Market Update Second Quarter 2018
Volatile June caps off eventful quarter
All three U.S. indices were positive for the quarter as the DJIA was up 1.3%, the S&P Index gained 3.4% and the Nasdaq Index moved ahead 6.6%. June was a volatile month, with earlier gains offset by later losses. Despite the volatility at month-end, the fundamentals for U.S. markets remained positive. According to FactSet, the estimated earnings growth rate for the S&P 500 in the second quarter stands at 20% (as of June 29). This would represent the second-highest quarterly earnings growth since 2011. We know that fundamentals drive long-term performance. If companies meet expectations, then this strong second-quarter growth should encourage further performance.
The MSCI EAFE Index, which represents international developed markets was down 1.1% during the second quarter. Recently, this index was negatively affected by the announcement of the European Central Bank that it plans to end its stimulus programs and to hike rates within the next year. The MSCI Emerging Markets Index declined by 7.7% durign the quarter, on a rising dollar and growing policy concerns.
The Bloomberg Barclays U.S. Aggregate Bond Index declined 0.2% during the second quarter, as rising rates negatively affected prices. As expected, the Federal Reserve (Fed) voted to hike the federal funds rate by 25 basis points at its June meeting. Further, the statement released by the Fed was more optimistic about the economy than expected, suggesting that more rate hikes are likely. The 10-year U.S. Treasury yield reached a high of 3.11% in June before ending the month at 2.85%.
Employment and spending show strong growth
Most of June’s major data releases painted a picture of stronger growth in the second quarter. Consumers and businesses saw high levels of confidence and spending growth throughout the month. Although consumer confidence did decline slightly in June, both major measures of confidence remain near multidecade highs. Historically, the health of the jobs market has been one of the main factors that influences confidence. So, it is no surprise that confidence remains high after May’s strong employment report.
The economy added 213,000 new jobs in June beating expectations of 195,000. At the same time the unemployment rate rose to 4% up from a record low of 3.8% in May as more people returned to the job market. Strong employment growth has been a major driver of the ongoing economic expansion, but wage growth has lagged.
Wage growth is important, but just as important is consumer willingness to spend. Here again, the recent news was positive. The combination of income growth and high confidence led to faster spending growth. Overall spending grew by 0.6%, well above expectations of 0.4%. The retail sales data was even better, with 0.8% headline growth in May.
While consumer spending growth was positive across the board, business spending was mixed. May data was weak, with durable goods orders dropping by 0.7%. This drop was due in large part to a dramatic 7% decline in the volatile transportation sector. The core figure, which excludes transportation, fell by a more modest 0.3% in May. Despite the weak month, a positive revision from 0.9% to 1.9% growth in April left the quarterly figure looking healthy. The overall trend for business investment remains positive.
Housing a drag on growth
Although the economy is generally healthy, there are signs of slowing growth. After a multiyear period of solid growth—driven by low mortgage rates and relatively affordable prices—housing appears to have slowed.
On the supply side, home builder confidence dropped in June. Here, rising lumber costs and a lack of labor hurt the profitability of new home construction. Building permits, which are the first step for new home construction, echoed the decline in home builder confidence. They fell by 4.6% during the month. On the demand side, home buyers appear to be taking rising home costs in stride, as new home sales rose by more than expected in May. Existing home sales dropped slightly, suggesting that declining affordability may be starting to make a difference. Housing growth has historically had a multiplier effect on overall economic growth as new home buyers spend more on furnishings and repairs. So, any slowdown in housing is something that should be monitored closely.
Political risks continue to affect markets
While the economy is growing at a healthy pace, politics and policy present the biggest risks to the financial markets. Again, the news here is a bit of a mixed bag. On a positive note, last month’s major concerns surrounding a euroskeptic government in Italy and the summit between President Trump and North Korea’s Kim Jong-un have largely subsided. But these very real improvements have been overshadowed by growing concerns about trade conflict. These worries have been fueled by the U.S. imposition of tariffs, along with the subsequent retaliatory actions from most major global economies.
It is still too early to know exactly how the trade conflict will play out. The probability remains that a negotiated deal will be reached before matters become much more serious. Nonetheless, effects are already showing up in the economy. If the situation does worsen, it will almost certainly lead to lower levels of growth both domestically and abroad.
Economic growth expected to continue
While rising political risks are a valid concern, the U.S. economy continues to grow at a solid pace. The positive tailwinds from tax reform and the strong jobs market are driving consumer and business spending, which in turn should lead to faster economic growth for the rest of the year.
There are certainly risks to this outlook—namely a slowdown in housing and rising political risks. On the whole, however, things appear to be pretty good right now. Of course, risks can always materialize and affect markets. As such, we continue to believe that a well-diversified portfolio that matches goals and time horizons is still the best way to prepare for the future and weather the potential storm.
Presented by Alexandra Armstrong, CFP®
All information according to Bloomberg, unless stated otherwise.
Disclosure: Certain sections of this commentary contain forward-looking statements based on our reasonable expectations, estimates, projections, and assumptions. Forward-looking statements are not guarantees of future performance and involve certain risks and uncertainties, which are difficult to predict. Past performance is not indicative of future results. Diversification does not assure a profit or protect against loss in declining markets. All indices are unmanaged and investors cannot invest directly into an index. The Dow Jones Industrial Average is a price-weighted average of 30 actively traded blue-chip stocks. The S&P 500 Index is a broad-based measurement of changes in stock market conditions based on the average performance of 500 widely held common stocks. The Nasdaq Composite Index measures the performance of all issues listed in the Nasdaq Stock Market, except for rights, warrants, units, and convertible debentures. The MSCI EAFE Index is a float-adjusted market capitalization index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a market capitalization-weighted index composed of companies representative of the market structure of 26 emerging market countries in Europe, Latin America, and the Pacific Basin. It excludes closed markets and those shares in otherwise free markets that are not purchasable by foreigners. The Bloomberg Barclays Aggregate Bond Index is an unmanaged market value-weighted index representing securities that are SEC-registered, taxable, and dollar-denominated. It covers the U.S. investment-grade fixed-rate bond market, with index components for a combination of the Bloomberg Barclays government and corporate securities, mortgage-backed pass-through securities, and asset-backed securities. The Bloomberg Barclays U.S. Corporate High Yield Index covers the USD-denominated, non-investment-grade, fixed-rate, taxable corporate bond market. Securities are classified as high-yield if the middle rating of Moody’s, Fitch, and S&P is Ba1/BB+/BB+ or below.