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Quarterly Economic Update: Q2 2018

U.S. Economy Likely Posted Strong Growth in Q2, But Trade Concerns Loom

Based on recent economic data, economists and market participants are expecting robust growth for the second quarter for the U.S. economy. If so, that would be welcome news following the final reading of the first quarter’s gross domestic product (GDP) released in late June which represented another downward revision to 2.0% from 2.2% in the Commerce Department’s second reading released in late May. The initial reading of first quarter GDP was 2.3%.

While recent economic data has been mixed, the economy’s second-quarter performance is still forecast to be well-above that reported in the previous quarter. A positive surprise came in early July as continued expansion in new orders, production and employment pushed the Institute for Supply Management’s  (ISM) purchasing manager’s index (PMI) up by 1.5 percentage points to 60.2 – the second highest reading of the current economic expansion that began back in June 2009.

The strong reading comes even as manufacturers deal with an operating environment of rising trucker shortages, tight supply chains, higher input prices and uncertainty over how the brewing trade battle between the United States and its trading partners will play out. About $34 billion of tariffs on Chinese goods took effect on July 6, with China responding with its own, similar set of tariffs on U.S. goods.

“Demand remains robust, but the nation’s employment resources and supply chains continue to struggle. Respondents are overwhelmingly concerned about how tariff related activity is and will continue to affect their business,” Timothy R. Fiore, the chair of ISM’s manufacturing business survey committee, said in the report’s press release.

The trend of rising prices was evident with 31 commodities reported to be up in price and none reported to be lower. In addition, eight commodities, including electrical and electronic components and capacitors, were said to be in short supply. Respondents noted these shortages, and the above-mentioned tariff concerns were contributing to disruptions in production, as well as uncertainty in terms of strategic planning.

Indeed, the ISM supplier deliveries index rose by 6.2 percentage points to 68.2 – its highest reading since May 2004. While this indicates a sign of strong demand for orders in the pipeline waiting to be fulfilled, it is also partly the result of supply chain issues companies are facing. According to ISM, these include transportation delays, lead-time extensions for production materials, and ongoing uncertainty in the steel and aluminum markets.

The accelerating pace of factory and manufacturing activity from the ISM report follows reports in late June that showed that momentum in the manufacturing sector was slowing. The IHS Markit manufacturing PMI came in at 54.6 for June, down from 56.4 the previous month – signaling the slowest improvement in overall business conditions since November 2017.

Still, Chris Williamson, IHS Markit’s chief business economist, noted that the latest figures round off the best quarter for three years and suggest economic growth for the second quarter has lifted markedly higher than the rate of expansion in the first quarter to well over 3%. ISM’s Fiore said in the July 2 press release that the past relationship between the ISM PMI being at 60.2 and the overall economy corresponds to a 5.2% increase in real (inflation-adjusted) GDP on an annualized basis.

According to a survey of more than 60 economists taken in June by The Wall Street Journal, the consensus estimate for second-quarter GDP growth is projected to be 3.6%.

On the consumer front, personal consumption expenditures (PCE) increased by a seasonally adjusted 0.2% in May from the previous month, according to the Commerce Department. That reading represented a slower pace of consumer spending compared to March and April. Inflation rose with the PCE price index, the Federal Reserve’s preferred inflation target, rising 2.3% in May compared to the previous year.

The nation’s employers continue to add to their payrolls with 213,000 jobs added in June, according to the Bureau of Labor Statistics (BLS). The unemployment rate rose marginally to 4.0% from 3.8% the previous month. Average hourly earnings rose 2.7% year-over-year to $.

The U.S. economy added 213,000 jobs in June, while economists polled by Reuters expected a gain of 195,000. Unemployment, however, rose slightly to 4 percent from 3.8 percent. Wage growth also missed expectations, climbing 2.7 percent on a year-over-year basis. Economists expected growth of 2.8 percent.

Consumer sentiment dipped slightly with the Conference Board’s Consumer Confidence Index at 126.4 in June, compared to 128.8 in May and the Expectations Index falling to 103.2 from 107.2 in May. While expectations remain high by historical standards, “the modest curtailment in optimism suggests that consumers do not foresee the economy gaining much momentum in the months ahead,” Lynn Franco, the Conference Board’s director of economic indicators, said in the press release announcing the June results.

