Linda S. Parenti, CFA
President & Chief Investment Strategist
Despite ongoing concerns on trade agreements and geopolitical uncertainty, the month of May delivered a positive return for a fourth year in a row, measured by the S&P 500 rising 2.4% in total return. The strong performance from equities has continued into June, reflecting healthy data on our domestic economy. Last month we saw solid reports from both the manufacturing and services sides of our economy. The unemployment rate has dropped to 3.75%, which is the lowest level in over 48 years. With steady employment continuing to keep consumer confidence running high, it makes sense that consumer spending rose in May, and April’s report was revised higher. Conversely, international equity performance has been lagging, and overseas economic growth has slowed.
Domestic stock prices were also lifted by robust first quarter earnings growth of 25%, coming in even better than upwardly revised estimates. Part of that growth reflects the benefits of lower corporate tax rates, but earnings were also helped by a 9% increase in sales growth. Second quarter earnings are also expected to be above average. Against this positive backdrop, on Wednesday the Federal Reserve announced a highly anticipated quarter point increase in the Fed funds rate, and raised expectations they will be raising rates twice, rather than once more this year.
There are periods when the Fed raises interest rates to slow down an overheated economy and battle high inflation. Equities tend to struggle during those cycles. On the contrary, the purpose of the current Fed tightening cycle is to bring interest rates back up to more normal levels, because our economy has sufficiently recovered from the previous recession. During these phases stocks tend to do well. There is always apprehension that if the Fed raises rates too quickly, they could endanger our economic growth, but this has not been the case yet. Wednesday’s increase was the 7th rate hike since the first one on December 16, 2015. Over this 2 ½ year period, the S&P 500 has risen over 43.4% in total return, or 15.5% per year. Given the firm footing of our economy, the markets appear to believe the Fed’s pace is appropriate.
Therefore, trade tensions may continue to be the main driver of short term market volatility. Tariffs restrict global trade and limit potential growth, yet they do exist. According to World Bank data, the U.S. levies an average weighted rate of 1.6% on its imports, which is the lowest rate in the world. By comparison, China and India charge an average weighted rate of 3.5% and 6.3%, respectively on imports. Using the average rate countries charge on imports alone is not sufficient to make a judgement on fairness. However, it is important that trade agreements between countries are reviewed and kept up to date, as technology and resources change over time. Trade negotiations are never easy, but addressing them when our domestic economy is very healthy would seem a preferred time to do so.