Stocks fall on weak economic data, recession fears

Every once in a while, the market does something so stupid it takes your breath away. – Jim Cramer

The January employment report released on Friday could be viewed both positively and negatively but investors chose the latter, sending the S&P 500 Index lower by almost 2%. The government reported that 151,000 new jobs had been created, which was less than expected and considerably less than the revised December jobs number of 262,000. The weaker than forecast jobs report renewed fears that the U.S. economy is slowing and could be slipping into a recession. However, viewing the glass as half full rather than half empty, the economy has gained an average of 231,000 new jobs over the past three months and the unemployment rate dipped to 4.9% in January, the lowest reading since 2008. Other encouraging signs in the report included a slightly higher labor participation rate, an increase in the average work week and rising wages as average wages have now risen 2.5% over the past year. The question now becomes whether or not the Federal Reserve will perceive the employment data as being strong enough to implement additional interest rate hikes. While the headline jobs number was disappointing, the other underlying data was favorable. Uncertainty is the bane of stock investors and once again they must play a guessing game on what the Fed’s next move will be. The fourth quarter earnings season has also not helped clarify the situation. Even though expectations were low heading into earnings season, the results have mostly been positive. With more than 300 companies in the S&P 500 having reported earnings so far, more than 70% of them have beaten analyst estimates. In fact, it’s very possible that when it is all said and done, earnings growth for the quarter may be flat compared to the 5% decline that was originally forecast. But revenue growth has been challenging and corporations are cautious on their outlook for the year. With so much uncertainty about economic growth prospects and Federal Reserve monetary policy, it is likely that the stock market will remain volatile until these issues are resolved.

Last Week

The Institute for Supply Management (ISM) manufacturing index for January posted a reading slightly below 50, in line with expectations but a sign of continued contraction. If there is a bright side, it is that manufacturing accounts for only about 12% of the U.S. economy. The January ISM non-manufacturing index slipped to 53.5 from 55.8 in December, indicative of continued expansion but worrisome given the magnitude of the decline. Factory orders for December also fell as expected and posted the largest drop since December 2014.

The price of oil resumed its downward descent last week as rumors that OPEC and Russia would reach an agreement to reduce output faded. Exxon Mobil, Royal Dutch Shell and ConocoPhillips all reported big quarterly profit declines last week and ConocoPhillips slashed its dividend by almost 70%.

For the week, the Dow Jones Industrial Average dropped 1.6% to close at 16,204 while the S&P 500 Index lost 3.1% to close at 1,880. The Nasdaq Composite Index fell 5.4% to close at 4,363.

This Week

Federal Reserve Chair Janet Yellen appears before the House Financial Services Committee on Wednesday and the Senate Banking Committee on Thursday and will discuss her views on the economy and monetary policy. Investors will obviously be listening to her perception of the state of the economy and the timetable of any interest rate hikes.

Retail sales for January are expected to show only a modest increase and the February Michigan sentiment index should show that consumers remain confident about the economy.

Although last week was the busiest week of the fourth quarter earnings season, this week’s calendar is still full. Consumer companies such as Walt Disney, Coca Cola, Pepsico, Kellogg, Whole Foods Market and CVS Health will dominate the schedule. Other companies expected to deliver their profit reports include Applied Materials, Cisco Systems, Ingersoll Rand, CBS and American International Group.

Portfolio Strategy

With the yield on the 10-year Treasury falling to just 1.85% last week and it looking less likely that the Federal Reserve will raise interest rates at its March meeting, it is becoming increasingly difficult for investors to find investments with an attractive yield that don’t involve a lot of risk. It may be tempting for investors to dabble in master limited partnerships (MLPS) or select energy sector stocks, but one must be careful for potential landmines, too. ConocoPhillips proved that last week as it cut its dividend from 74 cents a share to 25 cents a share. There are a number of stocks that yield 3% or more and the safest way to invest in these is through an exchange-traded fund (ETF) that has a low expense ratio. High quality municipal bonds are also attractive as demand remains strong and credit issues have receded. While municipal bond yields have declined recently, they still make a lot of sense for those investors who are in a fairly high tax bracket. Real estate investment trusts or REITs also provide above-average yields and should benefit from solid operating fundamentals and strong cash flow. The Vanguard REIT ETF is a diversified fund that invests in a broad range of real estate sectors, has a low expense ratio and yields about 4%.  Investment grade corporate bonds are also a good alternative to Treasuries as their yields are substantially higher for bonds with comparable maturities. Yields on intermediate-term corporate bonds rated BBB by Standard & Poor’s and Baa by Moody’s are 3% or higher depending on the specific issue and exact maturity date. In a year when returns may be difficult to generate, these investments should provide steady income and limit any downside risk to a portfolio.