The U.S. stock market dipped notably in early August and exhibited considerable volatility throughout the month. The market drop and subsequent instability, which stretched into September, were related to concerns about growth prospects for the U.S. and global economies. These concerns were validated by the Fed’s decision to cut interest rates in late July—the first rate cut since the Great Recession.
Stocks and bonds continued to perform well during the second quarter, in spite of an uncertain trade environment and worrying international tensions with Iran. For the quarter, the stocks of U.S. large companies were up 5.0%, U.S. small companies rose 2.4%, and foreign stocks rose 4.3%. U.S. bonds were up 3.0%.
While the markets ended higher over the three-month period, the rise was interrupted in May, when markets declined steeply after the president increased tariffs on Chinese goods. Reports of slowing global economic growth also contributed to the sell-off. The president likewise imposed tariffs on Mexico but suspended them before they took effect.
Both stock and bond markets rebounded strongly during the first quarter of 2019. In the U.S., large company stocks rose 13.6%, small companies were up 14.6%, and bonds were up 2.9%. Foreign stocks rose 10%. The markets were lifted by news that the Fed had reduced the number of planned interest rate increases for 2019, from a prior estimate of three hikes down to zero. Reports of slowing global economic growth and low inflation contributed to the revised interest rate position.
The final quarter of 2018 hit with a dramatic downturn for the stock market, while bond investments generally performed well. Large U.S. company stocks were down 13.5% over the quarter and down 4.4% for 2018. Small company stocks were down 20.2% this quarter and 11% on the year. Bonds were 1.6% higher for the quarter, though they were flat for the year.
The fourth quarter setback for stocks was abrupt and vexing. Large company stocks had recently risen 10.5% by the end of the third quarter. But by the year’s end, they were down 4.4% in a sharp reversal. Analysts have been reminding investors for years that a notable sell-off could arrive unexpectedly as the rising market endured longer and longer.
Stock markets were generally higher over the waning months of summer, with stocks of large US companies for the quarter up by 7.7%, small U.S. companies up 3.6%, and foreign stocks up 1.4%. Bonds, broadly measured, were flat for the quarter, though down 1.6% so far this year.
Trade tensions have remained front and center in economic news as the administration has continued to press for additional tariffs, as announced during the quarter. However, vigorous growth of the U.S. economy,
The stock market headed into summer on an up note, with large company stocks rising 3.4% for the quarter and small company stocks up 7.8%, though foreign stocks were down 1.2%. More interest rate hikes continued to weigh on bonds, which were off 0.2% over the three months.
The bond market is historically far less risky (volatile) than the stock market, though the market still does fluctuate. One of the key drivers of bond market fluctuations is movement in interest rates. The Fed, which sets short-term rates, has increased the rate twice so far in 2018 and has stated its intention to raise it twice more.
In an exceptionally volatile quarter for investors, markets ended lower, with US large company stocks down 0.8%, US small company stocks lower by 0.1%, foreign stocks down 1.7%, and domestic bonds lower by 1.5%.
The stock market swooned in February as traders showed alarm about rising US interest rates. The market sell-off was related to the long-anticipated rise—and possible accelerating future rises—in US interest rates (considered a negative for stocks and bonds) as well as concerns that inflation may be brewing. It may not be just coincidence that this reaction happened in the wake of the recent federal tax cuts, which analysts say will stimulate—unnecessarily say some—the US economy, leading to things such as higher interest rates and inflation.
Tax cuts, along with stepped-up government spending (in March Congress passed a $1.3 trillion budget), may serve to overheat the US economy in coming months, though it is an open question as to whether the tax cuts will actually spur economic growth. Following the passage of the tax bill, there was a series of well-publicized employee bonus and capital investment announcements. (Keep in mind bonuses are one-time and not the same as wage increases.) These were meant to show that big businesses were sharing the bounty of the tax cuts with workers. Since then, however, studies and polls have shown that business investment has not increased as a result of the tax cut—and neither have wages.
The fourth quarter was positive for stocks, topping off another year of growth for the markets. Large company stocks in the US rose 6.6% for the quarter and 21.8% for the year. Small US company stocks were up 3.3% for the quarter and 14.6% for the year, while foreign stocks rose 4.2% for the quarter and 25% on the year. Bonds were up 0.4% for the quarter and 3.5% for the year.
