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Stocks mixed on strong jobs report, higher interest rates

Regardless of what happens in the markets, stick to your investment program. Changing your strategy at the wrong time can be the single most devastating mistake you can make as an investor. – John Bogle

It was a tale of two markets last week as the technology-heavy Nasdaq Composite Index dropped about 2% on rising interest rate fears while the more economically sensitive Dow Jones Industrial Average gained nearly 2% and the broader S&P 500 Index was modestly higher. It was the third straight losing week for the Nasdaq as higher priced growth stocks are more vulnerable to higher rates. The yield on the 10-year Treasury seemed to have stabilized around 1.45% early in the week but a stronger than expected February employment report released on Friday caused the yield to rise above 1.60% before settling at 1.55%. Stocks rallied on the news with all three major averages in the green but the recent worrisome trend of higher interest rates has been negative for the stock market. In fact, a good news is bad news theme has been emerging as higher interest rates on expectations of stronger economic growth have led to weaker stock prices. Federal Reserve Chairman Jerome Powell did not seem to be concerned over the increase in interest rates. At a Wall Street Journal event, he commented that while he expects inflation to rise as the economy reopens, the increase should be temporary and not enough to alter the Fed’s accommodative monetary policy. He also said that he doesn’t expect the economy to reach full employment this year or for inflation to hit its 2% target on a sustainable basis. For this reason, the Federal Reserve is not likely to raise interest rates for the foreseeable future. With regard to vaccines, the news continued to improve. The Food & Drug Administration (FDA) approved the Johnson & Johnson Covid-19 vaccine and a deal was reached with Merck to help produce it. There is a good chance that by the end of May, there will be enough coronavirus vaccines available to inoculate every adult in the country. This news coupled with the likely passage of another $1.9 trillion fiscal stimulus bill could result in the best economic growth in a long time as the U.S. slowly recovers from the pandemic.

Last Week

As mentioned above, the February employment report was much better than expected with 379,000 new jobs created compared to estimates of 200,000 while the unemployment rate dipped to 6.2% from 6.3% in January. Although the report was positive, the jobs market is still a long way from recovering fully with millions of workers still unemployed. Earlier in the week, ADP reported that private companies added only 117,000 new jobs, well below expectations, and weekly jobless claims totaled 745,000, slightly below estimates. The ISM manufacturing index in February rose to its highest level in three years as new orders surged while the ISM non-manufacturing or services sector index was less than expected and below the level in January, but still solidly in expansion territory. Construction spending in January was much better than expected, spurred by cheaper mortgages and a migration to the suburbs due to the pandemic.

The Federal Reserve Beige Book showed that the U.S. economy expanded modestly with businesses optimistic about the rest of the year as Covid -19 vaccines become available.

For the week, the Dow Jones Industrial Average gained 1.8% to close at 31,496 while the S&P 500 Index added 0.8% to close at 3,841. The Nasdaq Composite Index declined 2.1% to close at 12,920.

This Week

Both the February producer price index (PPI) and the consumer price index (CPI) are expected to increase moderately but the core inflation readings that exclude food and energy are forecast to show only modest increases. The preliminary March University of Michigan consumer sentiment index is expected to be higher than in February as consumers become more optimistic about the prospects for an economic recovery.

The European Central Bank (ECB) announces its monetary policy decision and is expected to keep its benchmark interest rate unchanged at negative 0.5%, even though yields have risen on the expectation of stronger economic growth.

The most prominent companies scheduled to report quarterly earnings this week are Oracle, Docusign, H&R Block, Casey’s General Stores, Ulta Beauty, Dick’s Sporting Goods and Campbell Soup.

Portfolio Strategy

With the Senate approving the $1.9 trillion fiscal stimulus package over the weekend, it’s a foregone conclusion that the bill will be approved by the House this week. While such a massive spending bill will almost certainly help the economy and benefit the stock market, it also could fuel inflation fears and cause interest rates to rise. The strong February employment report released on Friday was good news for the economy but bad news for yields as the 10-year Treasury yield touched 1.61% before ending the day at 1.55%. Rising interest rates are a negative for high-priced growth stocks but the technology-heavy Nasdaq Composite Index managed to rebound strongly despite these higher yields. That could be viewed as a short-term positive. Inflation data for February to be released this week is likely to be benign but the pace of inflation will probably increase over the next few months compared with this time last year when the economy was shut down due to the pandemic. Investors also have to ask themselves if another huge stimulus bill on top of the one just passed in December is necessary and could overheat the economy and lead to higher inflation and higher interest rates. Current levels on the 10-year Treasury are not as much of a concern as the speed at which they got there, having started the year below 1.0%. The movement of the 10-year Treasury yield will likely dictate the direction of the stock market over the near-term and result in choppy trading and consolidation of stock prices.