The U.S. economy grew 4.1% in the second quarter to post its strongest quarter since the third quarter of 2014 and fifth strongest quarter of the expansion. Despite slightly missing the Bloomberg-surveyed economist consensus of 4.2%, the details behind the report were generally positive, with strong growth despite a headwind from a large contraction in inventories, as well as an added hurdle from an upward revision of first quarter growth from 2.0 to 2.2%. Fiscal stimulus had a clear impact, with a strong rebound in consumer spending from first quarter weakness, solid business spending, and increased government spending, although a rising budget deficit remains a concern.
Active management may be poised for a comeback. During the past several years, it’s been difficult for active managers to outperform equity benchmarks. There are a number of reasons for that, including the strength of the market, market distortions from central bank bond purchases, and high correlations between stocks. However, the tide has started to turn, which we believe sets active managers up for better relative performance opportunities in the coming years.
After a seasonally weak first quarter, expectations have been ramping up for the U.S. economy, which is now in the midst of its longest expansion since World War II. The first look at real gross domestic product (GDP) for the second quarter will be released Friday, July 27, and economists are expecting it to be the strongest reading in years. The median Bloomberg-surveyed economist forecast is for GDP growth is 4.0%, which, if realized, would be the largest quarterly increase since 5.2% growth in the third quarter of 2014.
Second quarter earnings season is underway and may be another good one. Consensus estimates are calling for a 21% year-over-year increase in S&P 500 Index earnings for the quarter, setting up a second straight quarter of 20% or higher growth and marking the eighth straight quarterly increase [Figure 1]. Should results come in ahead of expectations as we expect, our data indicate it would mark the 37th consecutive quarter of earnings exceeding expectations. While tariffs have dominated headlines recently, and some companies are being disproportionately affected, we do not expect trade tensions to have much impact on overall results. The season kicks into high gear this week (July 23–27) with 175 S&P 500 companies reporting.
We believe that the global growth story will continue in 2018, with an expectation of 3.8% gross domestic product (GDP) growth for the world economy, thanks to new fiscal policies and improved business vitality. We continue to expect the U.S. economy to remain a primary driver, aided by the anticipated growth trajectory of emerging markets, while Europe and Japan may lag. Primary risks include an unexpected rise in inflation, a substantial increase in trade friction, or a policy mistake [Figure 1].
The current environment looks favorable for strong earnings and stock gains. We do expect volatility, but steady economic growth provides a strong backdrop and the potential for opportunity.
The first half of 2018 saw the return of equity volatility after the docile trading patterns of 2017. The surge in bond yields after the January jobs report, along with the initial trade concerns in late March, resulted in the first market corrections (a pullback of at least 10.0%) since the Brexit vote in June 2016. Though higher bond yields caused market disruptions, rising market interest rates (especially from relatively low levels) have typically been associated with an improving economy and higher stock prices. As a result, when viewing market volatility in the context of steady economic growth, it is not something to fear, in our opinion, but to embrace, as temporary market selloffs may provide suitable investors with opportunities to rebalance portfolios toward long-term targets.