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Strong jobs report lifts Dow, S&P 500 to record highs

The extravagance of any corporate office is directly proportional to management’s reluctance to reward the shareholders. – Peter Lynch

After posting declines for the first three days last week, the stock market reversed course and ended the week with modest gains. In doing so, both the Dow Jones Industrial Average and the S&P 500 Index closed at record highs while the Nasdaq Composite Index finished the week with a slight loss. The month of December has historically been a strong one for stocks and it looks like that trend may continue. On a positive note, a government shutdown was averted as Congress extended the budget deadline until December 22nd, at which time another short-term fix will probably occur. Senate Republicans also passed a bill to reform the tax system and there is a chance that the House and Senate will be able to present a joint bill to President Trump by Christmas. Although there was little in the way of economic data last week, data that pertained to the labor market was all positive. ADP reported that private payrolls grew by 190,000 in November, which was better than expected as manufacturing jobs led the way and posted their biggest increase of the year. Weekly jobless claims followed suit with favorable numbers as claims fell by 2,000 to 236,000, a sign that layoffs remain very low. Finally, the November employment report released by the government showed that a better-than-expected 228,000 new jobs were created and that the unemployment rate remained at 4.1%, a 17-year low. The only disappointment in the report was wage growth, which increased only 2.5% on an annualized basis and was less than forecast. Without stronger wage growth, though, inflation will likely remain subdued and could mean that the Federal Reserve will be less aggressive in hiking interest rates in 2018. It is a foregone conclusion that the Fed will raise the federal funds rate next week, but beyond that the timetable is uncertain. A Goldilocks economy that is neither too hot nor too cold could produce modest to moderate growth with only mild inflation. Such a scenario would also benefit equities and fixed income investments.

Last Week

U.S. factory orders dropped slightly in October but were better than expected as demand for civilian and defense aircraft declined. Orders for core capital goods that are used to calculate business equipment spending were strong in October as many businesses were anticipating corporate tax cuts and strengthening global demand. Consumer credit also accelerated in October by $20.5 billion, the largest amount in 11 months, as there was a post-hurricane surge in automobile sales. The University of Michigan consumer sentiment index, which measures consumers’ attitudes on future economic prospects such as finances, inflation, interest rates and unemployment, fell slightly in December but still remained elevated.

CVS Health agreed to buy Aetna, one of the largest health insurers in the U.S., for $69 billion in a deal that could transform the drug industry.

For the week, the Dow Jones Industrial Average added 0.4% to close at 24,329 while the S&P 500 Index also gained 0.4% to close at 2,651. The Nasdaq Composite Index slipped 0.1% to close at 6,840.

This Week

Investors will get a good read on inflation as the producer price index (PPI), the consumer price index (CPI) and import prices for November will all be released this week. The PPI is expected to be in line with the previous month’s reading while the CPI is expected to increase at a higher rate. The biggest increase will occur in import prices but overall inflation should still remain under control. Retail sales for November are expected to register a healthy increase as consumers remain optimistic about the economy. November industrial production is forecast to show a modest increase after increasing nearly 1% in October.

It will be a slow week for quarterly earnings reports with the most prominent companies on the calendar being Verifone Systems, Adobe Systems, Oracle and Costco Wholesale.

Portfolio Strategy

One of the great mysteries about the economy this year has been the absence of meaningful wage growth. After another strong jobs report in November that saw 228,000 new jobs created, average hourly earnings only rose by 0.2% for an annualized gain of 2.5%. With a low unemployment rate that currently stands at 4.1%, most economists at the beginning of the year believed that wages would be noticeably higher by now, but that has not been the case. Instead, wage growth has been modest despite the lowest level of unemployment in 17 years, strong monthly job gains and GDP growth in excess of 3%. As economists look ahead to 2018, they once again are forecasting that employee paychecks will begin growing appreciably again. It is widely thought that tax reform and a reduction in the corporate tax rate will bring businesses back to the U.S. and the competition for labor will increase wage growth. But this explanation overlooks the challenge that many employers have in finding qualified workers to fill positions that are open. Technology is transforming the way that companies do business and until workers have the necessary skills and training to perform these jobs, there is a possibility that wage stagnation will continue.