Stocks post modest gains on jobs report, improved economic data

Speculation is an effort, probably unsuccessful, to turn a little money into a lot. Investment is an effort, which should be successful, to prevent a lot of money from becoming a little. – Fred Schwed Jr., professional trader and author of the book Where Are the Customers’ Yachts?

The major stock averages closed modestly higher last week in relatively quiet trading due to the Independence Day holiday. Minutes from the most recent Federal Reserve meeting showed that Fed officials were becoming increasingly concerned about the risks associated with its easy monetary policy and its potential effects on the financial markets. Despite low inflation, the Fed seems determined to normalize monetary policy by raising interest rates and reducing the $4.5 trillion in securities on its balance sheet. The Fed is confident that inflation will increase and could start to unwind its balance sheet as early as September. The European Central Bank (ECB) also expressed optimism in the economic recovery in the euro zone and suggested that any additional monetary stimulus may not be needed. Fed officials may be right in their assessment as economic data last week was mostly positive. The employment report for June was much better than expected as 220,000 new jobs were created, compared to estimates of 180,000. This was the largest increase in four months and both April and May job numbers were also revised higher. Although the unemployment rate edged higher to 4.4% from 4.3%, the reason for the increase was that more people looked for worked. But wage growth was modest and hourly wages have only risen 2.5% in the past 12 months, providing more evidence of low inflation. In a labor market that many economists consider to be tight, wages should be increasing more, leading to higher inflation. Other encouraging economic data last week were the Institute for Supply Management (ISM) manufacturing and non-manufacturing or services sector indexes, both of which were stronger than expected and well above the 50 threshold, a sign of continued expansion. Next week economic data will take a back seat to second quarter corporate earnings reports, which will have to be strong for stocks to move higher.

Last Week

Other jobs-related data last week was not as favorable. The ADP private payrolls in June rose by 158,000, below the forecast of 180,000, and weekly jobless claims also rose by 4,000 to 248,000, the third straight weekly increase. Factory orders in May fell but the decline was only slightly more than expected. U.S. automobile sales in June also suffered a steep drop compared to the same month in 2016 due mostly to higher prices.

In overseas news, President Trump met with Russian President Vladimir Putin at the G-20 summit and they reached an agreement for a cease-fire in Syria and North Korea launched an intercontinental ballistic missile that could potentially reach Alaska.

For the week, the Dow Jones Industrial Average rose 0.3% to close at 21,414 and the S&P 500 Index edged up 0.1% to close at 2,425. The Nasdaq Composite Index increased 0.2% to close at 6,135.

This Week

Both the June producer price index (PPI) and consumer price index (CPI) are expected to be basically flat, another indication that inflation remains under control. Retail sales and industrial production for June should post modest increases and improve upon last months’ results.

Fed Chair Janet Yellen will give her semi-annual testimony on monetary policy and an economic outlook before the House Financial Services Committee.

Pepsico and Delta Airlines are two of the most prominent companies scheduled to report second quarter earnings next week, but the big day will be on Friday when JP Morgan Chase, Wells Fargo, Citigroup and PNC Financial Services issue their profit reports.

Portfolio Strategy

Second quarter earnings season gets under way next week and profits are expected to grow by 6% but could see growth of more than 9%. This follows a strong first quarter in corporate profits that saw S&P 500 earnings grow by 10%. Strong earnings coupled with still accommodative monetary policies and low interest rates produced excellent returns for stocks. The S&P 500 Index of large cap stocks was up 3.1% in the last quarter and 9.3% for the first six months, helped mostly by the strong performance of technology stocks, which was the best-performing sector. The huge gains posted by the so-called FAAMG stocks – Facebook, Apple, Amazon.com, Microsoft and Google (parent company is Alphabet) – were also why large cap growth funds outperformed value funds, which typically invest in stocks with below market price earnings ratios and above-average dividend yields. Small and mid-cap stocks lagged large cap stocks and growth outperformed value in this asset class as well. By far the best performing asset class for the quarter and the year has been developed market international funds and emerging market funds, both of which posted returns between 15% and 20%. Stronger growth prospects and more attractive valuations should enable these international funds to continue to outperform. In the alternative space, real estate investment trusts or REITs posted low single digit returns in the first half while commodities, particularly oil, were weak and posted negative returns, with energy funds down about 20%. Intermediate-term bond funds were generally up about 2% or 3% during the first half, but could be under pressure in the second half if interest rates begin to rise appreciably. Implementation of Trump’s pro-growth policy agenda and continued strong profit growth could lead to further gains in stocks in the second half of the year, but investors should be mindful of the market’s stretched valuation and any possible missteps by the Federal Reserve.