The U.S. economy continues to expand at a steady pace, albeit a slow one. According to the Bureau of Economic Analysis, U.S. Gross Domestic Product (GDP) grew by 1.4% in the first quarter of 2017. The number was revised upward from the initial estimate of 0.7% and the second estimate of 1.2%. While the growth rate was more robust than initially indicated, this continues a trend that has been observed over the past several years of slower first quarter growth followed by a rebound in the second quarter. That appears to be the set-up again for this year with current estimates of second quarter GDP growth at 3.0% according to FactSet. As it stands now, third and fourth quarter growth looks to be around 2.0-2.5%, which would put full-year 2017 GDP up by 2.2%. While this would be better than the 1.6% expansion in the prior calendar year, it remains below the elusive 3.0% GDP growth that has been noticeably absent during the current economic expansion. The last time the economy grew by more than 3% for a full calendar year was in 2004 & 2005.
The overall employment picture continues to improve. In the month of May employers added 138,000 jobs. On average, payrolls have grown by 121,000 per month so far in 2017, which is somewhat lower than the pace in 2016 but still strong enough to continue to bring down the headline unemployment rate. At 4.3% the jobless rate hit a 16-year low, and there have only been three other periods in the past 50 years where the unemployment rate was as low as it is today.
Individuals remain upbeat overall. The Consumer Confidence Index, which had declined from its most recent peak in March, increased moderately in June. The index remains at levels last seen in the late-1990’s and early-2000’s. Other data included in the release show that consumers’ appraisal of current conditions improved with those saying business conditions are “good” and jobs are “plentiful” both increasing.
The manufacturing side of the economy continues to expand. The Institute for Supply Management’s Purchasing Managers Index (PMI) registered at 54.9, which was up 0.1% from April. A reading above 50 indicates that the manufacturing economy is expanding; below 50 indicates contraction. After stabilizing in the first quarter, crude oil prices fell throughout most of the second quarter. Prices plunged into bear market territory in June as WTI crude hit a low of $42.51 per barrel, a decline of over 20% from the most recent highs in February of this year. Despite efforts by OPEC to limit output, oil supply remains abundant as U.S. oil production has increased and the number of active rigs domestically is at a 2-year high.
As the second quarter ends, the economic expansion that began in July of 2009 will mark its 96th month. Compared to the average of 47 months, the current cycle has lasted twice as long and is the longest of all but two other expansionary periods in the post-WW2 era.
Yields on shorter-term government bonds increased during the quarter while yields on longer-term government bonds spent most of the period in a downtrend. The 10-year Treasury bond hit its lowest level since the November election on June 26th, closing at a yield of 2.13%. However, in the final days of June global bonds sold-off as a key measure of economic sentiment in the European Union reached its highest level since 2007 and comments from the European Central Bank hinted at starting to wind down the large monetary stimulus program sooner than anticipated. Ten-year Treasury yields finished the quarter yielding 2.30%, down approximately 8.5 basis points from the end of the first quarter. Shorter-term rates were influenced by the Federal Reserve’s June rate hike. The 3-month Treasury bill ended the quarter yielding 1.01%, up from 0.75% at the end of March. This flattening of the yield curve resulted in longer-term bonds outperforming their shorter-term counterparts during the period.
Corporate bond spreads remained relatively stable during the quarter. Both investment grade and high-yield spreads remain at the low end of their 52-week ranges.
The Federal Funds Target Rate now stands at a range of 1.00% - 1.25% after the Federal Open Market Committee voted to increase the rate at its June meeting. This move was the Fed’s second hike for calendar year 2017, and its fourth hike since it began raising rates in December 2015. Officials signaled that one more rate hike was likely this year if the economy continues to perform in line with forecasts. The central bank also detailed plans to begin slowly shrinking its $4.5 trillion portfolio of Treasury and mortgage-backed securities purchased during the three rounds of quantitative easing.
Inflation has surprised to the downside over the past few months. The headline Consumer Price Index (CPI) peaked at 2.8% in February. Since then, the rate has steadily decreased on a year-over-year basis with the most recent release at 1.9%. Core CPI (excluding food and energy) has also shown similar weakness, running below 2% for the past two months.
