Economic Commentary | Second Quarter 2017

Despite heightened domestic political risk, rising tensions with both North Korea and Syria, persistent pressure on global oil prices, and a Federal Reserve that is actively removing monetary accommodation, the market saw plenty of reasons to cheer this past quarter.  For the three months ending June 30, 2017, the large cap S&P 500 index increased 3.1%, the mid/small cap Russell 2000 index gained 2.5%, and the international MSCI EAFE index rose by 6.1%.

The US economy extended this period of slow and steady growth, with the final reading for First Quarter 2017 GDP (reported during June) coming in with a respectable gain of 1.4%.  The labor market continues to buttress the recovery, as jobless claims have remained below 300K for 121 weeks, the longest such streak since 1970.  Going forward, continued advances in the labor market will be harder to come by now that we are at full employment.  The unemployment rate is currently down to 4.3%, the lowest level since 2001, with wages rising 2.5% over the past year.

Various measures of confidence have picked up in recent months with both the Consumer Confidence and University of Michigan Consumer Sentiment indices hitting 16-year highs, while CEO Confidence is at its highest level in 13 years.  In addition, the Small Business Optimism Index has remained at historically high levels for the past six straight months.

We saw large gains in housing, with new home construction up 8.1% during the quarter relative to the same quarter in 2016 and housing permits up 10.4% over the same comparative period.  That said, there are some early signs that growth in housing is slowing due to labor shortages in the construction industry.  We will continue to keep our eyes on this development, as housing is a critical linchpin in the health of our economy.

The latest round of stress tests on our country’s banks occurred at the end of the quarter and provided some good news:  the largest 34 banks in the US have much stronger capital reserves (at a combined $1.2 Trillion) than was the case in the days leading up to the 2007-08 financial crisis.  The Fed demonstrated its confidence in these results by approving plans for many of these large banks to return excess capital to shareholders in the form of dividends and share buybacks.

Energy prices remain weak due to a glut of oil in global markets.  Although OPEC and Russia have committed to the agreed-upon production cuts, US output has largely offset these supply-reduction efforts, as US producers have taken advantage of recent technological developments that reduce the cost of oil and gas extraction.   West Texas crude ended the quarter at just over $46/barrel, still in the sweet spot that incentivizes energy companies to produce but which also benefits consumers by freeing up discretionary spending.

Broadly solid economic fundamentals led to the S&P 500 index hitting 11 new all-time highs during the second quarter on top of the 12 new highs already reached during the first quarter, for a total of 23 new all-time highs thus far in 2017.

Turning our attention overseas, investors breathed a sigh of relief when the moderate Macron won the French election, though Teresa May’s call for a snap election in the UK to shore up her support added to anxiety as her party lost seats that were important to successful Brexit negotiations.  Despite this sustained political uncertainty in the region, with critical German elections in just a couple of months, the Eurozone recovery is well underway, with an annualized gain in GDP of 1.8% during the quarter.  China, too, is enjoying strength, as the country’s economy gained 6.9% during the First Quarter, having achieved the enviable balance of strong growth momentum along with easing inflationary pressures.  The International Monetary Fund’s most recent projection calls for global economic growth in excess of 5%, marking an end to years of weak growth in the world’s developed economies.