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.