Treasury yields of selected maturities for recent time periods are displayed below.
|Treasury Bill||Treasury Notes & Bonds|
|3 mo.||2 yr.||5 yr.||10 yr.||30 yr.|
The total return numbers for various fixed income indices over the last twelve months are displayed below (data from Bloomberg).
|12 Month Returns (as of 06/30/17)|
|Barclays Capital US Aggregate||-0.31%||Merrill Lunch US High-Yield||12.75%|
|Barclays Intermediate Government||-1.25%||Merrill Lynch US Municipal Index||-0.53%|
|Dow Jones Corporate||1.32%||JP Morgan EMBI Global||5.52%|
Stock markets both in the U.S. and around the globe continued to rally for most of the second quarter, tacking additional gains onto the first quarter’s positive performance. Markets have continued setting new records this year with the S&P closing at a new high on 24 occasions and the Nasdaq setting a total of 38 new highs so far in 2017. Extremely low volatility has been another characteristic of this year’s markets. A recent Barron’s magazine article cited research by Bespoke Investment Group showing that the largest drawdown in the market this year was only 2.8%, the second smallest first-half drawdown in 89 years. The average drawdown in the first six months of the year is usually around 11.2%. In fact, stock market volatility as measured by the “fear gauge” or VIX index has been trading near all-time lows for most of the year. During the financial crisis in 2008-09, the VIX index traded as high as 80. So far in 2017 the index has traded below 12 for most of the year. In the entire history of the VIX, the index has closed below 10 on a total of 12 days, eight of those days have been since May 9th of this year. The other four times happened between November of 2006 and January of 2007.
Technology and growth stocks have been among the year’s biggest winners. In late-April the Nasdaq closed above 6,000 for the first time. The milestone comes 17 years after the benchmark first closed above 5,000 at the end of the tech stock bubble. Growth stocks in general are leading value stocks by a wide margin with the S&P Growth index up 4.42% in the second quarter compared to the return for the S&P Value index of 1.51%. Year-to-date growth stocks have returned 13.33% versus 4.85% for value stocks, one of the widest margins for growth relative to value over the past several years.
The increase in stock prices so far this year has been well supported by earnings growth. For the first quarter, S&P 500 earnings were up approximately 14% year-over-year, which was the highest growth rate for the index since the third quarter of 2011 according FactSet. Second quarter earnings growth is currently estimated to come in around 6-7%. On a valuation basis, the S&P is currently trading at 17.4x forward earnings, which is above the 5- and 10-year averages of 15.3x and 14.0x, respectively, as per FactSet.
Global equity markets have also seen strong returns so far this year. The Wall Street Journal reports that 26 of the 30 major indexes representing the world’s biggest stock markets by value are in positive territory year-to-date, the highest number since 2009. Earnings growth has also picked-up in Europe and Japan, which has provided a boost to overseas markets relative to the US after several years of underperformance. For the quarter, foreign developed and emerging markets were both up by over 6% as measured by the MSCI EAFE and MSCI EM indexes, respectively.
Below is a table which displays various equity index returns for the past quarter.
|Equity Indices||2nd Quarter 2017|
|Dow Jones Industrial||3.95%|
|S&P 500 Growth||4.42%|
|S&P 500 Value||1.51%|
|Russell 2000 (small-cap)||2.46%|
|MSCI/EAFE (developed international)||6.31%|
|MSCI/EM (emerging markets)||6.35%|
At the sector level, returns were relatively broad based with most individual sectors in positive territory for the quarter. Health Care stocks contributed the most, rising by over 6%, followed by Industrials and Tech. The only two sectors trading down for the quarter were Energy and Telecommunications. Energy stocks continue to be plagued by falling oil prices with the price of crude oil declining by as much as 16% during the quarter before recovering somewhat in the last few days of June. Stocks of Telecommunications companies have been hit by falling prices for wireless plans as competition to attract and retain customers has increased among the large providers.
The following table details S&P 500 sector returns for the quarter (price only).
|Return by Stock Sector||2nd Quarter 2017|
|1. Health Care||6.36%|
|3. Information Technology||3.66%|
|6. Real Estate||2.34%|
|7. Consumer Discretionary||2.00%|
|9. Consumer Staples||0.66%|