Despite weak jobs report, Dow and S&P 500 close at record highs

The message is clear: in the long run, stock returns depend almost entirely on the reality of the investment returns earned by our corporations. The perception of investors, reflected by the speculative returns, counts for little. It is economics that controls long-term equity returns; emotions, so dominant in the short-term, dissolve. – John Bogle

Bad economic news turned out to be good news for stocks on Friday as the Dow Jones Industrial Average and the S&P 500 Index both closed at record highs despite a huge miss in the number of jobs created in April. Economists had forecast an increase of about one million jobs in April but the employment report showed that only 266,000 jobs had been created, making it the biggest miss ever recorded. The unemployment rate also rose to 6.1% from 5.8% and, to make matters worse, the March jobs number was also revised lower to 770,000 from 916,000. There was a silver lining in the jobs report, though, as investors convinced themselves that the Federal Reserves’ easy monetary policies would remain in place for longer. These policies would include continued record low interest rates and massive bond-buying programs. Even the technology-heavy Nasdaq Composite Index rallied on the weak jobs data as higher interest rates tend to hit growth stocks harder since they reduce the value of future earnings. Although the yield on the 10-year Treasury plunged below 1.50% after the disappointing jobs report, it ended the day where it started at 1.60% as investors bet that one month’s data can be misleading and that there would be evidence of better economic data in the months ahead. With this mind, value stocks stand to benefit from a stronger economy as they have greater exposure to economically-sensitive sectors that are more leveraged to an economic recovery. First quarter corporate earnings results continue to be impressive as over 80% of S&P 500 companies that have reported have topped expectations and, in most cases, by a wide margin. In fact, investors have been frustrated by the fact that many stocks have not reacted positively to the upside in the face of strong earnings, a potentially worrisome sign that stock valuations are full.

Last Week

The ADP report on private payrolls in April was also disappointing as they rose by 742,000, below expectations of 800,000 new jobs. Weekly jobless claims, however, were 498,000, better than the estimate of 527,000 and the lowest level since the beginning of the pandemic. Both the Institute for Supply Management (ISM) manufacturing and services sector indices edged lower in April and were less than expected, although they remained above the 60 threshold, comfortably in expansion territory.

For the week, the Dow Jones Industrial Average jumped 2.7% to close at 34,777 while the S&P 500 Index rose 1.2% to close at 4,232. The Nasdaq Composite Index fell 1.5% to close at 13,752.

This Week

Retail sales for April are expected to increase slightly after posting a gain of nearly 10% in March. The core producer price index (PPI), which excludes volatile food and energy prices, is expected to increase modestly in April after a big jump in March while the core consumer price index (CPI) is expected to rise 2.3% year-over-year. The preliminary University of Michigan consumer sentiment index for May is expected to be higher than in April, which was at a one-year high.

Among the most prominent companies scheduled to report first quarter earnings this week are Marriott International, Airbnb, Walt Disney, Simon Property Group, Tyson Foods, International Flavors & Fragrances, Hanesbrands, Toyota Motor, Honda Motor, Occidental Petroleum, Duke Energy and Chesapeake Energy.

Portfolio Strategy

The positive reaction by the stock market to the weak jobs report last week was due mainly to the belief that that investors view the data as an anomaly and a one-off report. The fact that the disappointing job numbers will enable the Federal Reserve to maintain its easy monetary policies for a longer period of time will be tested this week with the inflation data. The Fed has long insisted that any spike in inflation will be transitory and not a reason to raise interest rates. If the headline inflation numbers for both the producer price index and the consumer price index that will be released this week are higher than expected, the market could begin to worry that inflation might be problematic and cause the Fed to tighten sooner than expected. Evidence of higher inflation has already showed up in the commodities market as the prices of copper, lumber, corn and oil have all risen significantly. After plunging below 1.50% on Friday after release of the weak jobs report, the yield on the 10-year Treasury rose to 1.60% to end the day about where it started. Investors shrugged off the lackluster jobs data because they believe that with an accommodative Federal Reserve, the prospect of additional fiscal stimulus and a faster growing economy with the rollout of vaccines, the economic recovery will continue to strengthen. The only downside with this scenario is the possibility of higher inflation and higher interest rates, which is another reason to favor economically-sensitive value stocks over technology and higher-priced growth stocks.