Stocks post gains despite mixed economic data, Fedspeak

Risk and time are opposite sides of the same coin, for if there were no tomorrow there would be no risk. Time transforms risk, and the nature of risk is shaped by the time horizon: the future is the playing field. – Peter L. Bernstein, was an American financial historian, economist and educator  

Despite mixed economic data and conflicting comments by Federal Reserve officials, the major stock averages managed to post modest gains last week. The Nasdaq Composite Index turned in the best performance with a gain of over 2% while the S&P 500 Index rose just over 1% and has been basically flat now over the past six months. The stock market began the week with heavy losses as protests erupted in China over government imposed Covid lockdowns and St. Louis Fed President James Bullard said that the Fed will likely raise the federal funds rate above 5% and that the rate could remain high through next year and into 2024. It appeared that the world’s second largest economy was on the verge of reopening, but the announcement of lockdowns and the demonstrations that followed increased the possibility of further supply chain disruptions. Later in the week, though, the stock market rebounded when Federal Reserve Chair Jerome Powell confirmed that smaller interest rate increases were likely to occur and could start as early as December. Although he cautioned that monetary policy would remain restrictive until progress was made om reducing inflation, he remained rather confident that a soft landing in the economy could still be achieved. Economic data released last week also provided mixed signals on inflation and the strength of the economy. On the one hand, the core personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, increased less than expected in October, giving hope to investors that inflation was finally ebbing. But the November employment report released on Friday showed that non-farm payrolls increased 263,000, much higher than the 200,000 that was expected, and that the unemployment rate remained unchanged at 3.7%. Average hourly earnings were also higher than forecast, adding to inflationary pressures. Even the second estimate of third quarter GDP showed a stronger economy as it increased at a 2.9% annual rate compared to 2.6% in the first estimate. Stronger economic data makes the Fed’s job of bringing down inflation that much more difficult and delays any possible pivot in terms of lower interest rates.

Last Week

Other jobs data last week was also mixed as ADP reported that 127,000 private sector jobs were added in November, well below estimates of 190,000, but weekly jobless claims were 225,000, below estimates of 235,000 and less than 240,000 in the prior week. The Job Openings and Labor Turnover Survey (JOLTs) showed that there were 10.33 million job openings in October, a decline of 353,000 from September, a sign that the Fed’s tightening policies are having an impact. Pending home sales in October fell for the 5^th straight month while the ISM manufacturing index in November registered a reading of 49, less than in October and the lowest reading since May 2020. A number below 50 indicates contraction. The November consumer confidence index edged lower as consumers continue to be gloomy about the short-term outlook for the economy.

For the week, the Dow Jones Industrial Average edged slightly higher by 0.2% to close at 34,429 while the S&P 500 Index rose 1.1% to close at 4,071. The Nasdaq Composite Index jumped 2.1% to close at 11,461.

This Week

The producer price index (PPI) for November is expected to increase about 7% year-over-year compared to an 8% increase in October as investors hold out hope that the Federal Reserve will slow the pace of interest rate hikes. The ISM non-manufacturing or services sector index for November is forecast to slow further but still be above 50, the threshold for expansion. October factory orders are expected to increase modestly and be slightly above orders last month.

The most notable companies scheduled to report third quarter earnings this week are Costco Wholesale, Campbell Soup, Casey’s General Stores, Vera Bradley, AutoZone, GameStop, Toll Brothers, Broadcom and DocuSign.

Portfolio Strategy

Although the Federal Reserve has raised the federal funds interest rate by 3.75 percentage points, the increases seem to have had little impact on the labor market as evidenced by the November employment report. Not only did the number of new jobs exceed estimates by a wide margin, but wages grew twice as much as expected with 12-month average hourly earnings rising over 5%, well above forecasts. While investors cheered Federal Reserve Chair Jerome Powell’s comments that rate hikes would likely be smaller in the future, they seemed to ignore his other remarks. He also said that interest rates would have to go higher than previously thought and that they would probably have to remain at those levels for an extended period to reduce high inflation. If this scenario were to happen, it would create another headwind for the stock market and be problematic for bonds as yields would likely move higher. (Bond prices and yields are inversely related and move in opposite directions). Nevertheless, in his speech, Powell remained hopeful that the Fed could engineer a soft landing for the economy that would involve no recession or just a shallow one. This would likely mean slower monthly job growth below 200,000 and a higher unemployment rate with wage growth considerably below current levels. The Federal Reserve’s next meeting concludes on December 14^th, one day after the release of the November consumer price index, data that will be key in determining the Fed’s forecast for the fed funds rate for next year. Jobs data is a lagging indicator and although the inflation data has recently been favorable, more data is needed to ensure that this is a lasting trend.