Economic Commentary | Fourth Quarter 2017
For the final three months of 2017, the stock market continued its upward march, as the S&P 500 index clocked in 29 additional new all-time highs. Investors’ optimism, despite myriad geopolitical risks, was largely based upon the pro-business tax reform package that Congress ultimately passed in the waning days of the year. For the three months ending December 31, 2017, the large cap S&P 500 index increased 6.6%, the mid/small cap Russell 2000 index gained 3.3%, and the international MSCI EAFE index rose by 4.2%.
The fourth quarter brought broadly improving economic fundamentals which resulted in strong corporate earnings: 74% of the companies in the S&P 500 beat earnings expectations while corporate earnings grew by 8.5%. Coming off highs set earlier in the quarter, both manufacturing and services cooled by December, though both sectors remained firmly in expansion territory. Consumer sentiment and confidence, too, cooled yet remained near highs not seen in over thirteen years. The labor market has firmed and settled in at an unemployment rate of 4.1%. Wage growth has remained subdued at a year-over-year gain of 2.5%, which helps to explain why inflation has not become a problem despite the length of the current recovery. Third quarter GDP, reported with revisions throughout this past quarter, came in at a very strong 3.2% despite a slowdown caused by the three hurricanes that pummeled the Gulf coast in late summer. Business spending, which accelerated in the latter half of 2017, was a highlight of the GDP report, as non-residential fixed investment gained 4.7%.
The housing market is continuing to rebound, aided by more workers entering the industry, as we suspected would be the case. Home prices are at levels not seen since before the great recession, sales activity has been on fire, and builder sentiment closed the quarter at an eighteen-year high. This spike in housing sentiment came despite some significant headwinds: shortages in land upon which to build, continuing shortages in skilled labor, and increased building materials prices.
While inflation remains low, particularly given the length of this economic recovery, the Federal Reserve is proactively raising rates to forestall future inflation. The Fed has hiked rates in quarter-point increments five times during the recovery, three of which occurred in 2017. With Jay Powell taking over the reins from Janet Yellen, many expect that the Fed will continue its path of a slow and careful return to historically-normal interest rates while reducing the Fed’s balance sheet. The strength of the economy certainly supports this gradual reduction of monetary stimulation.
Although the Fed was the pioneer in removing monetary stimulus, it has become a worldwide central bank theme on global economic strength. We saw the broadest global economic growth in a decade, which contributed to record-breaking gains in stock markets across the world.
The Eurozone grew by 2.6% in the third quarter, marking the strongest growth rate since the region’s financial crisis hit in early 2011. Despite Angela Merkel’s ineffective attempts to form a coalition government in Germany, growth in this largest economy in the Eurozone accelerated last quarter. Now that healthy growth has resumed throughout the Eurozone, the European Central Bank has dialed back their stimulative bond-buying program.
China’s economy grew at an annualized pace of 6.8% for the third quarter, which keeps it on track to meet its long-term growth goals. As we’ve mentioned before, the government is intentionally slowing economic growth to a level that is more sustainable over time, with a current target of 6.5% to 7% growth per year. It should be noted that the global economic recovery has provided significant support to China, as its economy is still heavily dependent upon exports. Broad and ambitious reforms in China, which began in 2013, are intended to move the economy away from a government-led allocation of resources (think of government spending, state-owned enterprises, and cheap exports) toward a market-oriented economy (think of private investment, entrepreneurship, and Chinese consumer spending). China accounted for more than a third of total global growth in 2017. Targeting a more sustainable level of growth is a critical component to Xi Jinping’s long-term government plan, which has been very successful thus far.
Finally, oil closed the year at $60.42/barrel, gaining over 16% during the quarter, after OPEC and non-OPEC producers agreed in early December to extend production cuts through the end of 2018.