The grim irony of investing is that we investors as a group not only don’t get what we pay for, we get precisely what we don’t pay for. – John Bogle
The Dow Jones Industrial Average came within one point of reaching the 20,000 milestone on Friday before falling back and ending the day at 19,963 to post a gain of 1% for the week. While the Dow fell just short of posting a record high close, the S&P 500 Index and the Nasdaq Composite Index both established record highs and were up higher on a percentage basis for the week. For the most part, economic data released last week was better-than-expected, including the employment report for December. Although 156,000 new jobs were created, fewer than the 180,000 that were forecast, the two prior months’ job numbers were revised higher and more than made up for the difference. The unemployment rate ticked up from 4.6% to 4.7% but average hourly wages registered a 2.9% annualized gain, the biggest increase since 2009. This increase was welcome news for workers and puts the inflation rate closer to the Federal Reserve’s target of 2%. Minutes from the most recent Federal Open Market Committee (FOMC) meeting also showed that Fed officials acknowledged the risks to their economic forecast of increased fiscal spending and higher growth under the new administration. According to the Federal Reserve, this increase in government spending could raise demand “above sustainable levels” and result in higher inflation, though the Fed reiterated that any additional interest rate hikes this year would probably be gradual. With the employment report out of the way, the next big hurdle for the stock market will be quarterly earnings. Whether or not the Dow will finally be able to reach and close above the 20,000 mark could be answered this week as the fourth quarter earnings season begins.
In addition to a solid jobs report in December, the weekly jobless claims fell 28,000 to 235,000 and were near a 43-year low. November construction spending was stronger than expected and reached its highest level since April 2006 and the ISM manufacturing index also beat expectations and has topped the 50 threshold for 9 out of the last 10 months. Any reading above 50 denotes expansion. The ISM non-manufacturing or services sector index also was above estimates and solidly in expansion territory. U.S. automobile sales for December came in much higher than expected, too, as Fiat Chrysler, Ford and General Motors all reported better-than-expected auto sales. The only disappointing economic report last week was November factory orders, which fell more than expected, but whose trend suggests that manufacturing is firming.
Macy’s and Kohl’s both reported disappointing holiday sales and cut their earnings outlook for the year. Macy’s also plans to cut more than 10,000 jobs and close about 63 stores. Sears Holdings also announced that it will close 150 more stores after posting weak holiday sales.
For the week, the Dow Jones Industrial Average rose 1% to close at 19,963 while the S&P 500 Index gained 1.7% to close at 2,276. The Nasdaq Composite Index jumped 2.6% to close at 5,521.
Retail sales for December are expected to be strong due to a surge in automobile sales and higher gasoline prices. December import prices should increase modestly while the producer price index (PPI) for December is expected to increase slightly in line with the previous month. Both numbers should indicate that inflation remains under control. The preliminary Michigan sentiment index for January should again be at a high level as consumers remain confident about the economy.
Among the companies kicking off the start of the fourth quarter earnings season are JP Morgan Chase, Bank of America, Wells Fargo, PNC Financial Services, Blackrock, Supervalu and Delta Air Lines.
At first glance, the lower number of jobs created in the December employment report suggests that the economy may be slowing. However, factoring in upward revisions for the prior two months and considering the big increase in annualized wage growth, it becomes clear that inflation appears to be bumping up against the Federal Reserve’s target inflation rate of 2%. The Fed hiked the federal funds rate in December and forecast an additional three rate hikes this year, up from its previous forecast of two increases. This change in the outlook coupled with stronger than anticipated economic data has propelled interest rates higher and bond prices lower as the yield on the 10-year Treasury reached 2.62% in mid-December. Since that time, the yield on the 10-year Treasury has fallen back to 2.42%. Just as the stock market is probably overbought based on the rosy scenario for President-elect Donald Trump’s pro-growth policies, the bond market is oversold for the same reason. There is a good possibility that any economic stimulus derived from these policies will be less than expected and could take longer than expected to implement and have an appreciable effect on the economy. A stronger dollar and possible restrictions on trade and immigration policies could also serve to keep interest rates from moving much higher. With all of the uncertainty over the new administrations’ policies and their potential effect on the economy, the yield on the 10-year Treasury could remain below 3% for the year. Until there is more clarity on this pro-growth agenda, investors would be wise to shorten the duration of their fixed income investments.