After the first losing quarter since Q3 2015, US stocks as measured by the S&P 500, regained momentum with a 3.43% return in the Q2 2018, leading to a year to date return of 2.65%. Continued US economic expansion and robust corporate earnings have provided the momentum for stock market gains this quarter. After growing 25% in Q1 2018, earnings are expected to grow another robust 20% in Q2 2018, aided by the positive effects from tax reform and strong consumer and business spending.
So far this year, investors are favoring companies with strong characteristics as they did in 2017. Many of these companies can be found in the technology, consumer discretionary and healthcare sectors. Small capitalization, energy, consumer discretionary and technology stocks were the market leaders in the quarter. While industrials and financials stocks were the laggards, down over 2.5%, US Treasuries were weaker in price with rising yields.
Concerns about trade tensions, most notably between the U.S. and China, remained throughout the quarter and led to some brief bouts of selling in stocks. However, skepticism continues about a full-blown trade war. Part of this skepticism lies within the perception that the US holds most of the cards due to its large trade deficits, which leaves China little room to maneuver in ways that won’t spark international complaints, such as currency devaluation. Investors also found comfort with the belief that the Trump administration’s use of the stock market as a scorecard, may resist harsh trade measures that could lead to a decline in stocks.
In our view, the main drivers for the stock market will be accelerating US economic expansion and growing corporate profits.
According to FactSet, S&P 500 earnings per share increased 25% in Q1 2018, the strongest growth since it began tracking the metric in Q3 2008. Heading into Q2 2018 earnings season, expectations are for S&P 500 earnings per share to increase 20.0% year over year, which would be the second best since Q3 2008.
With some estimates as high as $2.5 trillion, expectations are that corporations will utilize cash gained through tax cuts, repatriation of overseas profits, and economic growth to fund investments, share buybacks, dividends, and mergers and acquisitions.
Positive US economic fundamentals remain a key to further stock advances, with high expectations going into the report of Q2 U.S. GDP. As we exited the quarter, the Atlanta Fed was looking for 3.8% GDP growth in Q2 2018, up from the 2.0% expansion in Q1 2018. Investors will be focusing on how the accelerating economy influences the Fed’s monetary decisions and their impact on interest rates.
In summary, the key factors affecting both stock and bond markets in 2018 are economic growth, earnings, corporate capital investment, trade, and Federal Reserve policy. We will keep you appraised as these factors unfold and will be on the lookout for opportunities.
Nadim Joseph Nahas