The current economic recovery that began in the summer of 2009 is now the second longest in US history. As of June, the current expansion will have marked its 108th month. The only other time the US economy expanded for longer was the ten-year period that ended in March of 2001. With the economy likely to remain in growth mode over the coming 12 months, many economists expect the current cycle to become the longest ever experienced.
GDP growth came in at 2.0% in the first quarter of 2018, which was a decrease from 2.9% in the fourth quarter. However, second quarter estimates remain strong despite volatility in the financial markets and concerns over trade disputes. According to the Wall Street Journal’s Survey of Economists, GDP is expected to increase at a 3.6% annualized rate in the quarter ended June 30th. Some economists see growth potentially exceeding 4%.
The overall employment picture continues to improve and has now entered territory rarely seen. In the month of May, employers added 233,000 new jobs and the headline unemployment rate declined to 3.8%. We are currently seeing the longest continuous job expansion on record with the US economy adding jobs for 92 months in a row. The last time the unemployment rate was this low was in April of 2000, and the last time the rate was lower was during the economic expansion of the 1960s when it hit 3.4%.
Other measures of employment also paint a healthy jobs picture. The U-6 “Underemployment” ratio, a broader measure of unemployment that attempts to gauge hidden slack in the job market, fell to 7.6%, which is a new low for this cycle. The unemployment rate for women, at 3.6%, was the lowest since 1953 and the unemployment rate for African-Americans hit its lowest level on record. Jobless rates for Hispanics, teenagers, and those without a high school education are also at multi-decade lows according to the New York Times and government statistics. The most recent Job Openings and Labor Turnover Survey (JOLTS) from the Labor Department showed job openings at a new record, with the current number of jobs available exceeding the number of unemployed workers for the first time in history. The Wall Street Journal projects that if hiring and workforce participation trends continue, the unemployment rate will reach 3.3% by the end of 2018.
Both consumers and small businesses remain optimistic. Consumer confidence continues to remain near historical highs. The most recent reading of 126.4 from the Conference Board was below economists’ forecasts, but remains just off the 17-year high reached in February of this year. The NFIB Small Business Optimism Index increased in May to the second highest level in the survey’s 45-year history, citing optimism due to the recent tax cuts and regulatory changes.
Elsewhere around the globe, economic growth appears to have stalled in recent months. Growth in the Eurozone was the weakest since mid-2016 and German factory orders have fallen for the first four months of the year. In Japan, the economy shrank by 0.6% in the first quarter following eight consecutive quarters of expansion.
On the housing front, the picture has been a bit more mixed in recent months. The average rate on a 30-year fixed rate mortgage ticked up slightly during the quarter, but this doesn’t appear to have yet taken a toll on overall housing prices. The S&P Case-Shiller National Home Price Index showed a 6.4% annual gain through April. However, pending home sales declined 0.5% in the month of May, their fifth straight month of declines.
The manufacturing side of the economy continues to perform well. The Institute for Supply Management’s Purchasing Managers Index (PMI) registered at 58.7 for May, an increase of 1.4 percentage points from the April reading of 57.3. A reading above 50 indicates that the manufacturing economy is expanding; below 50 indicates contraction.
Crude oil prices continued to climb, reaching the highest levels since late-2014. WTI crude oil finished the quarter trading above $74 per barrel. Agricultural commodities on the other hand suffered sharp declines during the quarter with corn, wheat, and soybeans facing pressure from concerns over rising international trade tensions and generally good crop conditions. The Bloomberg Agriculture Sub-index is down over 50% from highs reached in 2011-2012 and is trading at multi-decade lows.
As expected, the Fed raised rates by 25 basis points to a range of 1.75%-2.00% at its June Federal Open Market Committee meeting. The committee also indicated a total of four rate increases in 2018, up from three at the March meeting. At the post-meeting press conference Fed Chief Jay Powell stated that the economy is in “great shape”.
Interest rates moved up across the curve during the second quarter. However, the move at the short-end of the curve, which is more directly influenced by Federal Reserve policy, was much greater than the longer-end. Short-term rates (two years or less) were up 20-25 basis points, while longer rates finished just slightly higher with the 10-year yield rising approximately 10 basis points and the 30-year just slightly above where it traded three months ago. During the quarter, however, the yield on the 10-year briefly broke above the 3% level for the first time since early-2014, hitting a high of 3.10%.
The slope of the yield curve continued to flatten during the quarter despite the outlook for stronger economic growth. The current spread between the 10-year and the 2-year reached a new cycle low and now sits just above 30 basis points. The last time the yield curve was this narrow was in 2007. This measure will continue to be closely monitored as an inverted curve (when short-term interest rates exceed those on longer-term securities) has been a consistent indicator of a looming economic recession.
