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Market Update for the Month Ending July 31, 2018

Strong July for global markets

Global markets rebounded from a volatile June. In the U.S., the S&P 500 Index gained 3.72 percent, the Dow Jones Industrial Average climbed 4.83 percent, and the Nasdaq Composite rose 2.19 percent.

Better-than-expected fundamentals supported the positive returns. Nearly three-quarters of S&P 500 companies have reported sales increases above expectations, and five out of six companies have beat earnings estimates thus far. The earnings growth estimate for the third quarter is also better than expected, at 21.3 percent as of July 31, versus 20 percent a month ago.

Technicals were supportive for U.S. markets as well, with all three indices finishing the month above their 200-day moving averages.

International markets bounced back in July after a weak June. The MSCI EAFE Index finished the period up 2.46 percent, and the MSCI Emerging Markets Index rose 2.28 percent. Technicals were challenging, however. The June pullback proved too deep to overcome in one month, and both indices remained below their long-term trend lines.

Finally, fixed income had a difficult July. The yield for the 10-year U.S. Treasury rose from 2.87 percent to 2.96 percent during the month, which held the Bloomberg Barclays Aggregate Bond Index to a gain of just 0.02 percent.

High-yield corporate bonds, usually less tied to interest-rate moves, had a better month. The Bloomberg Barclays U.S. Corporate High Yield Index rose 1.09 percent, showing investors are still comfortable paying up for higher yields.

 

Economic reports point to faster growth

Gross domestic product (GDP) growth in the U.S. came in at 4.1 percent in the second quarter—the highest level since 2014 (see Figure 1). Also, first-quarter growth was revised up from 2 percent to 2.2 percent. Growth was broad based, fueled by higher consumer spending, solid business investment, faster government spending growth, and a surge in exports.

 

Figure 1. Real GDP: Percent Change from Preceding Quarter, 2014–2018

Job growth remains healthy, despite a lackluster report in July, which came in at 157,000 new jobs versus expectations for 193,000. What this headline figure doesn’t show is that June’s strong employment report was revised up from 213,000 jobs to 248,000, accounting for most of July’s shortfall. The underlying data was also strong.

With consumers both able and willing to spend, consumer spending growth accelerated, rising 4 percent. Retail sales data was also solid, with a 0.5-percent increase over the prior month.

Consumers weren’t alone in driving growth. The Institute for Supply Management’s Manufacturing and Nonmanufacturing indices continued to post high expansionary numbers, as faster growth and lower corporate taxes led to healthy levels of investment. Business investment for the second quarter grew 7.3 percent, and durable goods orders for June rose a respectable 1 percent. Export growth of 9.3 percent was another bright spot, but such a large increase isn’t likely to be repeated.

 

But housing disappoints

Housing, a key economic sector, appears to have slowed, however. Both existing and new home sales declined in June. Homebuilder confidence, though still high, appears to be rolling over. Rising construction costs have lowered the profitability of new housing and led to declines in housing starts and permits.

Some of the slowdown in housing can be attributed to low levels of supply, but another key factor is slumping affordability. Housing prices are climbing faster than incomes, and mortgage rates are ticking up.

Even though the financial markets remain strong, and the economy continues to grow, any slowdown in housing growth must be taken seriously.

 

Political concerns muted but still there

Overall, the market’s perception of policy risks seemed to recede in July, as North Korea moved out of the headlines, and the trade war between Europe and the U.S. was put on hold. China, however, remains a major area of trade concern, with renewed U.S. tariff threats rattling markets at month-end.

Looking toward November, the midterm elections could lead to increased volatility. With a potential government shutdown in play as well, political risks are more likely to rise than to fall.

 

Prospects remain positive

Despite very real risks, the positive economic news from July points to continued healthy growth for the rest of 2018. Politics notwithstanding, a healthy economy and rising profits should support the markets.

We should still expect that, at some point, the news won’t be as good as it is now. Whatever happens, a well-diversified portfolio that matches risk-and-return guidelines is the best path to follow for achieving long-term financial goals.

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.

 

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Authored by Brad McMillan, CFA®, CAIA, MAI, managing principal, chief investment officer, and Sam Millette, fixed income analyst, at Commonwealth Financial Network®

© 2018 Commonwealth Financial Network®