Stocks post gains after favorable December jobs report

By developing your discipline and courage, you can refuse to let other people’s mood swings govern your financial destiny. In the end, how your investments behave is much less important than how you behave. – Benjamin Graham

Thanks to a strong rebound in stock prices on Friday after the release of a favorable December jobs report, the major stock averages ended another volatile week with gains across the board. The technology-heavy Nasdaq Composite Index rose about 1% while the Dow Jones Industrial Average and the S&P 500 Index each added nearly 1.5% in the holiday-shortened week. While there was plenty of jobs-related data to digest, the most important piece was the December employment report, which showed that 223,000 jobs were created and that the unemployment rate fell to 3.5% from 3.7%. The jobs number was slightly above estimates, but wage growth was below expectations as average hourly earnings were up 4.6% from a year ago. This slowing wage growth was encouraging as it strengthened the case for a soft landing in the economy. This good news also helped offset hawkish comments by Fed officials in the minutes of the Federal Reserve’s most recent monetary policy meeting in December. It showed that Fed officials are committed to fighting inflation and expect higher interest rates to remain in place until more progress is made. At that meeting, the Fed raised the federal funds rate by half of one percent to a range of between 4.25% and 4.5%, its highest level in 15 years. Rates are expected to remain high even after the Fed stops raising them as no Fed officials expect any rate cuts in 2023.  Members also acknowledged the two monetary policy risks that face them: one, that the Fed doesn’t keep rates high long enough and allows inflation to linger; and two, that the Fed keeps rates too high for too long, tipping the economy into a recession. But they were all in agreement that the tight monetary policies should be maintained until inflation was clearly on a sustainable path toward its 2% target. If job growth in the economy can continue without fueling excessive wage growth, then a recession will not be necessary to whip inflation and the Fed may be in a position to begin easing again. Such a scenario could be bullish for stocks, especially since the stock market tends to rebound after down years.

Last Week

Other jobs data was not as favorable from an inflation standpoint as the December employment report as ADP reported that private payrolls surged by 235,000, well above estimates, and weekly jobless claims were 204,000, below expectations and the lowest level since September. Both reports were a concern as strong jobs data could push the Federal Reserve to keep raising interest rates. The November Job Openings and Labor Turnover Survey (JOLTs) was slightly better than expected but still showed that the number of job openings was still nearly twice the number of available workers. The ISM manufacturing index for December came in as expected but at the lowest level since May 2020 while the ISM services sector index fell slightly below 50, the threshold for expansion, and well below estimates.

For the week, the Dow Jones Industrial Average climbed 1.5% to close at 33,630 while the S&P 500 Index also increased 1.5% to close at 3,895. The Nasdaq Composite Index rose 1% to close at 10,569.

This Week

The consumer price index (CPI) for December is expected to increase 6.5% year-over-year, less than in November and much less than in June when the index peaked at over 9%. The University of Michigan consumer sentiment index for January is forecast to be slightly higher than the previous reading.

Fourth quarter earnings season begins this week and the most notable companies scheduled to report are the four largest U.S. banks, namely JP Morgan Chase, Bank of America, Citigroup and Wells Fargo. Other companies on the agenda include Bank of New York Mellon, BlackRock, Acuity Brands, KB Home, Delta Air Lines and UnitedHealth Group.

Portfolio Strategy

The stock market’s positive reaction to the December employment report on Friday could be a sign that the Federal Reserve may be successful in pulling off a soft landing in the economy. Although the unemployment rate actually fell and the total nonfarm payrolls were slightly higher than expected, the number of new jobs created was much less than the 256,000 number in November. The most important takeaway from the report, though, was that wage growth was a full percentage point lower than when it peaked in the spring. This trend shows that the economy is slowly cooling off and the job growth in future months should continue to decline. The Fed is probably hoping that monthly job growth is below 100,000. The bond market also reacted positively to the jobs report as the yield on the 10-year Treasury fell to 3.57% and the 2-year Treasury yield dropped to 4.26%. (Bond prices and yields are inversely related). The release of the December consumer price index (CPI) this week will give the Fed more inflation data while the Fed’s preferred inflation gauge, the personal consumption expenditures (PCE) index, is also down significantly from its peak in February, though it is still well above the Fed’s target of 2%.  As a result of the Fed’s tightening and the highest inflation in forty years, most economists are predicting that the U.S. economy will fall into a recession sometime this year. But after two consecutive quarters of negative GDP to start the year, the economy has been resilient and is forecast to show surprisingly strong growth in the fourth quarter. The Fed is likely to raise interest rates by another half of one percent when it convenes on February 1^st, but it’s much closer to the end of this tightening cycle than the beginning, which could bode well for the market if the inflation data cooperates.