Stocks rally to begin March despite mixed economic data

The only investors that don’t need to diversify are those that are right 100% of the time. – Sir John Templeton 

After falling nearly 3% the previous week on hotter than expected inflation data, the stock market recovered some of those losses last week despite mixed reports on the current state of the economy. The S&P 500 Index rallied nearly 2% even as bond yields continued to edge higher with the 10-year Treasury yield eclipsing 4% before finally ending the week at 3.96%. The stock markets’ outsized gains in January proved to be unsustainable as the major stock averages all posted losses in February. Stubbornly high inflation has caused bond yields to climb higher, creating a significant headwind for stocks as investors are facing the prospect of interest rates being higher for longer. Last week, though, investors breathed a sigh of relief when Atlanta Federal Reserve President Raphael Bostic said that he’s firmly in favor of sticking with a 25-basis point (a basis point is one hundredth of one percent) hike in March, contrary to some who have been advocating a 50-basis point increase. Stocks rallied on his remarks and were also helped by stronger than expected manufacturing data out of China as the index expanded for the second straight month and at the fastest pace since 2012. Investors received more good news on Friday when the ISM services sector index was above estimates and higher than in January, showing that the non-manufacturing part of the economy remains strong and continues to expand. The services sector of the economy accounts for more than two-thirds of all economic activity. Investors also cheered the move lower in the 10-year Treasury yield after it broke an important psychological barrier of 4% on Thursday. The stock market is very sensitive to bond yields as the 10-year Treasury yield is a benchmark rate that influences mortgages and automobile loans. The move higher has caused mortgage rates to rise over 7% as inflation fears have driven bond yields higher. With quarterly earnings season winding down, the focus going forward will be on economic data and the Fed’s reaction to that data, which will likely have implications for the stock market.

Last Week

Durable goods orders in January were worse than expected but excluding a sharp decline in transportation orders, new orders actually increased slightly. The ISM manufacturing index in January was slightly below estimates and below the 50 threshold, indicative of contraction as production and new orders slowed. The consumer confidence index in February fell from January and was below expectations as worries grew over the longer-term outlook for the economy. Weekly jobless claims fell to 190,000, down 2,000 from the previous week and below the estimate of 195,000.

For the week, the Dow Jones Industrial Average rose 1.8% to close at 33,390 while the S&P 500 Index climbed 1.9% to close at 4,045. The Nasdaq Composite Index surged 2.6% to close at 11,689.

This Week

The February employment report is expected to show that about 200,000 new jobs were created and that the unemployment rate remains at 3.4%. ADP releases its National Employment report for February and it is forecast to show an increase of about 180,000 private-sector jobs. January factory orders are expected to decline by about the same amount that they rose in December.

The Bank of Japan (BOJ) announces its monetary policy decision and is expected to keep its short-term interest rate unchanged at negative 0.1%.

Among the most prominent companies scheduled to report quarterly earnings this week are Ciena, Brown-Forman, Casey’s General Stores, Campbell Soup, Ulta Beauty, Gap, Dick’s Sporting Goods, CrowdStrike Holdings and Oracle.

Portfolio Strategy

Although this week will be a relatively light one in terms of potential market-moving economic data, investors will be paying close attention to the February employment report on Friday. The markets were spooked by the jobs report for January that showed a gain of 517,000 jobs, more than 300,000 higher than the consensus estimate. The expectation for February is for an increase of about 200,000 new jobs. While this total is certainly good news for the economy, any number significantly above this amount could be problematic for the markets. An economy that is too strong brings into play the possibility of a 50-basis point interest rate hike by the Federal Reserve this month and could result in even higher bond yields. The yield on the 2-year Treasury note, which is the most sensitive to expectations about Fed policy, has risen to 4.90% from only 4.1% at the beginning of February. The 10-year Treasury yield jumped from 3.40% on February 1^st and rose as high as 4.06% before settling at 3.96% last week. The Fed’s terminal or peak federal funds rate is currently at 5.10% but that could easily be raised higher if the employment report is too strong. Federal Reserve Chair Jerome Powell is scheduled to testify before Congress this week and all eyes will be on his assessment of the economy and monetary policy. The resilient labor market has caused investors to rethink the possibility of a recession and has been replaced with the thought that the Fed could hike interest rates higher than previously expected and keep them higher for longer. Such a scenario could have implications for the stock market as higher bond yields could affect the market’s risk sentiment.