The U.S. economic expansion continued into its tenth year as the nation’s second-longest expansion on record. Real GDP grew at a 4.2% annualized rate in the second quarter, the most recent available. The economy was powered by robust consumer spending as well as the frontloading of exports to China before Beijing’s retaliatory tariffs came into effect in early July. Consumer spending, which makes up over two-thirds of the economy, rose 0.3% in August driven by healthcare spending but offset by weak auto sales. Core CPI, which strips out food and energy prices, rose marginally in August, rising 2.2% for the 12 months ending August. The unemployment rate decreased to 3.7% in September - the lowest level in 49 years! However, only 134,000 jobs were created in the month. Wage growth of 2.8% is starting to pick up but remains well below the 50-year average of 4.1%. U.S. manufacturing activity jumped in September; the reading is the strongest activity recorded in four months and was driven by sharper rises in output and new orders.
The Federal Reserve raised interest rates by a quarter point in September 2018; the recent rate hike was the eighth rate increase since December 2015 and the third time this year. The Fed also voted to raise the target range to 2.00% - 2.25%, nudging it up from near zero since the Great Recession. Despite the rate hikes, long-term rates have not kept pace causing the yield curve to continue to flatten. The 10-year Treasury bond yield increased by 0.20% to 3.05% during the quarter; the 30-year Treasury yield moved up by 0.21% to 3.15%. Since quarter end, the 10-year Treasury hit a 7-year high amid the announcement of September’s low unemployment rate and rising wages.
The top fixed income performers for the quarter were high yield and emerging markets bonds, increasing 2.4% and 1.9%, respectively. For the year-to-date period, high yield was the top performing fixed income sector. Developed international bonds and TIPS were the worst fixed income performers declining 2.4% and 0.8%, respectively. After a strong rally against most major currencies in the second quarter - especially the euro and the British pound, the dollar’s strength moderated in the third quarter.
The U.S. equity markets advanced strongly for the third quarter. The S&P 500 gained 7.7% - its biggest advance since the fourth quarter of 2013. The move was broad-based as all 11 sectors ended in higher territory. Healthcare, industrials, and communication services sectors showed the largest gains during the quarter, advancing 14.5%, 10.0%, and 9.9% respectively. Energy and materials recorded the smallest gains, up 0.6% and 0.4% for the period. The forward P/E for the S&P 500 increased to 16.8x for the third quarter, modestly above the 25-year average of 16.1x. Large cap stocks outperformed small caps in the quarter; growth stocks beat out value stocks. While small caps had done well in the second quarter as investors rotated into them as a safe haven from trade wars, investors moved back into large caps in the third quarter. The CBOE Volatility Index (VIX Index) continued to moderate in the quarter after a large spike upward early in 2018.
Developed international equities rebounded during the quarter as developed Europe (ex-UK) and developed Asia reported modest gains of 1.8% and 2.4% respectively. International gains paled in comparison to U.S. gains. After a big drop in the second quarter, emerging markets (EM) equities declined an additional 1.0% in the quarter; this resulted in a year-to-date decline of 7.7%; the stronger dollar has been a headwind for year-to-date EM performance in addition to political and macroeconomic conditions in emerging market countries. While emerging markets have outpaced developed markets over the last two years, there has been a reversal for the first nine months of 2018, as developed international stocks have declined less than EM stocks.
The Bloomberg Commodity Index declined by 2.5% in the quarter as prices of many commodities moved lower throughout the period. The weakness was due to a stronger U.S. dollar and concerns over international trade. The oil price recovery halted as U.S. crude oil prices backed off by 1.2% in the third quarter, ending the period at $73.25 per barrel; oil prices are almost triple the 13-year low of $26.55 which was set in January 2016. Gold prices declined 5.4% finishing the quarter at $1,187 per troy ounce. REITs modestly increased in the current quarter, with a year-to-date gain of 2.6%. Higher interest rates are dampening the U.S. housing sector.
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