Investors endured a flurry of trade headlines and emerging market turmoil in the third quarter, but that didn’t slow down U.S. stocks. The S&P 500 Index rose 7.2% during what has historically been the most volatile quarter of the year (7.7% including dividends), its biggest quarterly gain since the fourth quarter of 2013, its best performance in a third quarter since 2010, and the 11th gain in the past 12 quarters. It is also notable that the S&P 500 did not close up or down 1% on any day during the quarter, only the second time in history that feat has been accomplished during the usually volatile third quarter (1963 was the other time). Here we recap the third quarter and highlight some key factors for markets in the fourth quarter.
STOCK MARKET RECAP
The stock market’s third quarter performance was impressive given the tariffs and trade tensions, but those weren’t the only challenges. Fiscal stresses in Turkey sparked fears of contagion in emerging markets (EM), which entered a bear market in August. The Federal Reserve (Fed) raised interest rates for the eighth time this cycle last week and is on track to hike again in December. Long-term interest rates rose during the quarter, but the yield curve stayed flat in what some believe may be a sign of near-term economic weakness. The upcoming midterm elections introduce policy risk. Add to all that the fact that the third quarter has historically been the worst quarter for the stock market. Stocks sailed right through all of these headwinds, extending the longest bull market ever.
The strong performance of the U.S. economy was clearly a primary driver of the market’s strength:
- Gross domestic product (GDP) grew at a very strong—though likely not sustainable—4.2% annualized pace in the second quarter (reported in late July). With continued support from fiscal stimulus, expectations are for solid 3% growth in the current (third) quarter, based on Bloomberg consensus forecasts.
- Manufacturing activity remains robust, with the Institute for Supply Management’s Purchasing Manager’s Index reaching a 14-year high in August.
- Business confidence is strong. Small business confidence in August reached its highest level since 1973, according to the National Federation of Independent Business. The Business Roundtable and Chief Executive magazine surveys of U.S. CEO confidence are both elevated.
- Consumers remain upbeat, with the Conference Board’s consumer confidence measure at an 18-year high.
- Job growth remains steady and income growth is accelerating, though not by enough to spook the Fed.
In addition to the solid performance of the U.S. economy, corporate America delivered one of its strongest quarters of earnings growth in decades, supported by tax reform. More stellar earnings growth—likely over 20% based on Thomson Reuters’ consensus estimates—is expected in the third quarter. This would be the third consecutive quarter of earnings growth over 20%.
The overwhelming majority of recent data reflect a solid backdrop, but it’s not all good news. The housing and auto markets cooled; tariffs have started to curb some capital investment; and growth in Europe is slowing.
In terms of market cap, the globally focused large caps led during the quarter, which is encouraging given ongoing trade disputes with our largest trading partners. The U.S. dollar’s advance paused, which helped U.S. multinationals relative to smaller more U.S.-focused companies. Large cap stocks in the healthcare, industrials, and technology sectors performed particularly well.