Did someone forget to tell the markets that it’s summertime and that this is the quiet time of year? Although volatility still remains low and at some of the lowest levels in 25 years, July finished the month with stocks closing in on the highs set earlier this year. The Dow was up 4.71% for the month, bringing it into positive territory for the year. Meanwhile, the S&P 500 extended its gains, adding another 3.6% for a total return of 5.34% year to date. The technology heavy Nasdaq was up only 2.15% for the month but remains the leader with a gain of 11.13% for the year. As expected, interest rates were in focus once again with the Federal Reserve raising rates by .25% and long-term rates moving briefly above 3% again during the month. In addition, the U.S. dollar continued to strengthen, helping to lead oil prices down for the month. With numerous economic reports out and earning’s season underway, investors had a lot of data to digest on top of the onslaught of political headlines.
The highly anticipated GDP report confirmed expectations that our economy could once again exceed 3% growth. GDP growth has averaged 3.22% from 1947 through 2018, so the 4.1% rate posted for the second quarter of 2018 was a significant victory. You must go back to the third quarter of 2014 to see over 4% growth. Spending increased across the spectrum, this includes consumers spending on goods and services, government spending, and business investment. This can be attributed in part to consumer confidence. The consumer confidence index rose slightly in July after slipping in June. The index measures Americans’ sentiment on current economic conditions and prospects for the next six months, including business and labor market conditions. Consumer spending accounts for about 70% of U.S. economic activity, so the sentiment index is something economists pay close attention to.
A leading economic indicator that can give us some insight into the business sentiment is the PMI or Purchasing Managers’ Index. This is meant to measure activity in production, new orders, supplier deliveries, inventory, employment, price, exports and imports. An index reading over 50 indicates growth or expansion within the manufacturing sector of the economy. Although the index fell from 60.2 in June to 58.1 in July it remains well above the key level of 50. Small businesses remain optimistic about the future as well. The NFIB small business index’s numbers for June were released during July and posted its sixth highest reading in survey history. For context, the 45-year historic average of this index is 98. Since December 2016, the index has averaged 105.4, making the June reading of 107.2 remain well above average. Like the significance of manufacturing to the health of the economy, small businesses in this country are at the heart of jobs and hiring in the future. While the news of trade wars and tariffs dominate the headlines, business leaders appear to be focused on a more positive economic environment ahead.
Earnings have continued to justify current market levels. We spent most of the first half digesting the moves of 2017 and waiting for some confirmation that corporate America remains healthy and is continuing to grow. We can point to the health of corporate earnings as another contributor to finally getting investors off the sidelines in July. After an exceptionally strong first quarter, investors grew cautious about the potential impact on the economy of the escalating trade war fears. Very quickly, second quarter earnings revealed the continued profitability of U.S. businesses despite all the attention being given to tariffs and the impact of retaliatory actions. With 75% of the companies in the S&P 500 now reported, 85% have beat the estimates, confirming once again the strength and profitability of U.S. businesses.
A deeper look does show that investors are being selective about what they want to own, what is working and what is not. If we look at just sectors, industrials and health care were the top performing sectors in July, with financials taking the third spot. According to Goldman Sachs, investors are favoring domestic-revenue companies over companies with a large share of international exposure. Since the start of June, domestically focused companies have gained 5.8% compared to those that are internationally focused, which are little changed. Investors are also focusing on quality, bidding up shares of companies with the best balance sheets. This type of company has outperformed for the last five quarters, the longest winning streak in 12 years. Another driver is the tax reform. Companies with the highest tax rates have the most to gain under the new tax plan and are considered more attractive. In the second quarter, the basket of highest taxed companies outperformed the low tax basket of companies by 9%. As the broad index appeared to make a smooth move over the last month, it has become a very complex market underneath the surface.
The July jobs report, which showed the economy created 157,000 jobs for the month, was a little below the average forecast of 190,000. The unemployment rate declined from last month’s 4% to a current 3.9%. This brings the 12-month average for the jobs created to a healthy 203,000 per month. Although this month’s number was a little light of expectations, the prior two months were revised up by 59,000. A number that the Federal Reserve pays close attention to, wage growth, showed average hourly earnings increased by 7 cents to $27.05. With many industries reporting difficulty in finding qualified workers, it is not yet showing up in a meaningful way in the wage number. Rising wages can be inflationary, so for those worried about inflation, this month’s number can be viewed as a sigh of relief. The 157,000 number can continue to fulfill the “goldilocks” scenario, indicative of an economy that is not slowing and not overheating either.
With 7 months of the year already behind us, I would characterize 2018 as a constant “tug of war.” The economic data continues to justify to the bulls that the resiliency of the economy will overcome the headline risks currently dominating the attention of the media. The bulls argue that strong growth, along with a healthy jobs market and consumers willing to spend, will continue to drive the economy and taking the markets higher. However, the bears will point to the negative effect of rising long-term interest rates, rising energy costs, lack of wage growth, and the damage of trade fears ultimately driving the economy into a recession in the near term. This is like the saying “beauty is in the eye of the beholder,” all data is subject to interpretation. As we move later into the business cycle, the number of cross signals will likely increase. For now, we still believe in the glass is “half full” interpretation.
From all of us at 10-15 Associates we hope you enjoy the rest of your summer!