the U.S. economy. Kashkari’s comments appeared to push down long-term U.S. Treasury yields in particular (see below), which weighed on bank stocks. The financial sector also took a hit from insurance stocks, which wavered in anticipation of losses from Hurricane Irma on top of those from Hurricane Harvey.

Stocks regained some strength midweek, thanks in part to news of a deal in Washington to delay debt ceiling and budget fights until December. With deadlines looming at the end of September to fund the government and raise the debt ceiling, President Trump and Democratic congressional leaders agreed Wednesday to surprising three-month extensions for both in legislation attached to emergency funding for Hurricane Harvey relief. President Trump’s new willingness to work with Democrats and cut-out Republicans led to new worries about how he would get along with his ostensible party on tax reform, however. Reports that the conservative House Freedom Caucus had begun drafting its own tax plan seemed to weigh on sentiment on Thursday, along with continued worries about Irma and North Korea.

The yield on the benchmark 10-year U.S. Treasury note decreased sharply on Tuesday, reaching its lowest level since just before the November 2016 elections. The yield decline continued through Thursday morning. Falling longer-term yields and reduced expectations for another rate hike from the Fed in December contributed in turn to a decline in the U.S. dollar, which fell to its lowest level since the start of 2015, as measured against a basket of foreign currencies.

European equities, weighed down by geopolitical concerns, the euro’s strength, and some negative economic news, ended the week mostly lower. Within the pan-European benchmark Stoxx 600 index, the banking sector, most notably insurance stocks, was weak due to Hurricanes Harvey, Irma and the threat of Jose. The euro’s strength put further pressure on European exporters, whose goods become more expensive for overseas buyers as the eurozone currency strengthens.

In Asia, Japanese stocks declined last week and the yen dropped nearly two percent versus the dollar. Chinese stocks were lower too. Despite recent gains in Chinese reserves, a faster-than-expected slowdown and a resumption of capital outflows still pose risks to China’s outlook.

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U.S. equities finished last week and the first trading day of September with a gain Friday, on expectations that a weaker-than-expected rise in August nonfarm payrolls could dull the Federal Reserve’s desire further to raise borrowing costs in 2017. Small caps outperformed large caps for the week and foreign stocks generally outperformed domestic names. Trading was very light all week ahead of the Labor Day holiday weekend, but the S&P 500 did see its first four-day winning streak since July. The European, Asian and gold markets all were higher last week.

On Friday, the Bureau of Labor Statistics announced a weaker than expected jobs gain for August with prior month revisions subtracting even more jobs. The unemployment rate rose to 4.4 percent. This disappointing report probably won’t halt the Federal Reserve’s plans to begin reducing its balance sheet soon, perhaps later this month. However, the chances of a December rate from the Fed dropped to 42 percent, according to CME Group fed funds futures. U.S. factories ramped up in August to the fastest pace of expansion in six years, driven by employment gains, figures from the Institute for Supply Management showed, and consumer sentiment climbed to a three-month high amid an improving outlook for household finances and the economy, according to a University of Michigan report.

Construction spending unexpectedly declined in July. Sector spending fell 0.6 percent, compounding a 1.4 percent drop in June. Analysts anticipated an increase of 0.6 percent. Private construction dipped 0.4 percent, while public construction slumped 1.4 percent. Oil prices were erratic but mostly lower last week as traders assessed the impact of Hurricane Harvey on drilling and refining activity in the Texas/Louisiana area. Harvey has forced the shutdown of some major refineries along the Gulf Coast. According to some estimates, about a quarter of the U.S. refining industry was shut down.

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