June 11, 2018

The summer months are almost underway, which means that both vacations and midyear check-ins are ahead. As we approach the midpoint of 2018, many of us will take this opportunity to reflect on what we’ve seen so far and what may be ahead for the rest of the year. But we’re not quite there yet! So as we kick off the month of June, here are some valuable takeaways coming out of recent action in Italy and a quick check-in on the U.S. economy.

The impact of Italy’s shift in government has been a hot topic during the past couple of weeks. Three months after Italy’s election, political uncertainty led to heightened concern that Italy’s populist coalition may try to pull out of the European Union and Eurozone (countries that use the euro as their currency). The potential for Italy to operate outside of the Eurozone prompted investors to reassess the risk of Italy’s government debt, leading to large sell-off in Italian government bonds and triggering stocks to fall globally.

In hindsight, markets may have overreacted to Italian political risk. These moves partially reversed after markets digested the news and backed off the worst-case-scenario mindset. Italy isn’t expected to leave the Eurozone, although political unrest may continue, which could weigh on Europe’s outlook. One positive takeaway from the market’s initial reaction, however, is the role that high-quality bonds played. Investors reacted to the sell-off by flocking to U.S. Treasuries, reaffirming that high-quality bonds can be an important element of a well-balanced portfolio, particularly amid stock market volatility.

In U.S. economic news, the big headline was the May jobs report, which was generally positive. The report indicated that job growth may be accelerating, wage growth is increasing, and the unemployment rate is near a 50-year low. Wage growth is not at a level that would alarm the Federal Reserve (Fed), but likely keeps the Fed on track to increase interest rates at its next meeting this month (June 12–13), which is widely anticipated by the markets. This healthy labor market may continue to provide support for the economy and consumer spending.

Looking at these underlying factors of today’s economic and market environment suggests opportunity for further growth, despite this historically weaker season. Here are a few highlights to note:

• Impressive earnings season. With most companies having reported first quarter results, earnings for the quarter are tracking to a double-digit increase (more than 20%) compared to the first quarter of last year. Guidance for future earnings has also been positive.
• Solid economic growth. The initial estimate for gross domestic product for the first quarter was a slowdown from the prior three quarters, but it still exceeded expectations. The slowdown seems to be a result of temporary factors, and leading indicators suggest continued growth for the U.S. economy.
• Reasonable stock valuations. Although stock valuations are slightly above average right now, when considering the positive earnings outlook, low inflation, and low interest rates, stocks don’t appear to be as expensive as some would suggest.

Overall, the global economic backdrop, particularly in the U.S., appears to remain intact. Although the situation in Italy is an ongoing risk worth monitoring, we do not believe it indicates a change in the trajectory of the global economy.

Rest assured that as the days become longer and summer unfolds, I will continue to keep a close eye on developments in Italy and around the globe, watching for any potential investment impacts.

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