Stocks post modest gains as economic data mostly positive

We don’t prognosticate macroeconomic factors, we’re looking at our companies from a bottom-up perspective on their long-run prospects of returning. – Mellody Hobson, President and co-CEO of Ariel Investments

In the holiday-shortened week, all three major stock averages closed modestly higher as economic data was mostly positive and contributed to investor optimism about the economy reopening. Both the Dow Jones Industrial Average and the S&P 500 Index finished the month of May with gains, marking their fourth consecutive positive month while the small cap Russell 2000 Index rose in May for the eighth straight month. Only the technology-heavy Nasdaq Composite Index posted a loss in May. With nearly all of the S&P 500 companies having reported first quarter earnings, the results have been excellent with over 80% of them beating analysts’ estimates with gains in excess of 50%. Many of these same companies have also revised their earnings estimates higher for the second quarter. The most important piece of economic data last week was the May employment report, which showed that 559,000 new jobs were created and that the unemployment rate fell to 5.8% from 6.1%. While the number of jobs was less than the 670,000 that was expected, it was up significantly from only 266,000 jobs in April. In a way, it was a Goldilocks report for the economy as it was not too hot to cause the Federal Reserve to consider tightening its monetary policy nor too cold to cause concern about the economic recovery. There was a big jump in average hourly earnings compared to April, though, which could be problematic for inflation if the trend continues in subsequent months. The Federal Reserve’s Beige Book, a survey of current economic conditions in each of the 12 Fed districts, was also released and it said that the economy was growing faster in April and May than earlier in the year. Consumer spending picked up as more people became vaccinated and manufacturing activity improved despite supply chain disruptions. But the Fed noted that inflation pressures were building as prices moved higher and that the government’s extended jobless programs were responsible for workers not accepting jobs. At the moment, the positives of the economy reopening seem to outweigh the negatives of higher inflation and the possibility of higher interest rates, which has helped boost stock prices.

Last Week

The ISM manufacturing index in May was slightly better than expected and rose for the 12^th straight month even though companies and suppliers continue to struggle to meet increasing levels of demand due to shortages of basic materials and rising commodity prices. The ISM services sector index  in May was also better than expected and at the highest level ever recorded due to pent-up demand for service-related businesses. Other jobs data last week was better than forecast as ADP reported that private payrolls increased by 978,000 in May versus estimates of 680,000 and weekly jobless claims fell to 385,000, the first time they were below 400,000 since March 2020. April construction spending was less than expected while April factory orders were also worse than anticipated as a global semiconductor shortage weighed on the production of automobiles, electrical equipment and appliances.

For the week, the Dow Jones Industrial Average rose 0.7% to close at 34,756 while the S&P 500 Index added 0.6% to close at 4,229. The Nasdaq Composite Index gained 0.5% to close at 13,814.

This Week

The consumer price index (CPI) for May is expected to be higher than in April, which was at the highest level since the summer of 2008. The University of Michigan consumer sentiment index is forecast to be about even with the reading in May.

The European Central Bank (ECB) announces its monetary policy decision and is widely expected to keep its short-term interest rate at negative 0.5%.

With first quarter earnings season essentially over, the most prominent companies on the agenda this week are Casey General Stores, Campbell Soup, Vera Bradley, Brown-Forman and Vail Resorts.

Portfolio Strategy

This week promises to be very slow as only a handful of companies are scheduled to report quarterly earnings and there is little in the way of economic data on the calendar. The highlight of the week will be inflation data in the form of the May consumer price index (CPI), which will be closely watched even though it is not the Federal Reserve’s preferred measure of inflation. It jumped in April and expectations are for an even bigger increase in May as supply disruptions and shortages of materials has caused demand to rise and prices to increase. Up until now, the Federal Reserve has maintained that this inflationary spike will be transitory and that prices will settle down later in the year. The next Fed meeting is scheduled for June 15^th and 16^th and a surge in the consumer price index could make officials reconsider their current monetary policy. Last week the Fed announced that it would begin selling corporate bonds that it purchased during the worst days of the pandemic, but the stock market took the news in stride and barely reacted. A further reduction in its monthly bond buying program could ensue which might lead to an increase in the federal funds rate, which is not expected by the market until 2023. Contributing to the increase in inflation has been a surge in oil prices as West Texas Intermediate closed last week at its highest level since 2018. While OPEC has begun to return to normal oil production, demand has continued to rise as global economies recover from the pandemic. With air travel picking up and people hitting the road for summer vacations, demand for gasoline is only going to increase, causing gasoline prices to rise further unless production is ramped up to meet demand. Any change in the Fed’s view of inflation that causes it to tighten its monetary policy could be a negative for the stock market.