The stock market posted its largest monthly gain since January as rising corporate earnings and strong GDP growth numbers helped overcome concerns over tariff and trade issues. The S&P 500 Index moved up 3.60% in July after several months of lackluster results. Through the first seven months of 2018, the S&P 500 is up 5.34%. (The S&P 500 Index is a market-cap-weighted index that represents the average performance of a group of 500 large-capitalization stocks.)
July’s jobs report, which showed that the U.S. economy added 157,000 jobs and the jobless rate fell to 3.9%, highlighted the continued strength in the U.S. labor market. While July’s headline figure came in slightly lower than expectations, net revisions to the previous two months showed an impressive increase of 59,000 jobs. In addition, through 2018, monthly job gains have averaged 215,000, and wage gains have increased gradually. It is also encouraging to see another strong gain in manufacturing payrolls, which increased by 37,000. We believe that July’s jobs report did little to change the narrative of the Federal Reserve (Fed), which announced last week that it would keep its federal funds rate unchanged. Although, if the economy continues to grow moderately, wages keep rising, and inflation stays near its 2% target, we expect the Fed to continue quarterly increases in short-term interest rates. In addition, the Fed is steadily reducing its bond purchases to shrink its balance sheet. These actions mean monetary policy will slowly reduce the amount of stimulus for the economy, but we don’t think conditions have become tight enough to start to slow activity. JPMorgan Chase CEO Jamie Dimon recently commented that the expansion is only in the “sixth inning,” which is consistent with ISI Evercore’s recession model that shows the next recession is still years away.
Accelerating earnings, a steadily improving labor market, and a patient Fed all point to continued support for consumer spending, which accounts for nearly 70% of economic growth. A healthy consumer and a strong economy provide a good environment for stocks, in our view, although we still expect to see volatility given the ongoing trade headlines. It’s also important to not let rising rates keep you from owning investment-grade bonds – they still help reduce swings in the value of your portfolio when stocks drop because they tend to decline less or even rise. Higher rates make bonds more attractive for current income, too.
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.
There is unlikely to be a shortage of market excitement in the final months of the year. The US mid-term elections will be particularly important, so some consideration of the likely outcomes and market impact is a worthy exercise in these quiet summer weeks. Whether growth outside the US reaccelerates will also be an important factor shaping markets in the second half of the year. But with some trade tensions still unresolved and later cycle risks looming on the horizon, a more balanced approach to risk is appropriate. Investors should think about adding fixed income and alternatives selectively to provide downside protection but without increasing the vulnerability of portfolios to rising interest rates.