2nd Quarter 2018 Update

July 18, 2018

Key Points

• The global economic environment is expected to remain on an upward trajectory, benefiting from several drivers, including an expansionary fiscal policy in the US and improving trade and investment in many regions of the world.
• Equity markets lurched modestly higher during the quarter, seeming to take two steps forward and one step back.
• With the economy now in the second-longest expansion in history, investors are becoming acclimated to the FOMC’s need to normalize interest rates from abnormally low levels.
• If the trade brinkmanship doesn’t subside, there is a real possibility of a tariff-induced recession down the road.

The Global Economy

The US economy remained on an uptrend, although growth in the first quarter was the lowest in a year. The Bureau of Economic Analysis reported its third estimate of first quarter 2018 gross domestic product (GDP) of 2.0%, down modestly from the prior estimate, and lower than the fourth quarter’s 2.9% reading. The employment situation continued to post gains, with an average of approximately 179,000 jobs added each month. At the same time, the unemployment rate fell to 3.8%. The Federal Open Market Committee (FOMC) modified its interest rate policy by raising the federal funds rate target 25 basis points to a range of 1.75% to 2.00%. Economists expect up to two additional increases in 2018, as economic growth accelerates and inflation and wage pressures increase.

The global economic environment is expected to remain on an upward trajectory, benefiting from several drivers, including an expansionary fiscal policy in the US and improving trade and investment in many regions of the world. The Eurozone economy slowed somewhat in the first half, following a growth revival in 2017. Most analysts believe that China’s growth will moderate in the coming months as credit controls imposed to prevent overheating in certain economic segments kick in.

Below, we’ve highlighted broader market returns for the 2nd quarter and year-to-date time periods:

Source: Thomson Reuters, PMC

Fixed Income

Several factors affected fixed income securities’ prices and yields, including the FOMC’s decision to raise short-term interest rates once again at its recent June meeting; the escalating rhetoric with China and other trading partners regarding trade and tariffs; and geopolitical events, such as President Trump’s summit with North Korea leader, Kim Jong Un. The President’s continued strong stance on trade has disrupted financial markets, but the fixed income market has largely moved to the tune of the economy’s resilient growth. The benefits of an aggressive fiscal policy, including the tax cuts signed into law in the past six months, are now beginning to flow through the economy, and the FOMC is taking a measured approach to raising interest rates to mitigate any overheating. The FOMC expects to raise short-term rates at least two more times in 2018.

The shape of the Treasury yield curve again flattened somewhat during the quarter, with yields on short- to intermediate-term maturities climbing more than those for long-term issues. With the economy now in the second-longest expansion in history, investors are becoming acclimated to the FOMC’s need to normalize interest rates from abnormally low levels.

Equities

Equity markets lurched modestly higher during the quarter, seeming to take two steps forward and one step back. The volatility appeared to be a result of investor angst over the Trump Administration’s trade policy and its insistence on imposing tariffs on certain imported goods. Markets generally do not like tariffs, considering them to be a tax. In addition, our trade partners have not shrunk from the fight, retaliating with their own tariffs on goods that we export. These escalating tensions create uncertainty in the minds of investors, who are beginning to wonder if the benefits of the tax cuts will be offset by the adverse effects of the trade war.

International stocks performed poorly on a relative basis, with almost all markets lagging US equities. Economic growth, although still positive in most regions, cooled in the second quarter.

Summary

The US economy remains strong, and although the current expansion is now the second longest in history, the consensus among economists is that the prospects for further growth are solid. Aggressive fiscal stimulus in the form of deficit-financed tax cuts and increased government spending, according to many economists, has the potential to provide the fuel for continued expansion for at least the next several quarters. It is estimated that these factors will accelerate domestic economic growth to 3% over the next couple of years before slowing down somewhat at the beginning of the next decade.

Not all is bright on the horizon, however. The escalation in trade skirmishes poses a real threat to this growth, as investors view tariffs as tax increases, because consumers will spend more on imported goods. If the tariff retaliation were to end with what has already been imposed, leading economic consulting firm Moody’s Analytics projects that the overall effect would not be significant, amounting to a decline of only about 0.1% of GDP. However, if the additional tariffs that have been threatened—and their retaliatory responses—are imposed, Moody’s estimates the adverse impact on GDP would rise to about 0.4% and result in a loss of about 500,000 jobs. For that reason, if the brinkmanship doesn’t subside, there is a real possibility of a tariff-induced recession down the road. But the expectation is that if the equity market continues to have difficulties as a result of the back-and-forth tariff tiff, President Trump will relent, enabling the recent strong growth and employment gains to continue.

Information provided is for informational purposes only and should not be construed as investment advice. The views expressed are current only as of the publication date, are based on information that St. Clair Advisors believes to be accurate, and subject to change without notice. All investment decisions must be evaluated as to whether they are consistent with your investment objectives, risk tolerance and financial situation. St. Clair disclaims any liability for any direct or incidental loss incurred by applying any of the information in this publication. Indexes are unmanaged and one cannot invest directly in an index. Past performance is no guarantee of future results.

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