Underlying that question is the seven month rally in the equity markets and the fear that it may be too good to last. In our view, the economic fundamentals support the markets continuing to move higher. We certainly don’t discount a few down days in a row, or even the possibility of a summer not-quite-swoon, but we believe that the fundamentals point to a good second half of the year. We believe this primarily because of the continuing uptrend in consumer sentiment, and its positive implications for the back half of the year.
Consumers are clearly feeling more optimistic following the 17% year-to-date gain in the stock market, the 10% rise in home prices, and the steady labor market gains. This is important because rising consumer sentiment points to increased spending on services. Services account for approximately 65% of personal consumption expenditures, and consumer sentiment readings actually correspond more closely with services spending than with durable goods spending.
Up until recently, the main drag on services spending has been housing, which has only averaged 0.6% annualized growth since the recession ended. However, the recovery in housing is gaining momentum, and we believe it has significant further upside potential as prices, sales, rents, and consumption of related goods and services continue to log gains. To be sure, income growth and confidence will be key to supporting economic activity until the various production indices regain the traction they lost a number of months back.