The U.S. economy grew at an annual rate of 3.1% for the first quarter of 2019 (the most recent data available). This is now the longest U.S. economic expansion on record. Slower growth is anticipated for the rest of the year. June’s unemployment rate of 3.7% remained near historic lows. Strong job growth returned in June with 224,000 jobs created. Wages are finally rising but significant inflationary pressures remain at bay. The strong jobs report calmed market fears that the U.S. is on the brink of a slowdown; however, the data came in about as expected according to Fed Chairman Jerome Powell. Core CPI, which strips out food and energy prices, remained well below its 50-year average, growing at 2.1% in the 12 months through June. Consumer spending, which makes up over two-thirds of the economy, rose 0.4% in May as households boosted purchases of motor vehicles and spent more at restaurants and on hotel accommodations. The consumer is spending while businesses are being more pessimistic given concerns about trade wars and the fading impact of the 2017 corporate tax cuts. Trade war fears have undermined business confidence and manufacturing activity. U.S. manufacturing activity slowed to near a three-year low in June; U.S. construction spending declined by 0.8% in May.
After raising rates for three years, the Fed indicated it might need to cut rates beginning in the second half of 2019 as economic risks intensify. Normalizing the Fed’s balance sheet may also conclude later this year, ending the tightening cycle at a much lower level of interest rates than is typical on a long economic expansion. Long-term rates have not kept pace with short-term rate hikes causing the yield curve to invert as the yield on the 10-year Treasury note moved below the yield on the 3-month Treasury bill. The topic of yield curve inversion is often debated as to whether it is a reliable indicator of an upcoming recession. Historically, yield curve inversions have always been followed by recessions.
The top performing fixed income sectors for the quarter were investment-grade corporate bonds (+4.5%), followed by emerging markets and developed international fixed income (+3.8% for both). High yield bonds increased 2.4% after a strong start to 2019.
U.S. equities advanced 4.3% in the second quarter, following a strong first quarter recovery. Stocks jumped in June, marking its best June performance since 1955. This came on the heels of negative performance in May caused by trade concerns with China, Mexico, Canada, and Europe. Financials, materials, and technology showed the largest sector gains in the quarter, increasing 8.0%, 6.3%, and 6.1%, respectively. Energy was the worst performing sector and the only sector with a negative return, declining 2.8%, followed by healthcare (+1.4%) and real estate (+2.5%). Growth stocks outperformed value stocks. Mid-cap growth stocks had the best returns at 5.4%. U.S. equities were trading at slightly higher than historical valuations at quarter-end as the forward P/E for the S&P 500 increased to 16.7x, above the 25-year average of 16.2x.
Foreign equities extended their gains into the second quarter with substantial volatility. Developed international equity markets outpaced emerging markets (EM). Within EM Asia, China struggled in the quarter after rebounding nearly 18% in the prior quarter. China’s weakened economy prompted Beijing to roll out a series of measures in 2019 to support growth in the world’s second-largest economy. After previous trade talks fell apart in early May, President Trump and China’s President Xi Jinping revived trade talks toward the end of the quarter. Commodity prices moved modestly lower in the quarter. Oil declined by 3% while gold advanced by 9%. REITs continued to move upward after reporting returns of nearly 16% in the first quarter.
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