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Quarterly Market Review

July 2018

Quarterly Market Review

T. Rowe Price

U.S. Stock Market

Technology Shares and Small-Caps Outperform as Market Records Modest Overall Gains

Stocks recorded decent gains in the second quarter, although the performance of the major benchmarks varied considerably. The technology-focused Nasdaq Composite Index outpaced the large-cap benchmarks and reached new highs, helped by the continued strong performance of many “mega-cap” technology firms. The smaller-cap indexes also outperformed and set new records late in the quarter. The narrowly focused Dow Jones Industrial Average lagged as escalating trade tensions weighed especially on several of its export-focused components. Growth shares continued to outpace their value counterparts, except in the small-cap space. Volatility, as measured by the Cboe Volatility Index, subsided a bit from the multiyear peaks reached early in the previous quarter, but the market continued to see larger price swings relative to 2017’s remarkably steady climb upward. Within the S&P 500 Index, energy shares performed best as oil prices climbed to four-year highs, while industrials and business services, financials, and consumer staples shares endured losses.

Total Returns
  2Q 2018 Year-to-Date

Dow Jones Industrial Average

 1.26%

 -0.73%

S&P 500 Index

 3.43

 2.65

Nasdaq Composite Index

  6.33

  8.79

S&P MidCap 400 Index

 4.29

 3.49

Russell 2000 Index

 7.75

 7.66

Past performance cannot guarantee future results.
Note: Returns are for the periods ended June 30, 2018. The returns include dividends based on data supplied by third-party provider RIMES and compiled by T. Rowe Price, except for the Nasdaq Composite, whose return is principal only. Russell Investment Group is the source and owner of the trademarks, service marks, and copyrights related to Russell indexes. Russell® is a registered trademark of Russell Investment Group.

Tax Cuts and Global Growth Spur Best Profit Gains in Nearly a Decade

Generally, the second quarter seemed characterized by a tug of war between positive corporate fundamentals and a negative political backdrop. April and May brought evidence that corporate earnings had accelerated even more than expected following the December 2017 tax cut and further stimulus provided by federal spending increases in March. According to data and analytics firm FactSet, earnings for the S&P 500 as a whole rose by 24.6% in the first quarter relative to a year earlier, marking the best increase since Tprofits rebounded following the Great Recession nearly a decade ago. Steep cuts in the corporate tax rate deserved part of the credit, but top-line revenue growth also surprised on the upside. Indeed, more than three-quarters of firms reported higher-than-expected increases in both earnings and revenues.

Economic signals were less impressive overall but still encouraging. The quarter started on a down note, with the S&P 500 recording its biggest daily drop of the period on April 6, after March payroll gains came in substantially below expectations. T. Rowe Price Chief U.S. Economist Alan Levenson noted that the solid employment growth trend appeared intact, however—an outlook that later proved justified as payroll gains rebounded in April and May and brought the unemployment rate down to 3.8% in May, its lowest level in 18 years. Gauges of manufacturing and service sector activity remained elevated, if down a bit from multiyear peaks reached early in the year. Housing data were a bit more mixed. Home prices and existing home sales continued to increase at a healthy clip, but home construction lagged as builders appeared to focus on the higher end of the market.

Fed Likely to Remain Patient

Throughout the quarter, investors kept a close eye on whether the tightening labor market—with the unemployment rate already well below a level indicating full employment, according to most measures—would prompt the Federal Reserve to pick up its pace of interest rate increases. After keeping rates steady in May, the Fed raised rates by another quarter point at its June meeting, as was widely expected. Investors seemed to have modestly negative reactions to the Fed’s accompanying statement, however, which indicated that a majority of policymakers now expected four interest rate increases in 2018, versus three—suggesting two more hikes were likely to come in the second half of the year.

Little evidence suggested the Fed’s hand might be forced. Headline inflation increased in the quarter, reaching its highest level since early 2012 on a year-over-year basis, but core inflation (which excludes food and energy costs) remained near the Fed’s 2% target. More importantly, perhaps, modest wage gains seemed to indicate that the kind of wage-price spiral that led the Fed to hike dramatically in the past remained highly unlikely. Indeed, after briefly touching a seven-year high in mid-May, the yield on the benchmark 10-year Treasury note—a measure of longer-term inflation expectations—ended only modestly higher than where it had started the quarter.

