During the third quarter, capital markets continued to rise, led by strong domestic growth. The markets were bolstered by U.S. corporations’ robust revenue and earnings growth. In fact, this was the best single quarter in U.S. equity market performance since 2013. The strength of the U.S. economy lifted the entire global market performance, as shown by the chart below. Wages have begun to slightly increase, but not at a rate to signal inflationary concerns or the end of the expansion cycle. Major economic indicators such as job growth, manufacturing and consumer spending remained strong and steady. The impact of the 2017 tax reform bill continues as companies find opportunities to deploy cash repatriated back into the U.S. at more favorable rates. Most economists expect the positive tailwinds created by the corporate tax cuts to carry through the end of 2018 and into early 2019. For the 3rd quarter, major stock indices gained 6% on average and have returned 7% for the year. Fixed income returns have been down marginally.
The third quarter repeated many patterns set in the first half of the year, as economic expansion continued. Economic growth measured by GDP (gross domestic product) rose to 4.1%. The labor market reported record unemployment of 3.9%, generally considered by economists as full employment, further indicating strong fundamentals. Also, the leading manufacturing index, ISM (Institute for Supply Management) continued to rise to record levels during the quarter. As expected, the Federal Reserve implemented a .25% interest rate hike at its meeting in September and indicated its “accommodative” era was over. It maintained its forecast of one more interest rate hike for 2018 and three for 2019. The CPI (consumer price index) remained steady, indicating inflation is not a near-term threat.
The S&P 500 and Dow Jones Industrial Averages reached new historic highs in late September, driven largely by strong corporate earnings and fundamentals. P/E (price to earnings) ratios, which provide relative and historic stock value comparisons, continue to remain relatively attractive in spite of the market appreciation. The strong earnings results kept valuations from being excessive and provide the footing for further advance. During the quarter, the S&P Index was re-balanced and the Telecommunications sector was replaced by the Communications Services sector; notable companies now included in this new category include Google, Facebook, Netflix, Disney, Verizon and AT&T. The Energy sector continued to rise, driven by increasing crude prices, which averaged in the low $70 per barrel for most of the quarter.
During the quarter, the U.S. finalized a new trade agreement, first with Mexico and then, as of October 1, with Canada, replacing NAFTA. Trade negotiations with China remain ongoing, with rhetoric by both countries often dominating the news and process. While it is hopeful that a trade resolution can occur, an escalating trade war between the world’s two largest economies remains a possibility. So far, the U.S. markets have shown remarkable resiliency in response to the posturing and threats of higher tariffs. While inflation has remained benign for a significant number of years since the Financial Crisis of 2008, keeping interest rates depressed, the market’s volatility is likely to return to its historical norm as interest rates move upward. The extended period of lower stock market volatility over the past couple of years is highly unusual and upward movement of interest rates could provide the trigger to higher levels of market fluctuations. Most encouraging, however, the economy’s broad areas of strength even in the face of ongoing trade disputes and higher rates continue to provide the solid backdrop for positive economic and corporate earnings growth in the U.S. This base establishes an optimistic market outlook for the rest of 2018 and early into 2019.