Despite prolonged volatility, U.S. stocks continued to post modest gains in the second quarter. Large-cap stocks (generally defined as companies with a market capitalization of more than $10 billion) notched up 3.43% for the quarter and 2.65% for the year as measured by the Standard and Poor’s 500 (S&P 500). Small cap stocks (generally defined as having a market capitalization of less than $2 billion and measured by the Russell 2000 Index) led the way, gaining 7.75% for the quarter and 7.66% year to date. Pressured by a strengthening dollar, emerging markets stocks slumped 7.86% for the quarter and 6.51% year to date. In light of rising interest rates, fixed income investments (bonds) continued to face pressure, and the Barclays Aggregate Bond Index declined 0.16% for the quarter, bringing its losses to 1.62% for the year.
Trade concerns continue to dominate the headlines and move markets. Stocks pulled back from the top of their range as the quarter came to a close, and risks of a damaging trade war have risen. The $34 billion in tariffs the United States placed on Chinese goods is a drop in the bucket for a nearly $20 trillion economy, but it is the “second derivative” effects – namely, consumer and business confidence – that could have further-reaching ramifications. Thus far, these two indicators have remained high. However, if the specter of a disruptive trade war shakes the confidence of consumers or businesses, the likelihood that spending and capital investment will level off or decline grows, which could lead to a short-circuiting of the economic expansion and bull market.
In spite of growing concerns, the bull market is likely to stay intact. Corporate cash remains ample, and companies continue to repatriate more, as evidenced by a Bureau of Economic Analysis (BEA) report highlighting that $308 billion was repatriated in the first quarter, helping lead to a record $189.1 billion in stock buybacks. For now, the U.S. economy remains in a good position to withstand trade-related headwinds. We continue to benefit from a tax reform tailwind, and the job market remains strong. Employers added 223,000 jobs in May, sending the unemployment rate to a multi-decade low of 3.8%. However, the unemployment rate ticked higher in June to a still-low 4.0%, mainly due to an added 602,000 workers to the labor force over the past month. Released along with the June labor report was the average hourly earnings number, which advanced to a modest 2.7%, continuing a trend of low wage pressure. Wage growth is critical, as increasing wages are a trigger for inflation. With all of this good news in the U.S., the Federal Reserve lifted its target rate range by another quarter-point to 1.75% – 2.00% and signaled two remaining increases in 2018.
With the economic recovery entering its tenth year, two potential concerns could halt the economy’s momentum: rising inflation and the Fed’s plan for keeping inflation under control. In June, inflation, as measured by the Consumer Price Index, increased at an annual rate of 2.9%, its most significant gain in more than six years. Following its mid-June meeting, Fed Chairman Jerome Powell stated, “Growth is strong. Labor markets are strong. Inflation is close to target.” This statement is a departure from Fed statements over the past decade. Whereas the Fed was previously apprehensive about growth, maintaining interest rates at historically low levels to entice the economy out of the doldrums, now it must manage inflation without stalling growth. Every time the Fed has adopted an overly aggressive stance, the economy has ended in recession; it must now walk a delicate line.
How will all of these interconnected issues affect the markets moving forward? We believe the economy remains poised for future growth, despite a tightening Fed and trade concerns. However, headlines will continue to drive volatility, which may be violent and disruptive at times. Patience and discipline are essential in the face of ominous headlines.
The views and opinions expressed are of Persium Advisors, LLC. This commentary is provided for educational purposes only and should not be construed as investment advice. Persium Advisors is an investment advisor firm located in Atlanta, GA.
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