Economic Update

After a rocky month in July, stocks resumed their march higher in August. The S&P 500 was up 4.0% for the month and is up 9.9% year-to-date. The small cap Russell 2000 index also performed well for the month, up 5.0%. Year-to-date, small cap stocks have lagged and are up only 1.75% as of the end of August. International stocks continued to struggle in August and year-to-date with performance of -0.4% and +2.93% respectively.

The Bureau of Economic Analysis revised second quarter GDP growth up to 4.2% from the previous estimate of 4.0% in August. The reasons for the increase were many and confirm strong economic activity for the quarter. The rest of the year, GDP is expected to grow around 3%. Looking forward, the Federal Reserve expects economic growth in 2015 and 2016 to also come in around 3%. Longer term growth, though, is estimated at 2.2%.

The favorable economic outlook is supported by recently released economic reports. Over the past few weeks we have received good news about industrial production, housing starts, orders for durable goods, and the ISM Manufacturing Index. All of which point to continued economic expansion.

After six months in a row of 200,000+ increases in jobs, the jobs report in August disappointed with only 142,000 new jobs created. This was particularly disappointing considering analyst’s expectations of 220,000 new jobs based on favorable economic data. The unemployment rate did decline to 6.1% from 6.3%. Market response was muted as commentators predicted this would not ultimately be a reversal in the more favorable trend and that a healthy pace of job growth would resume in the months ahead.

As the last few companies in the S&P 500 report earnings for the quarter, the results continue to look very favorable. The blended earnings growth rate for the quarter so far is 7.7%. Of the companies that have reported 74% beat estimates. Revenue growth was also strong with a blended growth rate of 4.4% beating the prior estimate of 2.8%.

Strong earnings have kept P/E ratios from expanding over the past couple of months even as stock prices have moved higher. Considering the favorable outlook for economic growth and the low interest rate environment, stock valuations at current levels appear reasonable. The new Fed Chairperson, Janet Yellen also continues to make it clear that she has no intention of moving too early or too fast in removing stimulative policies.

The markets continue to shrug off the many geopolitical conflicts that continue to flare-up all over the world. Markets tend to view these events through a lens of economic impact. In other words they ask, “How large is the potential economic impact of this conflict”? If the perceived impact is small, the market reaction is small. Some of these conflicts have the potential to escalate rapidly and should be monitored closely.

We look for market volatility to provide buying opportunities and not something to fear. Diversification should continue to help reduce risk and smooth out long-term returns.

© Cambridge Advisors

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