Inflation has firmed over the past several months with both the headline and the core rates for the Consumer Price Index (CPI) above 2%. Over the past year, the CPI was up by 2.8%, driven by higher energy and housing costs. Stripping out the more volatile food and energy components, the core rate of inflation was up 2.2%.
Treasury yields of selected maturities for recent time periods are displayed below (data from Bloomberg).
|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 6/29/18)|
|Barclays Capital US Aggregate||-0.40%||Merrill Lunch US High-Yield||2.51%|
|Barclays Intermediate Government||-0.73%||Merrill Lynch US Municipal Index||1.67%|
|Dow Jones Corporate||-1.26%||JP Morgan EMBI Global||-2.45%|
The S&P 500 rebounded in the second quarter, rising 3.43% on a total return basis, and now stands 2.65% higher year-to-date. The Dow Jones Industrial Average rose 1.26% in the second quarter, but remains down 0.73% this year. Both indexes remain below their all-time highs reached early in 2018. Technology stocks remain the big winners so far this year, tacking on another 6.61% in the second quarter, bringing the YTD gain in the Nasdaq index to 9.38%. It was the eighth straight quarter of gains for the tech-heavy index as it reached several new all-time highs in the month of June.
Fears about escalating trade tensions gripped investor attention throughout much of the quarter as President Trump announced tariffs against trading partners including Canada, Mexico, the European Union, and China. Retaliatory tariffs were announced by several countries, stoking fears of an all-out trade war. Despite these and other fears, the underlying US economy and corporate fundamentals remain quite strong. Earnings growth for the S&P 500 during the second quarter is expected to be 20.0%, and comes on top of the 24.8% growth in the first quarter. If earnings growth holds at that level, it will mark the second highest quarterly growth rate since the third quarter of 2010 and the fourth consecutive quarter of double-digit growth, according to FactSet.
Growth stocks widened their lead over Value stocks in the quarter. The S&P 500 Growth Index tacked on another 5.25% vs. only 1.40% for the S&P 500 Value Index. Year-to-date, growth leads value by over 9%, and over the past year, growth’s advantage widens to over 13%. The dominance of Technology stocks (and to a lesser extent, Consumer Discretionary stocks) in the Growth index has certainly had a significant impact on the relative performance of the two indexes. As of the end of the quarter, the Tech sector makes up 42.3% of the S&P 500 Growth index vs. only 6.8% for the S&P 500 Value index. In the Growth index, Tech names account for six of the top ten stocks (seven if one includes Amazon, which is technically classified as Consumer Discretionary). In the Value index, there are no Tech stocks that currently land in the top ten holdings.
Turning to the other major indexes, small cap stocks had the strongest returns during the quarter, with the Russell 2000 Index returning 7.87%. The S&P MidCap 400 Index returned 4.29%. International equity markets continued to lag returns in the US with the benchmark for developed foreign stocks falling -1.06% for the quarter. Emerging market stocks were the worst performing area during the quarter with the index falling -7.90%.
With the strong growth in corporate earnings that are expected for the remainder of the year coupled with relatively modest YTD gains in the overall US market (as measured by the S&P 500), equity valuations have become more attractive looking out over the coming twelve months. According to FactSet, the forward 12-month PE ratio is now at 16.1x, which is below the 5-year average of 16.2x, although it is still above the 10-year average of 14.4x. As the effects of the corporate tax cuts that were passed in late-2017 continue to manifest, stocks should enjoy a tailwind from improving sales and earnings, as well as a boost from share repurchases and rising dividends as companies continue to repatriate cash from overseas.
Below is a table which displays various equity index returns for the past quarter.
|Equity Indices||2nd Quarter 2018|
|Dow Jones Industrial||1.26%|
|S&P 500 Growth||5.25%|
|S&P 500 Value||1.40%|
|Russell 2000 (small-cap)||7.87%|
|MSCI/EAFE (developed international)||-1.06%|
|MSCI/EM (emerging markets)||-7.90%|
At the sector level within the S&P 500, Energy stocks saw double-digit gains in the quarter as oil prices continued their ascent. Consumer Discretionary and Technology stocks also saw gains as investors continued to seek out areas with perceived sustainable growth. Financial and Industrial stocks fared the worst during the quarter. Bank stocks were hit with concerns over the diminished spread between short-term and long-term rates and the impact on future earnings, while industrials were a casualty of rising trade tensions.
The following table details S&P 500 sector returns for the quarter (price only).
|Return by Stock Sector||2nd Quarter 2018|
|2. Consumer Discretionary||8.17%|
|3. Information Technology||7.09%|
|4. Real Estate||6.13%|
|6. Health Care||3.09%|
|9. Consumer Staples||-1.54%|