Insights Q3 2018: U.S. Economy Climbing a Wall of Worry

Q3 2018: U.S. Economy Climbing a Wall of Worry

The U.S. stock market climbs a wall of worry better than any other market in the world, and its ability in doing so has been on display this year. Granted it has lost its grip at times, yet the S&P 500 is up 3.9% nearly half way through a year that has been filled with worrisome events and conditions. Fortunately, the bright shining light this year has been strong earnings growth, which has acted as a great stabilizer when the market has been thrown off balance by a litany of issues ranging from interest rates to trade to geopolitics.


That the market has been resilient in the face of turmoil is a sign of a well-functioning market, because the stock market should be swayed by earnings more than anything else—and, so far, nothing else has upended the positive earnings growth outlook for 2018.

  • Interest rates, while up, are still relatively low
  • Wage growth has remained lackluster despite the lowest unemployment rate in nearly 50 years
  • The dollar has rebounded, yet its current strength still falls short of the strength seen in the first half of 2017
  • Effective corporate tax rates are down—way down; and
  • Share buyback activity remains strong

Notwithstanding these strong fundamentals, the market has been buffeted at times by a festering concern that the balance of bull market power is about to shift on a fulcrum of rising interest rates, protectionist trade policies, and/or a volatility event that forces an unwinding of concentrated positions in ETFs and leadership stocks like the FAANG contingent (Facebook,, Apple, Netflix, and Alphabet).


Some have taken to describing the stock market’s action this year as “two steps forward, one step back.” That’s an apt description, because this market has been operating with an aim to squeeze as much out of this bull run as possible while remaining aware that the best of its easy-money days is behind it.

That thought is rooted in an awareness that the Federal Reserve is reining in its policy accommodation, that profit margin pressures are beginning to take hold in higher input costs and a tightening labor market, and that President Trump is ratcheting up his efforts to cut the U.S. trade deficit using tariffs that are being matched by major trading partners around the globe, including Canada, Mexico, China, and the European Union.

What the stock market has had on its side are tax cuts and deregulation, which have spurred the best earnings growth in seven years, near-record levels of business and consumer confidence, robust manufacturing activity, and a strengthening U.S. consumer whose spending activity accounts for close to 70% of GDP.

To be fair, consumer spending activity was weak in the first quarter, yet all signs point to a significant rebound in the second quarter that is driving the possibility of GDP growth having a 4-handle on it.


The U.S. is in good economic shape, yet the issue for the market with the economy is the same as the issue is for the market with earnings: there is a foreboding thought that both are at, or very close to, peak growth for this cycle.

Accordingly, investors have been less willing to pay up for every dollar of earnings as interest rates have picked up even though forecasts for earnings growth this year are quite strong; hence, there has been multiple compression even though earnings growth estimates have increased.

To wit, the S&P 500 entered 2018 trading at 18.3x forward twelve-month earnings and now trades at 16.6x forward twelve-month earnings, which is a slight premium to its five-year average.

FactSet informs us that earnings growth for the S&P 500 is projected to be 19.0% for the second quarter, 21.4% for the third quarter, 17.2% for the fourth quarter, and 19.8% for the year.

The stock market, however, is a forward-looking entity, and it is beginning to ruminate about the tough comparisons that await in 2019 when interest rates should be higher, according to the Federal Reserve’s latest projections, and the initial impact of the tax cuts fade away making earnings growth comparisons difficult.

The market also has trade issues on its mind, as they are potential spoilers for the U.S. economy and the high earnings growth expectations. Nevertheless, the positive slant of the S&P 500 at this juncture suggests it is trading more on what it knows than what it fears, which is to say it is climbing a wall of worry.


The market knows earnings growth is still strong; it knows interest rates are still relatively low; it knows the elements are in place for a pickup in consumer spending and business spending; and it hopes the trade spats aren’t going to lead to a full-fledged trade war.

The market knows the easy money has been made in this bull run, yet nothing has truly tripped it up yet, so it continues to climb a wall of worry constructed on concerns about peak economic growth, peak earnings growth, and a peak in monetary policy accommodation.

It’s sneaking a peak into a more challenging future, fundamentally speaking, so the market isn’t moving as resolutely today as it did not that long ago when it could feel assured the Federal Reserve wasn’t going to run interference by raising interest rates.

Those days are gone, and rate hikes are back because the financial crisis is over, and the economy is in good shape.  That’s not a bad thing, but it means the road ahead for the stock market won’t be a smooth one as a higher interest rate environment takes shape.

As always, I look forward to hearing your comments.

Warm regards,

John P. Swift, CFA, CPA
CEO & Chief Investment Officer