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Strong jobs report lifts stocks to record highs

As financial markets continue to broaden and deepen, the behavior of asset prices will play an important role in the formulation of monetary policy going forward, perhaps a more important role than in the past. – Timothy Geithner

A stronger than expected jobs report for June propelled the Dow Jones Industrial Average above 17,000 for the first time ever and catapulted the S&P 500 Index within reach of 2,000. The fireworks set off on the 4th of July could have served a dual purpose – that of celebrating the country’s birthday and the fact that both indexes are now perched at all-time highs. The government reported that the U.S. created 288,000 jobs in June, which easily beat estimates, and revised the previous two months higher by 29,000 jobs. The economy has now created at least 200,000 jobs for five straight months, the first time that this has happened since 1999. In addition, the unemployment rate fell to 6.1% from 6.3%, which is the lowest jobless rate since September 2008. Even the U6 rate, which takes into account people that have stopped looking for work and those who are underemployed, declined slightly during the month of June. It’s no wonder that stocks reacted positively to all of this good news as it confirms that the economy is gaining momentum and appears to be on solid footing as we enter the second half of the year. Whether or not stocks continue trending higher will likely depend on second quarter corporate earnings reports, which begin in earnest next week, as well as management’s guidance of full-year earnings. Although stocks appear to be fully valued, it’s difficult to bet against further gains as a lack of attractive alternative investments almost makes stocks desirable by default.

Last Week

While the unexpectedly strong employment report for June stole the spotlight last week, other economic news was decidedly mixed. Pending home sales for May rose to the highest level in eight months while the ADP private sector jobs report was also much better than expected. On the negative side, factory orders in May declined slightly on reduced defense orders from the Pentagon and the U.S. service sector grew more slowly in June.

In a speech to the International Monetary Fund, Federal Reserve Chair Janet Yellen calmed investors’ nerves by stating that Fed policy would not involve raising interest rates in order to reduce the risk of inflated asset prices caused by low interest rates. In other words, it’s not the Fed’s job to avert asset price bubbles before they start.

For the week, the Dow Jones Industrial Average jumped 1.3% to close at 17,068 while the S&P 500 Index gained 1.2% to close at 1,985. The Nasdaq Composite Index rose 2% to close at 4,485.

This Week

Economic data will definitely take a back seat to quarterly earnings reports this week as only May consumer credit and wholesale inventories are on tap. Neither report should have much effect on the markets. In other news, the Federal Reserve releases minutes from its June monetary policy meeting while several Fed officials will speak on monetary policy and the current economy.

Overseas, China is scheduled to report data on both producer and consumer prices for June and the Bank of Japan will issue a report on the state of its economy.

The second quarter earnings season begins unofficially this week with Alcoa’s report after the market closes on Tuesday. It actually gets off to a slow start as the only other familiar companies on the calendar include Bob Evans Farms, Family Dollar Stores, Gencorp and Wells Fargo.

Portfolio Strategy

Despite the Fed’s contention that interest rates will remain low for “a considerable time” and that they probably won’t be raised until mid-2015, the strong June employment report elicited questions again about the timing of any rate hike. Has the economy strengthened enough for the Fed to tighten and could the stock market continue to forge ahead in the face of higher interest rates? The reaction to the positive jobs data by the bond market was muted as the yield on the 10-year Treasury ended last week at about 2.65%. With steadily improving economic data during the quarter capped off by a blowout jobs number, one would have expected a larger sell-off in the bond market. A closer look at the employment report, though, revealed that wage growth was minimal and the labor participation rate remained stubbornly low. Without any appreciable increase in wage growth, inflation is likely to remain benign with no pressing need to raise rates. Since the Federal Reserve examines all aspects of the report, these weaknesses are likely to give the Fed pause with regard to any tightening. As far as the stock market is concerned, this should be good news, provided that corporate earnings reports confirm the economy’s recovery and strength in the second quarter.