Welcome to the Monthly Economic Update, I hope everyone had a great month and spent some time with their families.
Summer is one my favorite times of the year because of the time I get to spend with my family. We had some interesting things transpire in the month of July, but I want to address volatility in the market before we review the month.
Volatility may have you thinking it is crazy right now and that it hasn’t been like this in a long time. The truth is that we’ve gone through an extended period of time with little or no volatility. The expansion from quantitative easing coming out of the Great Recession led to a prolonged period of super low volatility that began to feel, for many, like the norm. Well, the reality is, the volatility we are experiencing in the market today is back to more normal behavior. Downward movement of 1% or more on the S&P 500 will occur, on average, around 15-20 times per year. So that volatility is normal even though it isn’t what we’ve been experiencing over the last several years.
July GDP and the Markets
Some really interesting things happened in July and I want to direct our attention to a couple of main points. 2nd quarter GDP came out at 4%, and this is the first time that we’ve seen quarterly GDP in that 4% range in what seems like forever. You would think that the day that 4% GDP was announced we should have seen things soar up, but in reality, we saw pullbacks in the market. We saw the Dow Jones Industrial Average, S&P 500, and NASDAQ falling. We saw the FANG stocks, really get hit. That’s the technology heavy stocks, your Facebook, Amazon, Netflix, and Google. All have gotten hit pretty hard just in the last few days.
What was the result of the good GDP and markets falling? Well, we’ve been talking for a long period of time about how we think some stocks may be over-extended a little bit. We talk about price to earnings ratios being pretty much elevated. The truth is that we are in a late stage cycle of this bull market. The things with later stage bull markets is that everything doesn’t necessarily work the way that we want it too. Sometimes good news is bad news for the market and vice versa.
What we’re seeing right now is that some of the markets are overextended. The FANG stocks are in correction territory, for example Facebook falling 19% in a single day. Were some of these stocks over-elevated? Absolutely, no question. Does this translate into the beginning bear market in technology? I don’t think that time has come yet. We still have very solid growth in the U.S. economy. That’s the one bright spot we can point to, and we have the data to back it up. Good solid economic growth right here in the U.S. is fueling the market.
It appears from some of the guidance we get from corporations out there, that earnings may have peaked in the first quarter of this year. However, just because they may have peaked doesn’t mean earnings have crashed. It just means that year over year earnings from the guidance that we are getting from corporate America today, isn’t necessarily as strong and it’s not continuing to increase. We had 21% earnings growth in the 1st quarter, and we’re forecasting 17% earnings growth for the 2nd quarter. Sure, that’s a drop in earnings growth, but it’s still growth and that’s the key.
The rhetoric on global trade and trade wars has weighed heavier on the markets than anything that has to do with fundamentals. The reality over all of the disputes over trade is that we really don’t know what is going to come out of the trade negotiations. The media wants us to believe that we’re already in a full-blown trade war. I don’t believe that’s the case. I believe that we’re in negotiation territory now, where we’re trying to get to some fair trade throughout the entire world trading with the U.S. We don’t know what the result of that is going to be, but the hype and discussions behind that are causing volatility in the market. And it’s causing, what I think, are some really good economic signs here in the United States being overshadowed by the uncertainty of what is going happen with trade with other nations.
Let’s get into what the markets did for the month of July. We will also be talking a little bit about interest rates. I’m not going to give much of a forecast here because we are going to be putting out our Half-Time Report, which is a summary of what we saw happen over the first half of the year. This will be a longer video format, probably 30-40 minutes. We’re also going to give some forecasts and some updates about what we see happening for the balance of the year.
Let’s take a look at the overall equity markets for the month of July. As you can see in Figure 1, the Dow Jones Industrial Average finished the month up 4.18%. It was the best performing indices of all, followed by the S&P100 and the S&P500. Looking at the NASDAQ, it’s up 1.34% and the SmallCap is up 0.90%.
I point these out because I want you to see what it looks like if we look at things year-to-date in Figure 2. If we look at the year-to-date numbers on these same indices, look at the two at the top. The NASDAQ is up 12.42% and the S&P 600 SmallCap is up 10.86%. The Dow Jones Industrial Average, which in Figure 1 was the winner, is only up 2.22% year-to-date. Remember, the Dow Jones Industrial Average was up 4.18% in July, so up until July it was in negative territory for the year.
When we look at the sectors today and their performance over the last month. Financials, Health Care, Industrials, S&P 500, and Technology are included. You see Utilities and Real Estate down a little bit for the month. Bottom line is that a month is too short of a time for us to see any worthwhile trends. It’s interesting to see the high-flying growth stocks of the NASDAQ and the SmallCap sectors both taking a back seat to the large value companies from the Dow Jones Industrial Average who have really been left in the dust this year.
Is this a shift from high growth to needing more of a value focus in the markets? A month trend is too early to tell. I can tell you this though, earnings growth and growth stocks have been the main driver of this market. I believe that as we move through the rest of this year we’ll see that continue to be the case.
Looking at interest rates, Figure 4, there has been a lot of talk about the flattening of the yield curve. That means that the short rates catch up with the long rates. If we have an inverted yield curve it means that the short rates will exceed the longer rates. In Figure 4, the blue line is January 2, 2018 and the green line is July 30, 2018. The 1 Month Treasury was 1.29% at the beginning of the year and now is at 1.91%. So, we’ve seen a pretty decent overall increase there. But look over at the 10 Year Treasury, it’s gone from 2.46% at the beginning of the year to 2.98%. So, we have similar movement for the first time in a long time. We saw shorter rates go up and we also saw those longer rates go up with it.
If we look at these rates in Figure 5 they go from the beginning of January 2017 to today. You can begin to see the difference in how the yield curve has flattened some since January 2017. The 1 Month Treasury at the start of 2017 was 0.52% and here we are today at 1.91%. Looking at the 10 Year Treasury for January 2017 it was at 2.45%, about where it began 2018, and today it’s at 2.98%.
If we back up the blue line even further to the beginning of 2016, Figure 6. The 1 Month Treasury was at 0.17% at the beginning for 2016 and the 10 Year Treasury was at 2.24%. We’ve seen about a 0.75% increase on the 10 Year Treasury over two and a half years. Where on the 1 Month Treasury we’ve gone from 0.17% to 1.91%. That’s a nearly 1.8% increase on the 1 Month Treasury. Compared to the 0.75% increase on the 10 Year Treasury, that’s what people are talking about when they mention the flattening of the yield curve.
The fear for many is that the short end of the yield curve is actually going to yield higher than the long term, that typically signals a recession. From what we’re seeing in the trends for the last couple of months I don’t think that is anywhere on the horizon. I don’t think a recession is anywhere on the horizon either. I think we’ll continue to see decent growth. Volatility is obviously back, but it’s normal volatility and nothing to get worked up or worried about.
Please keep an eye on your emails for notifications about upcoming Half-Time report. I’ll be going into a lot more detail on what has gone on in the economy as a whole for the first half of the year and give some predictions on what we see happening for the remainder of the year. As always, keep in mind that we are paying attention to what’s going on, and our objective is to help you live your one best financial life. We are here to make sure your money does what you need it to do in order for you to live that life. I encourage you to stay in contact with your advisor to let them know any changes that may be going on in your financial life and any questions you may have. We’re always here to help.
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Thanks for being with me today.
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