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Another Flat Week, Small Caps Lag

| March 06, 2017

Domestic equity markets ended flat to modestly higher despite an impressive rally on Wednesday. The Dow Jones Industrial Average performed best for the week and for the month of February that ended on Tuesday. The widely-watched benchmark also just missed setting a record for consecutive all-time-high closes, notching 12 daily gains before falling back on the last day of February. The broader S&P 500 Index was not as strong but logged its fifth straight weekly gain, its best such run since late 2015. It bears noting that the small-cap Russell 2000 Index recorded a modest loss and ended the week as the worst performer for the year-to-date after handily outperforming in 2016.

With fourth quarter 2016 earnings reporting season nearly complete, investors were free to deepen their focus on the political and economic environment, which appears to have dominated investor sentiment in recent months. With that in mind, the market’s biggest move came on Wednesday, following President Trump’s highly anticipated first address before both houses of Congress the previous evening. Although the well-received speech was short on specifics, investors seemed to welcome the positive tone of Trump’s remarks.

In addition to the President’s remarks, another mid-week rally catalyst was positive economic data. A strong reading on U.S. manufacturing activity cheered investor spirits. The Institute for Supply Management’s purchasing managers’ index (“PMI”) reached its highest level since late 2014, and the new orders component reached a peak not seen in nearly four years. The news was especially reassuring given the recent strength in the U.S. dollar, which weighs on the competitiveness of U.S. exports.

Thursday brought a pullback, although the reversal did not seem to reflect a broad shift in sentiment. Financials performed worst on apparent profit taking, and disappointing February passenger data from Delta weighed on airline stocks. However, the day also brought news that weekly jobless claims had declined to 223,000—the lowest level since early 1973, when the U.S. labor market was a bit more than half of its current size (89 million versus 160 million).

On Friday, Federal Reserve Chair Janet Yellen sent her clearest signal yet that the improvement in the economic outlook would likely lead the central bank to increase rates at its next meeting. "At our meeting later this month," she said in a speech in Chicago, "the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.”

Although the Fed is likely to make its first 2017 increase sooner than many had recently assumed, market watchers are not necessarily convinced that the central bank is now on a path to increase rates more than three times during the year. Recent economic data have only confirmed the growth, labor market, and inflation forecasts that the Fed has maintained for some time.

Finally, across the pond, major European indexes ended the week higher, with the pan-European index Euro Stoxx 600 touching a 15-month high midweek before settling lower amid news of lackluster corporate earnings. Volumes at the start of the week were about 30% lighter than average. Midweek, equity markets as a whole were up strongly, led by reflation hopes. Commodity-related and financial companies led the market. By the end of the week, European markets retreated somewhat and volumes fell. Sound familiar?