We have seen volatility return to the equity markets this year after an unusually calm 2017. The synchronized global growth environment that prevailed for the last two years has started to show some cracks, with many global markets seeing growth moderate.
The United States is bucking the trend when it comes to growth.
U.S. gross domestic product (GDP) growth has accelerated in 2018, hitting 4.1 percent in the second quarter. This is the fastest rate in nearly four years. This rate of growth is impressive, but the combination of tax cuts and increased federal spending may have pulled some of this growth forward into 2018, meaning it may be hard to replicate in the future.
Two Main Pillars Of The US Economy Appear Solid
Even with policy changes that may have accelerated growth, when we look deeper at the foundation of the U.S. economy—the consumer and corporate earnings—we see a healthy backdrop. These two pillars have both been performing well and are not showing signs of stress that we would consider indicative of the economic cycle nearing a negative inflection point or recession.
The U.S. consumer continues to benefit from a very strong employment market, continued low inflation and low interest rates by historical standards. This is keeping consumer confidence (and consumer spending) healthy despite moderating global growth and increasing trade concerns.
On the corporate side, earnings for companies in the S&P 500 Index were up more than 20 percent (year-over-year) in the second quarter of 2018 (Source: FactSet Earnings Insight, as of August 10, 2018. See www.franklintempletondatasources.com for additional data provider information.). While lower corporate tax rates provided a lift, the resulting higher profits will likely drive increased capital spending. In our view, this should add life to the aging economic expansion as profits are reinvested and the capital expenditure cycle drives improved productivity. For many companies, we think these benefits could last well into 2019 or 2020.
Bull Markets Don’t Die Of Old Age Alone
There’s been a lot of discussion about the duration of this current U.S. equity bull market. While we don’t expect markets to keep climbing forever without corrections, history has shown us that bull markets don’t generally die of old age alone. Historical triggers that typically have heralded the end of a bull market have included rapidly rising inflation or interest rates, the buildup of speculative excesses or bubbles, or a geopolitical shock that impacts demand. Above all, economic recessions usually mark the death-knell for bull markets.
The current U.S. economic expansion has certainly been long by historical standards, but investors should remember it has also been very shallow and slow compared to past periods of economic expansion. This slower rate of growth is a result of the severity of the global financial crisis a decade ago, but also the low-inflation, low-interest-rate environment that followed. Given the modest rate of growth in the nine years post-crisis, it is not surprising to us that the recovery has lasted longer than many expected and has not generated levels of excess that typically begin to appear this late in the cycle. At this time, we don’t see any of the classic signs the economic cycle is turning, or that a recession is on the horizon.