The Independent Market Observer

A Look Back at Q2 2018

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Jul 11, 2018 1:50:58 PM

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look back at Q2 2018As we start the second half of 2018, we find ourselves in a much different place than we were at the end of the first quarter. Back then, we were worried about a slowdown, and markets had pulled back. Now, despite very real policy concerns, the economy looks considerably healthier than it did then. Indeed, the markets have proven to be remarkably resilient in the face of growing policy risks.

In considering what the third quarter will look like, it is worth taking a more detailed look back at Q2 2018 and how it reversed a fairly weak first quarter.

Where we began

To start, let’s take a look back at the beginning of the second quarter. March was a tough month. It capped off a tough first quarter, with both the S&P 500 and Dow down. The economic news was improving, notably with job growth surging. But worries about slowing growth from earlier in the year, coupled with rising geopolitical risks, held markets back. While conditions were not bad, there was a real worry that they were likely to slide back down into weakness.

The good news

Since then, of course, the economic news has gotten better. Job growth continued to be very strong, actually accelerating over 2017 levels. Wage growth also remained steady. Consumer spending followed the money, rising significantly, while retail sales growth rose to the highest level since 2012. Housing construction has continued to grow, while demand and prices have also stayed strong. Plus, business confidence has remained healthy, at close to the highest levels since the financial crisis.

Overall, the second quarter was quite strong from an economic standpoint. Expectations are that growth accelerated significantly from the first quarter, with some estimates at more than 4 percent. While that would be great, even a lower level around 3 percent would signal continued and accelerating expansion. As we finished the second quarter, we could be much more optimistic about the immediate economic future than we were at the end of the first.

This optimism is also shared by the Fed. In its regular rate-setting meeting in June, the Fed raised rates and essentially declared victory on both employment and inflation. As this has been an ongoing battle over the past 10 years, this was a significant development. Given that the Fed has been notably cautious up until now, this declaration cheered markets even further.

With the economy showing continued healthy growth during the quarter, it was no surprise to see markets rise here in the U.S. Markets were up in April by a bit and then by much more in May. June gains were mixed; the S&P 500 and Nasdaq rose, while the Dow was down. But for the quarter as a whole, U.S. markets showed reasonable gains. Further supporting this was rising earnings. They were up by almost 20 percent as of the end of June, on faster sales growth and lower tax rates, and well above the already high expectations at the end of the first quarter. 

The bad news

Indeed, given the earnings growth, it is somewhat surprising that stocks did not rise even more. This brings us to the bad news for the quarter: rising trade risks held back U.S. markets and did actual damage to international ones. After a strong start, developed markets were down for the quarter on declines in June. Emerging markets were also down for the quarter and all three months. A strong dollar, buoyed by the strong U.S. economy, hurt emerging markets, while rising trade risks hurt both developed and emerging markets. This could be a harbinger of next quarter as well.

Looking ahead to Q3

As we end the second quarter, the picture is clear on the economy. It is growing and likely to keep doing so for the immediate future. But the picture is much less clear from a policy perspective. The growing trade conflict is not likely to sink the U.S. recovery in the short term, given the strength we see. But it may well do serious damage over the medium term. We just don’t know yet. Internationally, much of the damage has already been done—and it could get worse.

So, after a very healthy second quarter, the U.S. is well positioned for continued growth. But there could be obstacles appearing from policy decisions both here and abroad. Big picture, the second quarter was a good one. What that means for the third quarter, however, will be largely decided in Washington and other capitals—not in the economy or markets.

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