The S&P 500 has had four straight months of gains, after suffering through a bout of volatility earlier in the year.
GDP rose strongly in the second quarter, employment gains remain robust and stock buybacks are at a record pace
The FOMC used the word “strong” six times in their most recent statement on the economy and labor markets.
The economic backdrop supports a constructive view on equities, even as interest rates continue to normalize.
Mid-year has come and gone and until recently the markets were behaving like it’s 2017 all over again. Through July, the S&P 500 Index has had four straight months of gains. U.S. Treasury yields are relatively contained and the 10-year bond seems to have found resistance at the 3 percent level. Lastly, it seemed as though the spike in volatility that we saw early in the year had subsided when the volatility index (VIX), ever so briefly, dipped below 11. However, this was before the economic disruption in Turkey. Domestically, a combination of the healthy economic backdrop and the near constant buyback activity by U.S. corporations has given support to the equity market since the volatile first quarter.
GDP on the Rise
The last two weeks have given investors a reason to be confident in the domestic economy. U.S. real GDP rose at an annual rate of 4.1 percent in the second quarter, up from the first quarter’s revised growth rate of 2.2 percent. The report showed consumers ramped up their spending at a 4 percent annual pace in the second quarter and non-residential fixed investment rose at a 7.3 percent rate after rising 11.5 percent in the first quarter. The Employment Cost Index provided a more subdued picture of wage growth but the employment report later in the week indicated that incomes are rising. During the first half of the year, the economy expanded at a nearly 3.2 percent annual rate, slightly better than the 2.8 percent median forecast for the full year submitted by Fed officials.
A few days after the real GDP figures it was also reported that employers added 157,000 to payrolls in July and wages rose 2.7 percent year-over-year. Revised figures showed employers added 59,000 more jobs than previously reported the prior two months, pushing the three-month average for job gains to a healthy 224,000. Through the first seven months of the year, employers added an average of 215,000 a jobs a month, an acceleration from last year’s average through July of 184,000 a month. The unemployment rate ticked down to 3.9 percent from 4 percent the prior month. This figure is well below the natural rate of unemployment which the Federal Reserve estimates is between 4.5 and 5 percent.
All of this hasn’t been lost on the FOMC. After its most recent meeting on August 1st, the FOMC stated, “Economic activity has been rising at a strong rate,” The official statement also described job gains as “strong” and said business investment and household spending was growing “strongly.” In all, the statement used the word “strong”—or a derivative of it—six times to describe the economy and labor markets. The strong employment data, increased consumer and business spending and stable inflation readings support the committee’s decision to continue with the removal of the accommodative policies in place for the last decade.
Stock Buybacks Signal Corporate Optimism
Positive data certainly bolsters investors’ confidence but corporate buybacks may be another factor driving the steady climb in the S&P 500 Index. So far in 2018, buyback authorizations by the boards of U.S. corporations have reached $754 billion. Corporate buybacks in the second quarter by S&P 500 companies are at $135.2 billion. That is about 2 percent below the pace in the first quarter, when U.S. corporations set the quarterly record for total actual S&P 500 buybacks, at $189.1 billion.
Interest Rates Continue to Normalize
Before we conclude it is important to note that there has been one big change in the market. For the first time since the summer of 2008, the yield on the 3-month U.S. Treasury (2.06 percent) has surpassed the yield on the S&P 500 (1.85 percent). In fact, current money market yields are also above the yield on the benchmark index. Suddenly, the decision to add marginal risk to portfolios has gotten a little more difficult for investors. Given this economic backdrop, we remain constructive on equities, favoring a slight overweight. We also remain positive on credit and relatively short duration in fixed income.