Economic Commentary | First Quarter 2018

The market began the new year by continuing its upward march, as the S&P 500 index amassed thirteen new all-time highs in January in only twenty-one trading days!  By the end of that first month, however, a very strong jobs report rattled investors who were increasingly concerned with mounting inflationary pressures.  An official correction ensued, taking the S&P 500 index down more than 10% off its high over only nine trading days.  After taking some comfort from the resilience of the global economy, investors propelled the market higher once again until early March when President Trump announced tariffs on steel and aluminum in what was the initial salvo in a developing trade war with China.  During March, the two parties escalated tensions with threats of tariffs on various exports, culminating in a steep market sell-off which began in the US but spread across the globe.  For the three months ending March 31, 2018, the large cap S&P 500 index decreased 0.8%, the mid/small cap Russell 2000 index was down 0.1%, and the international MSCI EAFE index lost 1.5%.

The relatively modest declines in market index levels for the quarter mask the choppy ride throughout.  This choppiness is highlighted by an increase in the volatility index, a measure of the expected severity of up and down price moves for the S&P 500 index, from 9.8 at the start of the quarter to 20.0 by the end of the quarter, a level last seen well over a year ago.  The quarter also featured a brief intra-quarter period with the volatility index above 37, a 2½-year high.

Despite the stock market declines, the economic data released during the quarter demonstrated robust strength.  The Institute of Supply Management’s report on manufacturing and services came in at 14-year highs, indicating that both sides of our domestic economy continue to expand at an accelerating rate.  The US consumer was also quite optimistic, as consumer sentiment hit a 14-year high, consumer confidence closed near a 17-year high, and personal consumption increased 4%.  Much of these gains for the consumer can be attributed to the strength of the labor market, as employers created an average of 242K jobs per month while wages gained 2.6% over this time last year.  The unemployment rate held steady at a 17-year low of 4.1%, even while ever greater numbers of people streamed into the labor force.

Corporate earnings were another highlight of the quarter, with earnings growth for the S&P 500 companies surpassing 16% for the fourth quarter and expected to top 17% for the first quarter of 2018.  Perhaps unsurprisingly, the National Federation of Independent Business’ report on Small Business Optimism marked its best level in 35 years.  In addition, Duke’s CFO Global Business Outlook survey found that CFO optimism is at an all-time high since the survey began in 1996.  Duke conducts this quarterly survey because it has found that the optimism of CFOs is an accurate predictor of hiring plans and overall GDP growth.  Speaking of which, last quarter’s annualized GDP growth figure came in at a stronger-than-expected 2.9%, led by the biggest gain in consumer spending in three years.

Oil prices closed the quarter at just under $65 per barrel, gaining almost 8% during the quarter.  US shale production has surged in recent years, which may well offset any increase in prices arising from OPEC’s production cuts, now and for the next several years, an outcome that is surely not desired by the world’s largest oil producers.

Europe’s economic recovery continued during the latter part of 2017, with growth coming in at 2.7% for the fourth quarter.  In addition, Germany’s Angela Merkel was able to secure a fourth term in early March when she was able to form a coalition government with the Social Democrats.  A united Europe, led by Germany, is likely to be a stabilizing influence on world affairs and on the global economy in these days of myriad geopolitical risks.

China remained firmly on the path to its long-term growth goals that we’ve highlighted in recent letters.  For the fourth quarter of 2017, China’s GDP grew at an annualized rate of 6.8%; for the full year, growth came in at 6.9%, well in excess of its 6.5% target.  Only time will tell where the current trade dispute takes us and how far it extends beyond the US and China.  President Trump’s tariffs may be misguided, as they are likely to expand the US trade deficit and curtail global growth, clearly not intended outcomes at a time of robust economic expansion that is heavily reliant upon investment and international trade.