Tariffs are also on the mind of consumers, according to the University of Michigan’s surveys of consumers. Its Index of Consumer Sentiment at 98.2 has changed little during the past three months, due to favorable assessments of jobs and incomes. Yet the Index of Consumer Expectations fell to 86.3 in June, compared to 89.1 the previous month.

Chief economist Richard Curtin noted that a longstanding belief among consumers is that trade with other countries results in a broader range of goods at lower prices. And when asked in a recent survey about their views on international trade, two-thirds of respondents thought that more trade with other countries would be better for the domestic economy.

Consumers’ judgements about the impact of higher tariffs won’t “crystallize” until they gain more experience with actual changes in product prices and domestic employment, Curtin said. But while tariffs may have a direct impact on only a very small portion of overall GDP, “the negative impact could quickly generalize and produce a widespread decline in consumer confidence.”

Real Estate: Despite Slowing Price Appreciation, Housing Affordability Falls to Lowest Level Since ‘08

The ability of consumers to afford homes, meanwhile, continues to deteriorate in the nation’s housing market as mortgage rates are on the rise. And even as the pace of home price appreciation has showed some signs of slowing in recent months, wage growth hasn’t kept pace.

Despite these factors new homes sales were strong according to recent figures, but existing home sales have fallen for three-straight months and have fallen behind last year’s sales pace. The Census Bureau reported in late June that sales of new single-family homes rose in May at a seasonally-adjusted annual rate of 689,000. That was 6.7% higher than April’s revised rate and 14.1% above the May 2017 rate.

It was a different story for existing home sales. Total sales (including homes, townhouses and condos) fell 0.4% in May from the previous month to a seasonally-adjusted rate of 5.43 million. Sales are down 3.0% from the same period a year ago, according to the National Association of Realtors, which released its figures in late June. While total housing inventory increased 2.8% from the previous month, it is still 6.1% lower compared to a year ago and has fallen year-over-year for 36 consecutive months.

“Incredibly low supply continues to be the primary impediment to more sales, but there’s no question the combination of higher prices and mortgage rates are pinching the budgets of prospective buyers, and ultimately keeping some from reaching the market,” Lawrence Yun, the NAR’s chief economist said.

From an affordability perspective, home prices in the second quarter were at the least affordable level since the third quarter of 2008, according to the ATTOM Data Solutions U.S. Home Affordability Index. Nationwide, ATTOM Data’s second quarter home affordability index of 95 was down from 102 in the previous quarter and an index reading of 103 in the second quarter of 2017. The index stood at 86 in the third quarter of 2008.

ATTOM Data’s affordability report calculates its affordability index based on the percentage of income needed to buy a median-priced home relative to historic averages. An index above 100 indicates median home prices are more affordable than the historic average.

Through the first-half of this year 30-year fixed-rate mortgages have climbed to 4.52% as of July 5, up from 3.99% at the end of the year. While that increase is having an impact on homebuyers’ ability to afford the cost of a new or existing home, it is potentially also weighing on sentiment.



In a survey of 8,537 current homeowners by John Burns Real Estate Consulting, 24% of those surveyed said they definitely would not move if mortgage rates were 1.0% higher than their current mortgage. Another 36% responded they may not move, while 40% said they would still move. Based on those responses, a 13.3% decline in sales volume was calculated, meaning that sales should be roughly 13% lower than would otherwise be the case.

“Economic strength, consumer confidence, and mortgage underwriting standards are just a few of the many other variables that determine sales volumes. We just thought it would be good to understand the extent of the impact of rising rates,” co-authors John Burns and Steve Dutra said in the report.

According to figures from ATTOM Data, the median home price of $245,000 in the second quarter was up 4.7% compared to a year ago, down from 7.4% price appreciation in the first quarter. While price appreciation is slowing, home prices were still above the average weekly wage growth of 3.3%. Since bottoming out in the first quarter of 2012, median home prices nationwide have increased 75%, while average weekly wages have increased 13% during the same period, the Irvine, Calif.-based property data warehouse provider says.

