3rd Quarter 2018 Update

October 29, 2018

Key Points

• The global economic environment has been strong in many areas of the developed world, but continues to be volatile in the emerging economies.
• 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 2.00% to 2.25%
• Although current economic conditions have created favorable conditions for earnings gains and driven stock prices to record highs, it also is worthwhile to consider potential risks.

The Global Economy

The US economy, buoyed by the effects of pro-growth fiscal policies, accelerated sharply in the second quarter. The expansion is currently 111 months old, the second-longest in history, and will become the longest if the economy continues to grow through July 2019. The Bureau of Economic Analysis reported its third estimate of second quarter 2018 gross domestic product (GDP) of 4.2%, in line with the prior estimate, and much higher than the first quarter’s 2.2% reading. The employment situation continued to post gains, with an average of approximately 185,000 jobs added each month. At the same time, the unemployment rate remained steady at 3.9%. 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 2.00% to 2.25%. Economists expect at least one additional increase in 2018, as economic growth remains robust, and inflation and wage pressures increase.

The global economic environment has been strong in many areas of the developed world, but continues to be volatile in the emerging economies. In addition, many economists believe that the global economy may be nearing a peak. The Eurozone economy has stabilized at an annualized growth rate of about 2%. Strong capital investment and consumer spending supported growth in the region during the quarter, and continued to be aided by aggressive monetary policy. Japan also gained ground, with GDP expanding due to solid capital expenditures. China’s growth has continued to slow, generating 6.7% annualized GDP growth in the most recent report, the slowest pace since 2016. A deceleration in investment growth and industrial output, as well as uncertainty caused by trade friction with the US, were the primary reasons for the slowdown.

Below, we’ve highlighted broader market returns for the 3rd quarter and year-to-date time periods:

Source: Thomson Reuters

Fixed Income

The factors affecting fixed income securities’ prices and yields remained largely the same as in previous quarters. The surging economy, the FOMC’s decision to raise short-term interest rates once again at its recent September meeting, and the escalating rhetoric with trading partners such as China and Canada were among the most important drivers.

Yields meandered during the first half of the quarter, and then rose steadily for the remaining several weeks. Yields at the short end of the yield curve (up to three years) were generally about 25 basis points higher than in June, whereas those on the longer end were higher by about 20 basis points. Inflation expectations rose modestly, with the Fed’s gauge of five-year forward inflation expectations remaining steady at 2.15%, up slightly from 2.14% in June. Many analysts expect the FOMC to raise short-term rates at least once more in 2018.

Equities

Equity markets delivered strong gains during the quarter, bucking the negative seasonal trends of August and September. Stock prices thus far have shrugged off the ongoing trade disputes and higher interest rates. The focus has been primarily on the surging economy and the benefits of the tax cuts and increase in government spending. Consumer confidence remains elevated, and near the highest levels since prior to the bursting of the tech bubble in 2000.

International stocks generally posted mixed results relative to US equities. Economic growth has been modest throughout the developed world, but emerging economies have struggled in the face of rising US interest rates.

Summary

The US economy has experienced a late-cycle acceleration, and if growth remains positive through July 2019, it will become the longest expansion in history. Aggressive fiscal stimulus in the form of deficit-financed tax cuts and increased government spending are the primary drivers fueling the growth, and their effects are likely to result in solid growth for the next few quarters. Although the current economic conditions have created favorable conditions for earnings gains and driven stock prices to record highs, it also is worthwhile to consider potential risks. One such risk is an overheating economy that produces increased wage pressure and inflation. Inflation currently remains fairly well contained at about the 2% level, but with the economy at or near full employment, it will be more difficult to restrain prices if growth continues to accelerate. The trade war also poses risks. The financial markets have so far done an excellent job of digesting the heated rhetoric on all sides of the trade debate; however, if the size of tariffs ratchets higher, investors could expect volatility to ensue.

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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