Stocks surge on strong February jobs data

It’s not always easy to do what’s not popular, but that’s where you make your money. Buy stocks that look bad to less careful investors and hang on until their real value is recognized. – John Neff, American investor and former manager of Vanguard’s Windsor Fund

The stock market celebrated the ninth anniversary of the current bull market on Friday with huge gains as the Dow Jones Industrial Average rose about 440 points or 1.77%. Not to be outdone, the technology-laden Nasdaq Composite Index was also strong as it hit an all-time high. Since the S&P 500 Index closed at its bear market low of 676.53 on March 9^th, 2009, this benchmark has more than quadrupled. This bull market is now the second longest one in history at 109 months. Only the bull market from October 1990 to March 2000 was longer at 114 months. What caused the surge in stock prices on Friday was a near-perfect February employment report as a better-than-expected 313,000 new jobs were created and the unemployment rate remain unchanged at 4.1%. The December and January nonfarm payroll numbers were also revised higher so the 3-month average job gains were 242,000. Unlike the prior month that saw a higher than expected increase in wages, wage growth was modest as average hourly earnings were up only 2.6% on an annualized basis, below expectations. The jobs data provided a Goldilocks scenario for both the Federal Reserve and the stock market. For the Fed, it was not too hot as to warrant more interest rate hikes nor too cold that the Fed should be concerned by softness in wage growth. For the stock market, it was not so strong that inflation might cause interest rates to rise faster. In other words, the strong jobs report indicated moderate economic growth with only modest inflation pressures, the best of both worlds. Although the stock market cheered the employment report, stocks had been lower earlier in the week on news that White House chief economic advisor Gary Cohn had resigned, raising concerns that a trade war might ensue. Cohn believed in free trade and was opposed to any tariffs, which President Trump signed into law anyway last week by imposing a 25% tariff on steel and 10% on aluminum. Canada and Mexico were given an exemption pending a renegotiation of NAFTA and the administration stressed that it would be flexible in either removing or modifying tariffs for each country. But by week’s end, the blowout jobs number enabled investors to forget about Cohn’s departure and the negative effects of tariffs, at least for now.

Last Week

U.S. factory orders in January recorded their biggest decline in 6 months and were slightly worse than expected. However, tax cuts, a weaker U.S. dollar and a stronger global economy are expected to support manufacturing going forward. The February ISM non-manufacturing index dipped slightly but was better than expected and near 60, indicating strong expansion. The final Michigan consumer sentiment index in February was high and slightly better than estimates as consumers remain very confident about the economy.

The Federal Reserve Beige Book stated that the economy was expanding at a “modest to moderate” pace during the first two months of the year and that businesses were reporting widespread labor tightness across the country with faster wage gains in many regions. The European Central Bank (ECB) left interest rates unchanged.

For the week, the Dow Jones Industrial Average jumped 3.3% to close at 25,335 while the S&P 500 Index climbed 3.5% to close at 2,786. The Nasdaq Composite Index surged 4.2% to close at 7,560.

This Week

Investors will be able to get a much better read on inflation this week as the producer price index (PPI), consumer price index (CPI) and import prices for February will all be released. Forecasts call for only modest increases in each of these following worrisome increases last month. February retail sales are expected to bounce back with a healthy increase after declining in January.

It will be a relatively quiet week for earnings as Dick’s Sporting Goods, Williams-Sonoma, Tiffany, Dollar General, Adobe Systems and Broadcom are the most notable companies scheduled to report.

Portfolio Strategy

One of the worst performing sectors of the market this year has been real estate investment trusts or REITs. These are companies that purchase office buildings, hotels, apartment buildings, storage facilities, shopping centers and other real property. The Vanguard REIT ETF (VNQ) has fallen 8.9% this year after posting a total return of 5.0% in 2017. The biggest reason for the weakness in REITs has been rising interest rates as the yield on the 10-year Treasury has risen to 2.89% from 2.41% at the start of the year. Other interest-rate sensitive investments such as bonds and high dividend paying stocks have also been weak but REITs have suffered the worst damage. Usually if interest rates are rising because of a stronger economy, then REITs generally fare rather well. Strong job growth as evidenced by the February employment report should translate into rent and occupancy increases and allow earnings to exceed interest expense. Most REITs do an excellent job of hedging their portfolios against rising interest rates. The recent decline in the prices of REITs has caused their yields to increase and they now are very attractive relative to other investments. The current yield of the Vanguard REIT ETF is about 4.8%. REITs also have a relatively low correlation with the broad stock market, which is another reason to own this asset class as it offers increased diversification and lowers overall portfolio risk. That means that when the stock market rises, REITs tend to underperform and vice versa.