For the week ending July 26
Second Quarter Growth Slows, But Exceeds Expectations
Last week’s series of economic reports, which included Home Sales (both new and existing), Durable Orders (manufacturing activity), and Initial Claims (new unemployment insurance benefits) didn’t have much of an effect on the financial markets.
The most impactful piece of economic data was the advance estimate of U.S. second quarter Real Gross Domestic Product (GDP) 2019 released last Friday morning. Economic growth clearly decelerated, but equity markets reacted favorably to the 2.1% quarter-over-quarter annual growth rate. This figure was better than the consensus estimate (1.8% growth rate). Consumption, which is a critical component of the U.S. economy and a measuring stick for the services sector, rose +2.9%. Other than government spending, other categories that comprise the GDP calculation were modest detractors.
Quarterly Real GDP Trailing 4 Years Ending 6/30/2019
(Real GDP: Percent change from preceding quarter)
Source: U.S. Bureau of Economic Analysis. Seasonally adjusted at annual rates.
The second quarter Real GDP report clearly fits the slower growth narrative and captures the impact trade-related disputes have had on global supply chains given the lackluster business investment reading. Our key takeaway from this report is that the data will not cause a material shift in Fed monetary policy and it supports our view of a slowing economic expansion, but not one where a recession is imminent.
A First Glimpse at Second Quarter Earnings Season
We are in the middle of second quarter earnings season which, overall, has had a more material effect on equity markets than the recent round of economic reports or global macro headlines. Based on data compiled by FactSet Research Systems Inc., approximately 44% of companies that comprise the S&P 500 Index have released second quarter 2019 results as of July 26, 2019. While earnings and revenue growth rates have weakened dramatically relative to 2018, we are encouraged by the number of companies that have posted numbers that exceeded consensus estimates. In fact, 77% of S&P 500 companies have reported a positive earnings per share (EPS) surprise and 61% of companies have reported a positive revenue surprise thus far. In addition, S&P 500 firms that derive more than 50% of revenue overseas have fared better than many investors had feared despite all the trade-related rhetoric.
Financial Market Recap
U.S. equity markets continued to grind higher last week with the S&P 500 Index appreciating +1.66%. We are also encouraged by the performance of small cap stocks as measured by the Russell 2000 Index, which appreciated over +2%. Small caps have been a notable laggard, which we’ve written about in the past, and it was a favorable development for equity markets to see this more economically sensitive area of the market finally outperform albeit on a very short-term basis.
International stocks did not fare as well. Most indices, including the MSCI EAFE (international developed) and MSCI Emerging Markets (international developing), posted modest losses for the week.
There were no notable developments on the fixed income side. Interest rates drifted higher across different maturity buckets and the yield curve modestly flattened as short-term rates rose by a greater margin compared to long-term rates. At the end of last Friday’s trading session, the 10-Year U.S. Treasury bond finished at 2.07%, which was 2 basis points (0.02%) higher relative to the prior week. Credit spreads are still fairly tight as investors are clearly venturing farther out on the risk spectrum to pick up some additional yield.
This upcoming week will be busy on the economic front as investors will be afforded the opportunity to react to several key reports pertaining to inflation, consumer confidence, and manufacturing survey data. However, the upcoming Federal Open Market Committee (“FOMC”) meeting on the docket for Wednesday, July 31, 2019 will clearly attract the most attention for both equity and fixed income markets. Investors seem to be anticipating that the Fed will follow through with an interest rate cut and offer statements about more accommodative monetary policy going forward. Given the strong performance of stocks and bonds heading into this FOMC meeting, there is arguably quite a bit of optimism being reflected in asset prices. We will be closely monitoring the outcome of the FOMC meeting and will keep our clients apprised of any developments.