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Strong jobs report overshadows trade war fears to lift stocks

The man who begins to speculate in stocks with the intention of making a fortune usually goes broke, whereas the man who trades with a view of getting good interest on his money sometimes gets rich. – Charles Henry Dow, American journalist who co-founded Dow Jones

Stocks continued to be whipsawed by geopolitical news last week but a strong employment report on Friday stabilized the market and the S&P 500 Index closed modestly higher. The Dow Jones Industrial Average, however, posted a slight loss while the technology-laden Nasdaq Composite Index surged higher with a gain of 1.6%. Investors came back from the long Memorial Day weekend in a selling mood as fears spread that a new general election in Italy could threaten the euro. The euro fell to its lowest point against the dollar since 2017 and Italian government bond yields spiked. On Wednesday, though, investors had a change of heart and decided that even though Italy has a lot of debt, default risk is low and the odds of Italy leaving the European Union are remote. Yields on Italian government bonds fell as credit fears eased and stocks regained all that they had lost the previous day. But geopolitical uncertainty reared its ugly head again the next day as the U.S. announced tariffs on steel and aluminum imports from Europe, Canada and Mexico that would take effect immediately. The announcement came at a time when the U.S. is trying to renegotiate the North American Free Trade Agreement (NAFTA) and only served to escalate trade war fears. But the unexpectedly strong May employment report released on Friday put all of the geopolitical concerns on the back burner and stocks soared. The unemployment rate fell to 3.8%, the lowest level in 18 years, and 223,000 new jobs were created, compared to estimates of 190,000. Wage growth was in line with expectations and rose at only a modest annual rate, calming investors’ fears that inflation might be headed significantly higher. Other economic data reported last week was also mostly positive, proving once again that more often than not, it’s the economy and earnings that drive the direction of stock prices.

Last Week

In addition to the strong employment report, consumer confidence in May was at the highest level since 2001 and consumer spending in April recorded its biggest gain in five months. The April personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation, also rose just modestly, alleviating any inflation fears. On the negative side, final first quarter gross domestic product (GDP) was revised lower to 2.2% from 2.3% and pending home sales in April were less than expected due to higher mortgage rates and rising home prices.

The Federal Reserve’s Beige Book showed that every region of the country performed well as manufacturing was strong, loan demand by banks was high and home builders were busy. It also stated that inflationary pressures were modest and that economic growth could top 3% in the second quarter.

For the week, the Dow Jones Industrial Average fell 0.5% to close at 24,635 while the S&P 500 Index added 0.5% to close at 2,734. The Nasdaq Composite Index jumped 1.6% to close at 7,554.

This Week

It will be a slow week for important economic data as April factory orders are expected to decline after posting a strong reading in March and the Institute for Supply Management (ISM) reports its non-manufacturing or services sector index for May.

The G7 summit begins Friday in Quebec and President Trump meets with Japanese Prime Minister Shinzo Abe to discuss North Korea and dismantlement of its nuclear, chemical and biological weapons and ballistic missile programs.

In a very quiet week for corporate earnings reports, Broadcom, Verifone Systems, JM Smucker, Vera Bradley and Casey’s General Stores are the most prominent companies on the agenda.

Portfolio Strategy

The surprisingly strong May employment report signals that the U.S. economy has a lot of momentum as it heads into the second half of the year. Despite first quarter growth that barely exceeded 2%, the balance of the year appears to be solid as economic fundamentals point to accelerated growth and an even stronger economy. In addition to the positive jobs report. both the ISM manufacturing index and construction spending were also much better than expected. The Atlanta Federal Reserve currently forecasts that GDP growth in the second quarter will approach 5%. Even though their forecast was overly optimistic in the first quarter and much higher than it turned out, many economists are predicting second quarter growth of between 3.6% and 4.8%. The strong job gains coupled with the jump in consumer confidence and increase in average hourly earnings should translate into higher levels of consumer spending, which accounts for about two-thirds of all economic activity. News last week that tariffs were being imposed on Europe, Canada and Mexico understandably sent shock waves through the market as they might retaliate, which could ultimately lead to a trade war. While exports comprise a relatively small part of the U.S. economy, companies in the S&P 500 generate over 40% of their sales overseas. For this reason, it is hoped that cooler heads will prevail and that any tariffs imposed now will be used as a negotiating tool and not to spark a full-blown trade war.