Global Stocks: U.S. Markets Mostly Continue to Outperform Developing, Emerging Markets

U.S. stocks generally outpaced shares in overseas markets as investors and market participants began pricing in the risks from a full-blown trade war. While shares in China moved into bear market territory during the second quarter, other emerging markets also sold off with the trade jitters as well as signs that economic growth may be slowing. Commodity-dependent markets also posted losses.

The S&P Emerging BMI Index fell 4.32% for June and by 8.16% for the second quarter. Year-to-date through the second quarter, emerging markets as gauged by the Emerging BMI Index, are down by 5.63%, according to S&P Dow Jones Indices.

Shares in Europe, particularly Germany, also faced pressure during June over worries of an escalating trade war. The European Union is considering tariffs if the U.S. follows through with tariffs on European automakers.

The STOXX Europe 600 Index fell by 0.8% during the month, but gained 2.4% during the quarter. Still, the STOXX Europe 600 has fallen by 2.4% for the year through the second quarter. Germany’s DAX 30 index neared correction territory in June, with the benchmark German index down by 9.8% as of month-end from its high on January 23.

On the domestic front, the S&P 500 rose by 2.93%, while the Nasdaq Composite index gained 6.33% for the second quarter. The Dow Jones Industrial Average (DJIA) was marginally up by 0.70%, but has fallen by 1.81% year-to-date through June 29. For their part, both the S&P 500 and Nasdaq remained in positive territory for the first half of the year, even as all three benchmark indexes in the U.S. have experienced bouts of sharp volatility throughout the first and second quarters.

June was no different with trade tensions weighing heavily on the Dow. The DJIA ended the quarter with a three-week swoon that saw it lose about 4.15%. Tariff-related news during the month hit the stocks of some multinational companies, which receive a good portion of their revenues from overseas.

And as the DJIA comprises only 30 stocks, significant movement in the share price of some companies can drag down the overall performance of the index.



Taking a closer look at the broader market within the S&P 500, energy stocks were the best performing sector in the second quarter, as rising oil prices continue to be a sector headwind. Indeed, while the energy sector gained only 0.57% during June, it was still up by 12.69% in the second quarter as oil prices traded at a three-year high, according to S&P Dow Jones Indices.

Beaten-down consumer staples stocks – the sector has declined 9.93% year-to-date – were the best performers in June. The sector was up by 4.15% but was still in negative territory for the quarter, losing 2.34%. The consumer discretionary sector is the best performer this year among the S&P 500’s 11 sectors. It is up 10.81% year-to-date and posted a 7.84% gain during the second quarter, according to S&P Dow Jones Indices.

Emerging Markets: Trade Woes Hit Chinese Yuan, Pressures Shanghai Shares, Global Commodity Prices

The looming trade battle between the United States and China has been pressuring China’s stock markets while also rippling through global currency and commodity markets. As previously mentioned, the U.S. imposed about $34 billion of tariffs on Chinese goods on July 6, with China responding with additional tariffs on U.S. goods.

The Shanghai Composite Index ended the month of June down 8.0% and fell by 10.1% in the second quarter. Since the beginning of the year China’s benchmark index is down 17.3% through July 5, among the worst performing markets across the globe.

China’s currency, the yuan, has also weakened considerably against the dollar, even as policy makers from the country’s central bank have been saying that they won’t use the currency as a weapon against the U.S. in the trade standoff between the two countries. The yuan fell by nearly 3.3% in June. The yuan on July 3 reached its lowest level against the dollar in 11 months, according to this CNBC report.

China’s central bank attempts to keep the value of the yuan within a 2% band against the dollar from a daily mid-point or reference rate set by the central bank each day. With the yuan weakening considerably during June, the central bank has had to step in, yet it has signaled to markets and investors that a weaker currency “could be beneficial as the economy is slowing,” according to this Reuters report, citing sources familiar with the People’s Bank of China (PBoC).

The PBoC’s balancing act now includes the potential impact of the tariffs and pricing of Chinese exports, as well as concerns over capital flight from the mainland. A previous bout of yuan weakness in 2015 led the PBoC to have to use foreign currency reserves to defend the yuan as stocks and the currency were roiled by capital outflows.

