In some respects the U.S. economy is getting better with age. After shooting up by 4.2% in Q2, the highest in almost four years, we anticipate an above-average GDP growth for the balance of this year and forecast it will expand by 3.0% in 2019. Business capital spending has gained momentum. It surged at a 10% annual rate during the first half of 2018, the strongest back-to-back quarters in six years. This is notable because it was stagnant in 2015 and 2016. Consumer spending holds the key to future expansion, as it represents roughly 70% of total domestic economic activity. We believe consumer spending has the capacity to remain buoyant. Strong job growth, ultralow unemployment, higher wages, and tax cuts are the primary reasons spending should stay elevated, with relatively tame inflation playing a supporting role. Additionally, wealth gains generated from the equity market and higher home prices should undergird the mid- to higher-income household segments.

Corporate profits - the other major component of equity market performance over the long term—should remain in growth mode as well, albeit at a slower but healthy pace. Profit data from the GDP report, compiled from IRS tax filings, jumped 7.7% y/y for non-financial firms in Q2, the fastest pace in almost four years. This data tends to be a good signal of overall economic momentum, as well as prospects for equities and other risky assets, because profits reported to tax authorities usually dip when economic momentum begins to slow. Trends can change quickly, but the Q2 data confirms what our other indicators are saying: the expansion and bull market have further to go. S&P 500 earnings data, which differs because it represents the largest companies rather than all companies and is governed by distinct accounting rules, is signaling a meaningful slowdown in profit growth in 2019. Should this be a concern? If lower earnings growth rates were mainly driven by economic or outside factors, it would be an unwelcome development. However, in this case, much of the phenomenon is just math. The S&P 500 earnings growth rate likely peaked in Q1 or Q2, depending on the calculation methodology (there are subtle differences between even the best data providers). Growth surged 26.6% y/y in Q1 followed by 24.8% in Q2. The consensus forecast dips slightly for Q3 and Q4, but remains above 20%. It’s important to bear in mind that roughly 8% of the growth rate in 2018 represents the tax cut boost. In 2019, the tax cut boost will drop out of the data because growth is calculated on a year-over year basis. Of course, companies will continue to benefit from lower tax rates. Furthermore, earnings growth will be tougher to come by next year following such a strong 2018. (The year-over-year calculation methods play a role again—the data is always competing against the same period in the previous year.) We believe S&P 500 earnings will rise in the high single-digit to low double-digit range in 2019—an average or above average rate—depending on the strength of the economy. A meaningful deceleration in growth, yes, but to a respectable level. It’s actually normal for earnings growth rates to ebb and flow significantly throughout an expansion cycle.

Stay invested - With the economy getting better with age and corporate earnings aging gracefully, we think U.S. equities deserve the benefit of the doubt. Respectable earnings growth combined with above-trend economic momentum should support higher U.S. stock prices over the next year, at least. We remain constructive on U.S. equities and would hold a slightly Overweight position in equities overall.

Tim