Better than expected economic data lifts stocks

How many millionaires do you know who have become wealthy by investing in savings accounts? I rest my case. – Robert G. Allen

Just when almost everyone was convinced that there would be no Fed tapering until the spring of 2014, better than expected third quarter GDP growth and a strong jobs report have caused investors to reevaluate their forecast. Despite a partial government shutdown and a showdown over the debt ceiling that damaged business and consumer confidence, the job market showed remarkable resilience in October. As a result, many analysts now believe that a reduction in the monthly bond buying program may begin as early as December, especially if next month’s jobs report is also strong. In a volatile week that saw stocks plummet over 1% on Thursday only to recoup all of their losses on Friday, investors seem comfortable with the idea that the economy may well be strong enough to withstand any reduction in Fed stimulus. A faster-growing, more vibrant U.S. economy, coupled with improving economic data from China and Europe, are reasons to be optimistic about stocks. For the most part, corporate earnings have been solid even though the economy has been sluggish. With improved data on industrial production and factory orders in recent weeks, stocks should benefit as the economy continues to expand. However, what may be good news for stocks is bad news for bonds as the 10-year Treasury yield rose to 2.75%. Provided yields on government bonds and other safe fixed income investments don’t rise too much, stocks will continue to look less expensive by comparison.

Last Week 

The most important piece of economic data last week was the employment report as the economy added 204,000 jobs and the unemployment rate ticked up to 7.3% from 7.2%. The strength of the jobs report caught most economists by surprise as only about 120,000 positions were expected to be created. Gross domestic product (GDP) for the third quarter increased by 2.8%, which also beat expectations, but was helped by a large buildup in business inventories that could prove to be temporary.

The strength of the market for initial public offerings was demonstrated last week by the debut of Twitter as it was the second biggest IPO ever for an Internet company. Priced at $26 a share, shares of Twitter opened trading at $45 and will raise as much as $2 billion.

Overseas, the European commission lowered its forecast for economic growth in the Eurozone and raised its estimate for unemployment. In response to this worsening economic data, the European Central Bank (ECB) lowered interest rates in the hope of jumpstarting the economy. 

For the week, the Dow Jones Industrial Average climbed 0.9%, the S&P 500 Index increased 0.5% while the Nasdaq Composite Index bucked the trend and slipped 0.1%.

This Week

Compared to last week, the economic calendar this week is light. Industrial production for October should confirm that the manufacturing sector continues to expand while the trade balance for September should improve slightly due to a drop in net oil imports. An index that measures small business optimism will probably show a significant decline as a result of the government shutdown.

On the corporate earnings calendar, retailers are in the spotlight this week as the earnings season winds down. Among those reporting include Dicks Sporting Goods, Macys, Wal-Mart Stores, Kohl’s, Nordstrom and Williams Sonoma.

Portfolio Strategy

Although the economic data last week would have an investor believe that the economy is on solid footing, one cannot read too much into one set of numbers. On the surface, the jobs report was encouraging but a closer look revealed that many of the jobs were low-paying, part-time positions and people were still leaving the work force. Quarterly GDP reports are also subject to revisions in future months and the apparent strength of this third quarter report may prove to be illusive. Fixed income investments could also be vulnerable this week as the government plans to sell $70 billion in new Treasury notes and bonds. The supply could weigh on demand, causing further upward pressure on yields. The mixed economic signals also make it difficult for an investor to assess the future direction of stock prices in a year that has seen the S&P 500 Index rise 25%. Any new investments in bonds should have maturities in the short-to-intermediate term range as a way to protect principal in the event that interest rates gradually rise. In such an environment, bonds that mature would be reinvested at higher rates that would produce more income. For those investors underweighted in equities relative to their desired allocation, buying on any market weakness or pullbacks over an extended period of time makes the most sense. With so much uncertainty in the financial markets, investors should review their current portfolio allocation and be comfortable with their mix of stocks, bonds and cash as determined by their investment goals, time horizon and risk tolerance.