S&P 500 rises over 2% on strong economic data

What we learn from history is that people don’t learn from history. – Warren Buffett

Despite increasing odds of a Federal Reserve interest rate hike over the next few months, stocks climbed more than 2% last week as economic data was better than expected. Investors have become more comfortable with the possibility of a rate hike as the economy seems to be gaining momentum in the second quarter. Although there was some trepidation by investors ahead of Fed Chair Janet Yellen’s comments on Friday, there really was nothing new in her remarks as she said that an interest rate increase may be appropriate in the coming months depending on the economic data. The emphasis on the term “data dependent” should have come as no surprise as this has been the Fed’s mantra since day one of this ongoing saga. What was surprising last week was the strong economic data and the fact that growth appears to be accelerating. The Atlanta Fed raised its estimate for second quarter growth to 2.9% from 2.5% and first quarter GDP growth was revised upward to 0.8% from 0.5%.  Housing data released last week was also strong and U.S. durable goods orders for April surged 3.4% as transportation equipment orders were particularly strong. Orders for March were also revised higher. Encouraging economic news was not confined to the U.S., either. European economic data improved and recent polls indicate that there is less support among British voters for the United Kingdom leaving the European Union. The never- ending trials and tribulations of Greece also took a turn for the better as Eurozone finance ministers and the International Monetary Fund (IMF) agreed to new loans for Greece and laid out plans designed to grant debt relief to Greece in the future. While stronger economic data almost assuredly means that the Fed will raise the federal funds rate sooner rather than later, it also means that growth is likely to increase, leading to better corporate profits and higher stock prices.

Last Week

New home sales in April rose to the highest level since January 2008, well above estimates, and pending home sales in April rose to their highest level in 10 years. The prospect of higher rents and mortgage rates is bringing more interested buyers into the market. Weekly jobless claims fell to 268,000, below estimates, signaling that labor markets remain healthy and that the economy is gaining momentum. Consumer sentiment in May was also strong but slightly less than expected.

In corporate news, German drug maker Bayer bid $122 a share for Monsanto, a 20% premium over its closing price, but Monsanto rejected the offer by saying it was too low. There were reports that Apple asked its suppliers to make more iPhone 7s than expected, fueling speculation that demand could outstrip supply later this year when they hit store shelves.

For the week, the Dow Jones Industrial Average rose 2.1% to close at 17,873 while the S&P 500 Index jumped 2.3% to close at 2,099. The Nasdaq Composite Index surged 3.4% to close at 4,933.

This Week

It promises to be a fairly heavy week for economic data but earnings reports will be limited. Both the May Chicago Purchasing Managers Index (PMI) and the May ISM Manufacturing PMI are expected to be slightly above 50, indicating continued expansion. April construction spending and factory orders should also show improvement over the previous month. The most important economic release will be the May employment report on Friday and expectations are for 160,000 new jobs to be created and for the unemployment rate to remain unchanged at 5.0%.

In overseas news, the European Central Bank (ECB) meets and is expected to leave interest rates unchanged while the Organization of Petroleum Exporting Countries (OPEC) also meets and is not expected to set an output target.

Medtronic is the most prominent company scheduled to report earnings this week while lesser known companies such as Broadcom, Joy Global, Ciena and Piedmont Natural Gas are also due to report.

Portfolio Strategy

Last week’s stronger than expected housing data and durable goods orders and the upward revision in first quarter GDP proved that the economy is on more solid ground than was thought just a few weeks ago. While growth remains modest and is likely to remain in the 2% to 2.5% range for the year, economic activity does not appear to be as weak as some of the first quarter data indicated. Minutes from the April Federal Open Market Committee (FOMC) braced investors for a possible rate hike in June, but at the time the weak state of the economy did not seem to support an increase in the federal funds rate. Investors had become complacent with regard to an increase in interest rates and generally dismissed the likelihood of one until December. Based on the minutes and recent remarks from several Federal Reserve presidents, the Fed has reset expectations and the odds of a rate hike by July are now 50%. But the difference now is that perceptions have changed about the economy and recent data would seem to indicate that the economy is strong enough to handle a rate hike. Even if the Fed raises interest rates twice this year, global monetary policy remains very accommodative with the European Central Bank’s (ECB) bond buying program just getting started and the possibility of further easing by the Bank of Japan (BOJ) in coming months. Against this backdrop, there could still be life in this old bull market yet as valuations based on projected earnings are reasonable and investor sentiment on the stock market remains negative, generally a fairly reliable contrarian indicator for stocks.