In terms of the economy, overall manufacturing activity based on official purchasing manager indexes remain above 50.0 – or in expansion territory (readings below 50.0 indicate that manufacturing is generally contracting), though momentum is fading and activity among small- and mid-sized companies is showing signs of contraction.

China’s official manufacturing PMI decreased 0.4 percentage points to a reading of 51.5 for June. The PMI for small-sized enterprises rose 0.2 percentage points to 49.8, while the PMI for medium-sized enterprises fell 1.1 percentage points to 49.9. In addition, at 49.8, the June new export orders index fell into contraction territory for the first time since February. The nation’s services sector, though, continues to demonstrate momentum and steady activity. The National Bureau of Statistics reported that the non-manufacturing PMI for June increase 0.1 percentage point to 55.0.

Commodities: Long Bets Off on Most Metals and Agriculture, though Crude Still on the Rise

With the exception of crude oil, the prices of many commodities, including industrial and precious metals and grains have declined in recent weeks. The price of copper on COMEX, for example, which is also highly sensitive to the performance of the Chinese economy, has fallen by nearly 12.0% since June 8.

Trade tensions between the U.S. and China as well as with neighbors closer to home such as Mexico are also contributing to price declines for corn and soybeans. “Trade war concerns, a stronger dollar and signs of an economic slowdown among key EM [emerging market] countries, led by China, continued to take its toll on money managers’ appetite for commodities,” Ole Hansen, head of commodity strategy for Danish banking group Saxo Bank, said in a report released in late June.

During the week through June 26, investors were net sellers of 19 out of 24 major traded commodities. And following four weeks of continued selling, the combined net-long positions in these futures contracts were at their lowest point since January 2, according to the Saxo Bank research.

Crude oil prices, meanwhile, are expected to further fluctuate over the coming months as a number of factors come into play. These include whether or not global demand remains as strong as it has during the past year or so, the impact of supply disruptions from Venezuela and possibly Iran (as sanctions near in November), widening geopolitical tensions and how much OPEC (the Organization of the Petroleum Exporting Countries) and its key partners (including Russia) will ramp up demand.

OPEC, its members and non-OPEC partners agreed in June to end production curbs put in place in 2016 to offset a global supply glut that had been pressuring prices since late 2014. The agreement calls for roughly another one million barrels of crude per day to hit the markets, though less than that will likely be produced in the upcoming weeks and months since some OPEC members may not be able to raise output to meet the new levels right away.

“Rapidly rising prices in recent months have raised doubts about the strength of demand growth, and we have modestly downgraded our estimate for 2018, the International Energy Agency said in its June 2018 update of its Oil Market Report. “Prices are unlikely to increase as sharply as they did from mid-2017 onwards and thus the dampening effect on demand will be reduced.”

This year West Texas Intermediate crude futures have jumped by 22.7% through June 29, while Brent Crude futures are   up by 18.8%. Despite surging output from the U.S. shale boom, prices continue to hold steady above $70 a barrel, which, in turn, have pushed up gas prices.

At $2.86, gas prices were at their highest point for an Independence Day holiday in four years, though about 11 cents cheaper than this past Memorial Day holiday, according to AAA. Elevated crude oil prices and other geopolitical concerns could tilt gas prices more expensive in the early fall despite an expected increase in global crude production from OPEC and its partners, Jeanette Casselano, AAA spokesperson, said.

Indeed, as Saxo Bank notes in its quarterly outlook for the third quarter, Saudi Arabia and Russia “seem to have drawn a line in the sand” with $80 a barrel the level above which “demand destruction” could begin to emerge. “On that basis, we maintain the view that Brent crude oil will remain rangebound between $70/barrel and the low $80s over the coming months before downside price pressure starts to emerge ahead of year-end.”



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Sources for Financial Data:

Dow Jones Industrial Average:                                                                                                                                             

S&P 500:                                                                                                                                              


10-Year TIPS:                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                                        

STOXX Europe 600 Index:          

Shanghai Composite Index:

COMEX Copper:

West Texas Intermediate Crude:                                                                         

Brent Crude:                                                                                                                                                                                                                        

Oil Prices:                                                                                                                                                                                                                                                       

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