Although markets were less turbulent in the second quarter than the first, volatility persisted as investors shifted their focus from improving U.S. growth data to trade, currencies and diverging monetary policies. As we enter the second half of the year, the U.S. economic expansion continues, supported by an upbeat consumer, strong corporate earnings, contained inflation, deregulation and tax reform. Outside the U.S., the softening economic data and signs of rising credit risk call for added caution but do not preclude investment opportunities. Our positioning reflects the following beliefs:
- Fears of an imminent U.S. recession are premature; tax policy and a more business-friendly regulatory environment provide long-term catalysts for the economy.
- Although conditions outside the U.S. are less encouraging, positive global growth should continue, albeit with growing divergence among countries.
- Mid-term elections, trade concerns, more normalized U.S. interest rates, and a higher level of global economic uncertainty will fuel volatility into the autumn. This turbulence does not signal the end of the bull market in equities.
- The risks to watch most closely include continued tightening of global liquidity conditions, heightened escalation in trade uncertainty, and building political pressures in the EU.
Figure 1: Market Review
Propelled by the tailwinds of deregulation and tax reform, the U.S. economy is positioned for continued growth. Encouraging employment data, rising home prices, healthy consumer activity, and improving sentiment in manufacturing are among the factors that support our positive outlook through the remainder of the year, and likely longer. Small and mid-size businesses, a key engine of economic activity, are also in growth mode. Wage growth has been subdued and inflation is within expectations. The Fed’s course to normalizing monetary policy has been gradual and largely expected. We expect corporate earnings announcements to be strong over these next weeks, as well as through the second half of the year. Higher oil prices, wages and tariffs should push up inflation modestly, but not to extremes.
Many investors have questioned how much longer this current expansion can last, as it has already run for more than nine years. For much of this period, growth has been unusually shallow, only shifting into higher gear more recently. As a result, we believe this expansion can be sustained further. (For more on this, see our recent post.) Although interest rates are rising, credit risk is still contained in the U.S., which supports our view that the end of the economic cycle is not imminent. As middle and lower income consumers strengthen their footing, they can help extend the current expansion. The full impact of tax reform and deregulation will be reaped over time, providing long-term growth catalysts for large and small businesses.