Trade Worries Appear to Keep a Lid on Gains

Trade tensions clearly deserved much of the blame for stock prices being unable to follow profits higher. Market indexes recorded sharp intraday declines on several occasions in the quarter following the announcement of new tariff threats from the Trump administration, as well as vows of reprisals from U.S. trading partners. The growing trade conflict between the world’s two largest economies—the U.S. and China—garnered the most attention. Over the quarter, the Trump administration announced a steady escalation in possible tariffs on Chinese goods, eventually reaching $200 billion on a range of goods by late June. In late May, the U.S. also extended the metals tariffs to Canada, Mexico, and the European Union (EU), while the Department of Commerce announced that it was considering raising tariffs on auto imports on national security grounds.

Whether the mounting threats were merely negotiating tactics on all sides remained unclear, but markets appeared to waver late the in the quarter as evidence emerged that the prospect of tariffs was already impacting corporate strategy and profit outlooks. Stocks slumped in particular on June 21, after German automaker Daimler lowered its profit outlook due to prospective higher tariffs on SUVs it manufactures in the U.S. and sells in China. A few days later, Harley-Davidson revealed in an SEC filing that it was planning to move some of its motorcycle production overseas to avoid retaliatory tariffs recently announced by the EU. Shares of Boeing, Caterpillar, and other U.S. industrial firms also fell sharply late in the quarter as concerns grew about their export markets. Signs of slowing growth in Europe and China, even in advance of an all-out trade war, also weighed on sentiment toward exporters.

Earnings Continuing to Rise Faster Than Stock Prices Would Make Valuations More Compelling

T. Rowe Price Group Chief Investment Officer Rob Sharps observes that earnings growth will likely slow from its rapid first-quarter pace over the rest of the year, but only moderately. Nevertheless, he cautions that investors should expect lower returns relative to the last couple of years. On balance, U.S. large-cap valuations, as measured by the S&P 500 Index, still appear moderately expensive—off recent peaks but still far from compelling. A relatively painless path to more attractive broad valuations, he observes, would be if earnings continued to rise at a faster pace than equity prices over the balance of 2018 and into 2019.


Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of July 2018 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

This information is not intended to reflect a current or past recommendation, investment advice of any kind, or a solicitation of an offer to buy or sell any securities or investment services. The opinions and commentary provided do not take into account the investment objectives or financial situation of any particular investor or class of investor. Investors will need to consider their own circumstances before making an investment decision.

Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy.

Past performance cannot guarantee future results. All investments are subject to market risk, including the possible loss of principal. Stock prices can fall because of weakness in the broad market, a particular industry, or specific holdings. Fixed-income securities are subject to credit risk, liquidity risk, call risk, and interest-rate risk. As interest rates rise, bond prices generally fall. International investments can be riskier than U.S. investments due to the adverse effects of currency exchange rates, differences in market structure and liquidity, as well as specific country, regional, and economic developments. These risks are generally greater for investments in emerging markets. All charts and tables are shown for illustrative purposes only.

T. Rowe Price Investment Services, Inc., Distributor.

USA—Issued in the USA by T. Rowe Price Associates, Inc., 100 East Pratt Street, Baltimore, MD, 21202, which is regulated by the U.S. Securities and Exchange Commission. For Institutional Investors only.

T. ROWE PRICE, INVEST WITH CONFIDENCE, and the bighorn sheep design are, collectively and/or apart, trademarks of T. Rowe Price Group, Inc. © 2018 T. Rowe Price. All rights reserved.

201807-535822

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T. Rowe Price ("TRP") claims compliance with the Global Investment Performance Standards (GIPS®). TRP has been independently verified for the twenty one- year period ended June 30, 2017 by KPMG LLP. The verification report is available upon request. Verification assesses whether (1) the firm has complied with all the composite construction requirements of the GIPS standards on a firm-wide basis and (2) the firm's policies and procedures are designed to calculate and present performance in compliance with the GIPS standards. Verification does not ensure the accuracy of any specific composite presentation.

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