The second quarter of 2017 was another good quarter for the markets. Equities added several percentage points, pushing year-to-date gains into the double digits in several sections of the market. The S&P 500 (SPY), which measures large-cap stocks, gained 2.6%. Smaller stocks continued to lag their large cap counterparts. The S&P 400 MidCap Index (MDY) was up 1.6%, while the S&P 600 SmallCap Index (SLY) added just 1.4%. All of these gains were overshadowed by international equities. The MSCI EAFE, which measures the performance of large and midcap stocks in 21 developed economies, gained 5.0%. These gains have occurred in spite of record low volatility, with the S&P 500 experiencing changes of more than 1% on just 10 days thus far in 2017.
The economy continues to grow, albeit at a slower rate that in 2016. Gross domestic product (GDP) grew at an annual rate of 1.4% in Q2 compared to 1.6% for all of 2016. The potentially negative effect of slow growth on the stock market has been offset by strong corporate earnings. According to FactSet, the S&P 500 delivered nearly 14% year-over-year earnings growth, the highest growth rate since 2011, finally supporting some of those outsized valuations with 75% of companies exceeding their earnings expectations.
The labor market continues to show signs of improvement. The official unemployment rate continues to creep downward to 4.4% at the end of the quarter, compared to 4.7% at the end of 2016 and 5.0% at the end of 2015. However, wage growth remains almost nonexistent as more people reenter the labor market, suppressing salaries and wages. Tepid economic growth and stagnant wages means that future increases in interest rates will likely be muted. After increasing the target Federal Funds rate four times since December 2015, the Fed declined to increase the rate again at its last meeting.
These rate increases have taken a toll on the fixed income markets, as reflected in the year-to-date return of less than 1% in the S&P 500 Muni Bond index. While returns have been disappointing, fixed income instruments continue to provide investors the opportunity for tax-free income and regular cash dividends.
In conclusion: The US economy is projected to increase by 2.2% for 2017, a slight increase from the first half of 2017 and from 2016, according to economists at The Conference Board. However, lack of wage growth international trade issues are creating headwinds. Modest inflation and relatively poor productivity growth are two key factors keeping wages from rising faster. And domestic economic growth and interest rate increases have strengthened the US dollar relative to other currencies, putting downward pressure on exports. We’ll keep you informed as these conditions continue to unfold.