The drivers that have moved markets all year continued during the fourth quarter: optimism among traders about anticipated tax cuts and deregulation, which they believe will stimulate the economy, at least in the short-term. Positive US and global economic data have also further supported market gains.
Massive tax-cut legislation was passed in the waning days of 2017. The lion’s share of the benefits will accrue to corporations and high-income Americans in the form of lower tax rates. This comes at a time when corporations already have robust profitability; the disparity in US incomes has never favored top earners so much. The story being sold in Washington is that the tax cuts will spur dramatic economic growth, which will benefit the middle and lower economic classes as prosperity spreads, raising the financial boats for all, as it were.
However, there are reasons to doubt that the benefits will find their way into the middle or lower classes. Despite the growth, corporations generally will keep wages flat in favor of rising profits. Economics tells us that wages rise when unemployment falls because employers must compete for workers by paying them more. But in the absence of such tight labor conditions, corporations will generally use added profits for executive bonuses, reducing debt, share buy-backs, shareholder dividends or capital projects, which may include investing in automation as a way to keep their labor costs down.
Worker wages have remained stubbornly low throughout the economic recovery that began in 2008, even though unemployment has declined and is now lower than it was prior to the recession. Research shows that primary reasons for lack of meaningful wage growth include ever-growing automation, applications of technology, and foreign outsourcing—not immigrant labor, as many anti-immigrant leaders proclaim. Corporations did not raise wages meaningfully in 2017 because they were not compelled to do so, although minimum wage increases in 18 states have just gone into effect as of January 1.
Economic growth has been running at around 2% since the 2008 recession, below the rate for some prior recovery periods and below the long-term average of about 3.2%. (It is important to note that the long-term rate was accompanied by jarring boom-and-bust cycles that included growth rates as high as 16% and as low as -10% between 1947 and 2017.)
The Fed is projecting a growth rate for 2018 of 2.5%, reflecting the economic momentum coming out of 2017 and possibly some incremental rise from tax cuts Interestingly however, the Fed’s long-term growth rate estimate remained unchanged at 1.8%, suggesting a belief that potential growth from the tax cut will be temporary in nature. The widely forecasted ballooning federal debt generated by the tax cuts will likely be longer lasting.
As we look forward into 2018, leading economic indicators are generally viewed as relatively strong and forecasts support the expectation of continued growth for the year. Among the risks we are considering is the possibility that growth spurred by tax cuts and deregulation will create an overheated economy, a situation which is likely to end in an abrupt and possibly harsh recession, and may well be accompanied by a decline in the stock market. On the other hand, it is also certainly possible that the tax cuts fail to produce the economic growth promised by the legislation’s sponsors.
Finally, we acknowledge the conclusion of Janet Yellen’s four-year term in February as the first woman Fed Chief. During her tenure, she oversaw the first interest rate hike in seven years as the Fed sought to normalize its rate policy following the tumultuous 2008 recession. She has led the Fed with dignity and poise, and history will likely judge her work at the Fed favorably.
The stock market continued its upward march during the third quarter. Large company stocks ended up 4.5%, while small companies rose 5.7%, and foreign stocks were up 5.4%. Bond returns for the quarter broadly measured— were also positive, up 0.8%.
These results arrived amid a backdrop of generally positive global economic news. IMF economists believe the pickup in global economic growth will remain on track and have expressed particular optimism for developed European economies. Though difficult to predict reliably, there is some analyst consensus that foreign stock markets may present better opportunities in 2018 than U.S. markets.
This is in part because the U.S. is now in an (unhurried) interest rate increase cycle. Rising interest rates are known to have a cooling effect on an economy. You might think of low rates as oiling-up the economic machine, while higher rates can slow the machine, to a degree. A recent Wall Street Journal poll of economists showed that the majority expects the Fed to raise rates once more this year, in December.
Both stock and bond markets finished the quarter with solid gains. Large company stocks in the U.S. were up 3.1%, while smaller companies gained 2.5%. Foreign stocks were in the black as well, up 6.1%. Bonds advanced 1.4%, even as the Fed raised interest rates.
Federal Reserve officials forged ahead with another interest rate hike in June, the third in six months, and maintained their outlook for one more hike this year. The Fed announcement struck a careful balance between showing resolve to continue increasing interest rates toward more historically normal levels, and acknowledging concern over unexpectedly low inflation this year. While we may think of inflation as a bad thing, the Fed sees benefits in it—in the right measure.