June was a volatile month for the financial markets, as they struggled to process the mixed messages coming out of the data. The U.S. continued to grow, and the S&P 500 and the Nasdaq rose. But the Dow was down. International markets were down pretty much across the board for the month and the quarter. Rising rates, a consequence of the strong economy, hit fixed income markets as well.
In some respects, this volatility is odd. Here in the U.S., we have strong employment growth. This growth has actually accelerated in 2018. Plus, extremely high consumer and business confidence are both close to decade-plus highs. After a slow—but not terrible—first quarter, economic growth looks likely to pick up substantially for the second quarter. The economic fundamentals are not just good; they are very good. Even the Fed is on board, essentially declaring victory in its press conference. Growth like this has normally been great for financial markets. So, why the volatility? There are two reasons, both forward looking.
As good as it gets? First, as good as the economic news is, there are signs that this may be as good as it gets. Both consumer and business confidence, for example, are at very high levels. As such, there simply isn’t much room for improvement. On a more worrying note, housing hit its peak several months ago and now appears to be slowing. As a major driver of spending and sentiment, housing is a good leading indicator.
And then there’s the Fed. When the Fed stops worrying about supporting the economy, which is what has helped get us where we are, it usually starts worrying about slowing the economy down. This is where it looks like we are going. In other words, markets really are starting to worry that this is as good as it gets.
Policy disruptions. The second reason is policy. From an economic standpoint, there has been some very good news in the first half of the year: tax cuts and higher government spending, as well as continued job growth. But the good things have largely already happened, while the inevitable aftereffects are now looming larger: deficits (which I will write about tomorrow) and labor shortages. Even more worrying is the developing trade war, which has the real possibility of spiking inflation. This spike could make the Fed raise rates even faster and slow down the job growth we expect.
More of the same. Looking forward to July and the rest of the year, I think we can expect to see more of the same. The economic fundamentals should remain strong and keep driving growth. Corporate earnings are expected to do well through the rest of the year. Many of the same factors that got us to here should keep working through the rest of the year.
Continued growth at a slower rate. At the same time, we can expect to see the good news start to slow. July job growth, for example, is expected to tick down somewhat. Consumer confidence, while still high, has dropped back a bit. And, of course, all of this is before considering what happens if the trade confrontation dials up even further.
In other words, June will likely end up as a pretty good guide to July and later months. We should see continued growth but at a slowing rate. We should also see more market appreciation but at a slowing rate and with more volatility.
The big thing to watch will be whether slowing growth and possible policy disruptions start to shake confidence. The steady level of growth has led investors to believe that everything will be okay, which has become something of a self-fulfilling prophecy. That, as much as the solid fundamentals, has been what has driven markets up this far. Confidence, therefore, will be a key factor to watch. So far, the news is good. At some time after July, that news is likely to start changing.